A mismatch not made in heaven

Assets & liabilities: a mismatch not made in heaven

Richard L. Kauffman

If interest rates and stock market returns remain low–and the question is how low–there’s a big problem looming for the global economy. Without resorting to melodrama, this apparently prosaic issue could represent one of the biggest policy challenges of the next generation.

The Fed and other central banks have lowered interest rates to encourage consumers to spend and businesses to invest to stimulate the economy. But we must look at the other side of the ledger: as rates go down, the value of fixed liabilities goes up. For some years now, investors have increased their debt load assuming that their investment returns would provide the necessary funds to repay the loans. Put differently, you are going to sleep a lot easier if you owe $10,000 in ten years if you are investing your money at 10% than if you are earning 2%.

The combination of low interest rates and low stock market returns creates a double whammy: the degree of liabilities goes up and the value of assets is inadequate to generate enough returns to service the liabilities. Liabilities for our society are everywhere: people need to retire, to put their children through school, to purchase homes. And then there are the liabilities that are held by banks and insurance companies, by governments and by individual investors, such as margin and mortgage debt.

Bluntly stated, if the current combination of low interest rates and low returns continues, there’s a tidal wave of asset-liability mismatch headed our way. In the US, many households relied on 401 (k) stock accounts and rising home prices as a source of savings and relied on these savings to take on increasing amounts of debt. Credit card debt has tripled in the last decade, now amounting to over 15% of household income. With this level of debt and a reduction in stock prices, it is no wonder that observers question whether consumers can spend the economy out of recession.

How to get out of the asset-liability “mismess”? The best answer, of course, is if government stimulus succeeds and returns increase. But we must ask the question, what if such medicine fails to work? There are other answers, some of which are not pretty: Retire later. Or aren’t people entitled to retire, or must they work until death? Save more. In the short term, increases in savings will come from reducing consumption and with it economic growth. But will we be the Depression Generation Redux telling our grandchildren to be thrifty? Or greater government intervention. If markets don’t seem to work and individuals can’t save enough, will government enforce savings? And how will that be funded?

Asset-liability mismatch. It is a prosaic term. But it could be a big problem you’ll be hearing more about.

This article does not provide individually tailored investment advice and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. It was based on public information, and Morgan Stanley makes no representation that it is accurate or complete. Investments and services offered through Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., members SIPC, Morgan Stanley and One Client At A Time are service marks of Morgan Stanley.

Richard L. Kauffman

Vice Chairman of Institutional Securities

COPYRIGHT 2003 CFO Publishing Corp.

COPYRIGHT 2008 Gale, Cengage Learning