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If you’ve played Jenga, the wooden tower game, you know that if you remove one of the finger-length timbers from the top of the tower, you’re safe. But if you remove a timber from the lowest, most fundamental layer, the tower collapses. Game over.

Over the past week or so, a comment by Donald Trump about offering to buy back U.S. Treasuries from supposedly anxious debt holders has sparked a fresh round of debate about the federal debt and deficit. (I’m not sure what Trump said; often, instead of Trump’s own words, we hear a reporter’s riff on something that the presumptive Republican presidential nominee said.)   

Distortions notwithstanding, the comment seemed to refer to printing dollars to buy back Treasuries at a discount. Trump was said to have suggested that the U.S. should offer debt holders less than 100 cents on the dollar for Treasuries—a partial default that creditors would presumably prefer to a complete default.

The media treated it like a real possibility. A Bloomberg TV reporter asked Randall Wray of Bard College, a noted Post-Keynesian economist and interpreter of the work of Hyman Minsky, if such a move could lead to hyper-inflation a la the Weimar Republic of the 1920s, when it took wheelbarrows full of Reichsmarks to buy a loaf of bread. Wray started to explain, but ran out of time.

Let me count the ways that these reports about a Treasury default, and what Trump said (if he said it), don’t make sense.

The owners of Treasuries, foreign and domestic, obtained them with dollars. The dollars were spent into the U.S. economy. Presumably the money was put to good use, and generated profits at a rate higher than the Treasury coupon. (If it didn’t, we wasted an opportunity.) As a country, we can afford to buy back our debt.   

Treasuries are among the world’s most liquid paper, almost the same as cash. Anyone who holds Treasuries today can easily convert them to cash. The prices of Treasuries are at an all-time high; their actual and perceived risk is at an all-time low. If Treasuries were hard to sell—if they were illiquid, like mortgage-backed securities during the financial crisis—the government might in theory have to intervene and bail itself out by exchanging one kind of Federal Reserve Note (cash) for another (bills and bonds). But that’s not a big problem. A country whose debt is denominated in its own currency can always do that. 

U.S. money, and U.S. bonds, which is U.S. money that pays interest, will be popular for as long as people all over the world want to buy stuff that dollars buy. And they will, for a very long time. Among the expensive things that Chinese families want to buy, for instance, are college educations for their young people in places like Cambridge, Mass. and Palo Alto, Calif. They also want our equities, and McMansions in Texas, and lots of other dollar-denominated assets. Like oil.

Now, back to the Jenga analogy. Treasuries are the bottom row of the financial Jenga pile. If Treasuries somehow became risky—if the price fell and the yield rose—then the prices of all of the other securities that are by definition riskier than Treasuries would lose even more of their value. Any sort of debt that’s collateralized or backed by U.S. Treasuries—including the currencies of other countries—would drop in value and require fresh capital.

That would require the liquidation of other securities, which would cause the Mother of All Financial Crises. Soft Treasury prices would be the least of our problems. In fact, you’d see a flight to Treasuries, as we saw in 2008.  To talk about U.S. Treasury bonds as casually as if they were the dispensable top-timbers on a Jenga pile, when they actually comprise the indispensable bottom tier, is ridiculous. A president who indulges in such fantasies would be dangerous.

© 2016 RIJ Publishing LLC. All rights reserved.

RIJ’s cover story this week describes “auto-portability.” This is a newly conceived process, based on a repurposed bit of financial technology, that would automatically consolidate your old “stranded” 401(k) accounts into your active 401(k) account, assuming you have one. 

If it were practiced universally, auto-portability could rescue old accounts from the dead letter office of the retirement system and forward them to a participant’s latest address. This would improve the current non-system, which encourages people to cash-out small accounts and squander the money on, stereotypically, flat-screen smart TVs.  

The UK has taken a stab at DC account consolidation, but the effort has been a victim of politics and industry opposition. Last year the British authorities proposed instituting a policy called “pot-follows-member.” It would make sure retirement accounts follow people from job to job. But there’s no British counterpart to our rollover IRA, which is essential to the process.

The British out-do the US in one aspect of their defined contribution system, in my opinion. Their form of tax-deferral is arguably better than ours. When a DC plan participant in the UK contributes to a tax-deferred plan, the government adds the participant’s “tax relief” to his retirement account.

To understand this, you have to look inside a paycheck. Assume that a hypothetical Briton has a £5,000 monthly salary and a 25% income tax rate. The government withholds £1,250 in taxes each month. If he contributes 10% of pay (£500) to a DC plan, the government credits 10% of his tax (£125) to his plan account. His plan balance after one month is £625. His take-home pay is £3,250.

In the U.S.—please correct me if I’m wrong about this—it works differently. Assume that a hypothetical American has a $5,000 monthly salary and a 25% income tax rate. If he contributes 10% of pay ($500) to a DC plan, the federal government withholds $1,125 in tax on the remaining $4,500 in his paycheck. His savings balance after one month is $500. His take home pay is $3,375.

The Briton saves 25% more each month than the American. The difference in savings adds up to a lot over the hundreds of months in a work-life. Ignoring investment gains or losses, the Briton in my example saves £7,500 in the first year;  the American saves $6,000. Over a lifetime of tax-deferred saving and compounded returns, the Briton will end up with a lot more savings than the American.

How much more? I consulted two well-known retirement experts about the best way to calculate the difference in long-term results. It’s not very complicated, said Wade Pfau of The American College.  If the U.S. DC system switched to the British method of tax-deferral, participants in American would save 1 x (1 + 0.25 tax rate) as much as they do now, or an additional 25%. In my hypothetical, that would mean an extra $110,000 or so for the American retiree if he saves for 35 years and has a 4% rate of return. (For simplicity, we’re ignoring inflation, etc.)

Alternatively, Moshe Milevsky of York University suggested that if Americans kept their current system but chose to invest their tax savings in their tax-deferred accounts (and invested the tax savings on the reinvestment of the initial savings), they would save 1/(1 – 0.25 tax rate) as much as they do now, or an additional 33%.

Somewhere, the gods of behavioral finance must be howling with laughter, or in frustration. Both participants chose to contribute 10% of pay to their DC accounts, but one of them has significantly more savings at retirement. It means that changing the design of our system could, without asking participants to change their habits or preferences, make millions of Americans much more secure in retirement.

As a nation, the Britons are at different stage in their transition from defined benefit pensions to defined contribution pensions. And the process isn’t going very smoothly, according to what I read at IPE.com. But I admire the way they designed their tax-deferred savings system. By comparison, our method endows us with tax-deferred growth, but lets the tax savings on contributions slip away. (Another attractive feature of their system: retirees can withdraw 25% of their tax-deferred savings tax-free.)

The British system may have another advantage, although it’s difficult to quantify. Their policies might produce a greater sense of shared purpose between the public and the government regarding retirement savings. If Americans saw their government, in effect, contributing directly to their retirement accounts, the government’s demands for minimum taxable distributions at age 70½ might not seem so perplexingly intrusive. 

I think we can agree that our retirement system offers many opportunities for improvement. We change jobs frequently and cash-out or leave unvested employer matches on the table; we may drop out of the system entirely for a few years here and there; our employers don’t always offer plans, let alone matching contributions; fees can reduce our rate of return by 25% or more over a lifetime; volatility slows down the accumulation process; taxes come due during retirement; and we’re prone to dumb investing mistakes along the way. With so many pitfalls along the road to a well-funded retirement, it might help if the system defaulted us into saving, not spending, the tax break on contributions. 

© 2016 RIJ Publishing LLC. All rights reserved. 

Part of the debate over the Department of Labor’s fiduciary rule and the related debate over “robo” financial advice has focused on investor behavior during periods of extreme market volatility—like the ones we all endured back in 2008-2009.

Critics of the fiduciary rule argued that it would eliminate commission-based advisors. And skeptics of digital advice predicted that, if it replaced advisors and brokers, middle-class investors wouldn’t have any options (other than, say, to a Vanguard or Fidelity phone rep) when the VIX spiked and they needed someone to talk them out of dumping equities.

These arguments puzzled me, because I thought that ordinary savers—retirement plan participants, for instance—were more inclined to inertia than panic during market upheaval. It was all the more puzzling because I also assumed that rich people—the upper 5%—are too smart to sell in a panic. On the contrary: I assumed they were scooping up bargains (as did the Sage of Omaha back in 1975).

But if both those assumptions were true, then who is responsible for the panicky selling? In a new research paper, entitled “Who Sold During the Crash of 2008-2009? Evidence from Tax Return Data on Daily Sales of Stock” (NBER W22209), a group of Big Ten economists and an IRS analyst say that wealthy people and older people are the most likely to sell in scary market downdrafts.    

Older people, I can understand. Wealthy people? That’s somewhat surprising. It contradicts the conventional wisdom that they have financial advisors who can pull them away from the TV and Internet and calm them down. 

The jittery ‘one percent’

But no. “We find that, starting in September 2008, the share of sales volume attributed to the top 0.1% of income recipients rises sharply until the beginning of 2009. More generally, we find that high-income taxpayers have a greater propensity to sell during periods of market tumult,” the six authors of the study wrote. Four were economics professors at the University of Michigan, one was an Ohio State University economist, and the sixth works for the Internal Revenue Service.

“Sales volume rises much more strongly with lagged VIX changes for the top 95-99, 99-99.9, and 99.9-100 income percentiles than for other income groups over the period 2008 to 2009,” they continued. The same was true for people over age 60. “In multi-dimensional analysis, both high income and age over 60 are associated with a strongly positive sales volume-VIX relationship, as are income and receipt of Social Security income.”

High-net-worth and older investors were more likely to sell equity mutual funds than individual stocks. They weren’t more likely to sell financial stocks than other stocks, but they were less likely to sell consumer-durable stocks than stocks in other sectors. While high wealth levels tend to overlap with higher ages, the researchers saw separate effects for age and income.

“Younger high-income investors were also selling much more than younger, lower-income investors,” co-author Daniel Reck of the University of Michigan told RIJ in an email. “Basically, we see strong relationship between age and crisis sales at all income levels, and also a strong relationship between income and crisis sales at all age levels. So we conclude that the income relationship isn’t driven purely by the fact that high-income investors are older.”  

“Other aspects of investors—gender, marital status, region and state of residence, presence and amount of a mortgage interest deduction, and 2007 zip-code-level house price growth—are not related to the volatility sensitivity of stock sales,” the paper said.

The study was based on data from federal tax returns with the names removed. The economists matched asset sales reported for capital gains taxation purposes with some demographic information on each taxpayer. Asset purchases were identified indirectly, from dividend receipts and a supplementary brokerage account data set “suggesting that individuals with high levels of gross sales are also, to a substantial extent, net sellers of stocks,” the authors wrote.

The study didn’t cover trading in tax-deferred accounts, such as IRAs and employer-sponsored retirement plans, because it was based on IRS data and trades in tax-deferred accounts don’t leave a tax trail.

Reasons for selling

The tendency of high-income investors to sell in high-volatility episodes, the authors wrote, could exist because:

• They tend to pay greater attention to their portfolios. 
• They perceive themselves better able to time the market.
• They are more likely to own stocks on margin, which potentially multiplies their losses.
• They blame their money managers for stock market losses and withdraw their funds in response.
• They lose trust in financial intermediaries in response to market turmoil.

“Some investors may be forced to sell due to constraints on their risk-bearing capacity (e.g., leverage constraints, liquidity shocks), some may be less tolerant of short-run risk than the average investor (e.g., close to retirement), some may perceive themselves to be better informed than others and anticipate a further price decline, and some investors may lose trust in the stock market altogether and perceive it as a rigged game,” the paper said.

“Individuals trading in mutual funds as opposed to individual stocks are likely more risk-averse and thus more prone to reduce the risk in their portfolios during the crisis by moving their wealth from mutual funds to something safer. Mutual fund investors could also be less confident in their own ability to pick winning stocks, which could make them more likely to sell off in tumultuous times than investors who are confident enough to pick individual stocks.”

The researchers added, “The greater sensitivity of older investors is consistent with the idea that investors close to retirement (with less opportunity to make up losses through future labor income) should be particularly sensitive to a perceived rise in risk.”

The researchers couldn’t rule out the possibility that plan participants and IRA owners were trading just as frequently as the top 5% during volatile markets. They noted that high-income and older people hold a higher share of their wealth in taxable accounts “perhaps due to the limits on contributions to tax-deferred retirement accounts. The same is true of older individuals.” Overall, the researchers found it easier to understand why older people sell in choppy markets than to understand why the wealthiest do.

The authors of the paper included Jeffrey Hoopes of Ohio State University, Stefan Nagel, Daniel Reck, Joel Slemrod and Bryan Stuart of the University of Michigan, and Patrick Langetieg of the IRS.

© 2016 RIJ Publishing LLC. All rights reserved.