Yale’s Robert Shiller used his occasional Sunday New York Times column this week to dive deeper into the risk sharing issues at hand in the debate about public employee pensions. As I mentioned in a previous post, the idea of pensions as a risk sharing device is probably a fruitful line to pursue. Shiller hardly moves the ball, but the mere fact that someone of his stature and insight picked it up at all is encouraging.
En route, Shiller mentions a paper by Henning Bohn of UC Santa Barbara. Two things to note about that paper… First, it’s less about risk sharing and more about arbitraging financial frictions. I suppose the two are closely related, but they sure sounds distinct. Second, and more importantly, Bohn’s paper is about the right level of funding for pension plans, and in no way takes a stand on the right valuation of the existing liabilities. Bohn’s claim is something like this: one should underfund a $100 liability by putting aside only $60. But even if you give him this point, that isn’t the same thing as saying that at $60 the pension is fully funded. The liability is still $100, and Bohn’s paper doesn’t contest that. He’s just saying it’s ok to underfund. As mentioned in my earlier post, these are two distinct points.
Shiller ends the column with a plug for an idea he has been hawking for a while, GDP linked bonds. The idea sounds exactly right. But it hasn’t taken off–yet. Perhaps it will soon. Or perhaps the mechanics are just infinitely more difficult than it sounds like at first. Pensions and risk sharing and financial innovation are a hugely complex topic. The time scales are long and the actors involved encompass the whole body politic–born and yet to be born. Moreover, the issues to be settled are so vast that it is difficult to imagine any narrowly crafted contract — and all financial contracts are narrowly crafted, unlike a ‘social’ contract — could adequately express and delineate whatever consensus was achieved. This is where an attempt to address the problem from a purely technocratic, financial perspective, as Shiller’s proposed GDP bonds purport to do, is bound to miss the mark by a mile.