Gary Trennepohl presents "Financial Markets in 2013" during Reynolds Business Journalism Week 2013. Reynolds Business Journalism Week is an all-expenses-paid seminar for journalists looking to enhance their business coverage, and professors looking to enhance or create business journalism courses. For more information about business journalism training, please visit businessjournalism.org.

1. Financial Markets in 2013:
Where are the Stories?
Strictly Financials
Saturday
January 5, 2013

2. Donald W. Reynolds National Center
for Business Journalism
at Arizona State University
Strictly Financials 2

3. n Gary Trennepohl, Ph.D.
n ONEOK Chair and President’s Council Professor of Finance
n Oklahoma State University
n Trustee, Oklahoma Teachers Retirement System
n Member, OSU Foundation Investment Committee
n gary.trennepohl@okstate.edu
Strictly Financials 3

4. Major Economic Themes for
2013
THE EVOLVING STORY OF “THE FINANCIAL CLIFF”
AND REVISING THE U.S. TAX CODE
SOCIAL SECURITY AND MEDICARE
HOW UNDERFUNDED ARE PUBLIC WORKERS’
PENSIONS?
SURVIVAL OF THE “EURO” AND THE EUROZONE
Strictly Financials 4

5. What is the “Fiscal Cliff”?
n The Mix of Expiring Tax Cuts and
Spending Reductions that, if we go over
the cliff, could lead to a “double dip”
recession.
Strictly Financials 5

6. Why Something Must Be Done
n The economy is weak, so any reduction
in demand it is feared may lead to a
“double-dip” recession.
n However, federal, public and private
debt is at historic levels – we are
borrowing more than is prudent.
n So, should we increase taxes and
reduce spending in a weak economy?
Strictly Financials 6

7. Strictly Financials 7

8. Strictly Financials 8

9. Strictly Financials 9

10. Automatic Spending Cuts
n Directed reductions that begin on
January 2, 2013, of $1.2 trillion over 10
years.
n Federal spending cuts:
n Defense $55bn in 2013 (a 10% cut to every program.)
n Other - $55bn (an 8% average to every program.)
Strictly Financials 10

11. Bush-Era Tax Cuts Expire
n Income Tax Rates Rise
n Will be: 15%, 28%, 31%, 36% and 39.6%,
n Up from 10%, 15%, 25%, 28%, 33% and 35%.
n Capital-Gains Rate Rises–
n Increase from 15% to 20%
n Dividend Tax Rate –
n Increase from 15% to ordinary income rate
n Other tax credits reduced or eliminated
Strictly Financials 11

12. Others
n Payroll taxes back up to 6.2% from 4.2%
(This funds Social Security system).
n Unemployment-benefits extension expires.
n Medicare-payment rates to physicians drop by
27%. (Congress has repealed this
requirement every year since it was passed.)
n New Medicare surtax of 3.8% on individuals
with AGI above $200,000, on all income.
Strictly Financials 12

13. Potential Calendar-Year Fiscal
Impact, 2013 (in $bn)*
n Discretionary-spending caps $ 84 Most Impact
n Health-care law taxes 21 .
n Payroll-tax cut expires 116 .
n Bush tax cuts for “wealthy” expire 45 .
n Bush tax cuts for others expire 150 Impact
n Tax extenders expire 30 .
n Extended jobless benefits expire 25 .
n Physician payment cut 20 .
n Alt. min. tax not patched 94 Least Impact
Total $670
(“The Economist, Nov 10-14, 2012)
Strictly Financials 13

14. MAKING SENSE OF THE TAX
ISSUES
Congress also will be considering a major
tax overhaul. Here are some “tax
expenditures” that have been mentioned
for reduction or elimination.
Strictly Financials 14

15. “Tax Breaks Under Fire” and
Their 2012 Costs1
n Health Care – employer-provided insurance
and Medicare: $201B
n Savings Incentives – 401Ks, IRAs, defined-
benefit plans: $135B
n Mortgage-Interest Deduction $ 84B
n Dividends and Capital Gains $ 93B
n Charitable Donations $ 40B
n State-Tax Deductions $ 47B
Laura Saunders, WSJ, Weekend Edition, Nov 8-9, 2012
1
Strictly Financials 15

16. Tips for Following this Story
n Be careful of your emotions versus the
“facts” of the stories.
n People usually form their opinion about
tax policy based on their personal
situation – “Don’t tax me and don’t tax
thee; tax the one behind the tree!”
n Educate readers about the public policy
implications of tax policy.
Strictly Financials 16

17. Story Ideas:
n Does your community have Department
of Defense installations?
n Is your state a net “giver” or “taker”
regarding federal taxes and payments?
n Do you live in a high-tax or low-tax
state? – Changes in tax laws will impact
communities differently.
Strictly Financials 17

18. WILL SOCIAL SECURITY AND
MEDICARE BE YOUR SECURITY?

19. Social Security and Medicare:
The Looming Political Crisis
n Social Security (taxes paid on income up to
$113,700 in 2013).
n Provides retirement benefits for a worker and his/her spouse
to the second death
n Provides disability benefits to injured workers regardless of
age
n Provides survivor benefits to widows and eligible children to
age 19 (or 22).
n Medicare (tax paid on total income)
n Provides hospital insurance at age 65 and above
n Don’t forget to register before you turn 65!
Strictly Financials 19

20. FAQs Regarding the SSA
n How much can I earn and still receive
benefits?
n After reaching full retirement age (FRA), your SS benefits
will not be reduced, but…
n If your income is over $44,000 (joint), 85% of benefits will
be taxable.
n At what age should I start taking Soc Sec
benefits – 62 years, 66 years, 70 years?
n Also, keep in mind that SSA and Medicare are independent
decisions. You have to sign up for Medicare at 65, but you
don’t have to start drawing SS benefits.
Strictly Financials 20

21. Social Security Myth 1
n “There’s a lockbox that keeps and invests the
FICA taxes you pay.” No, not really
n Taxes paid by current workers are used to pay the benefits
of current retirees. You don’t have an individual account
with your money in it, just a ledger balance at the SSA.
n Surpluses are deposited in the “Social Security Trust Fund,”
which then buys non-marketable U.S. government bonds.
In reality, this goes directly to fund the federal deficit.
Strictly Financials 21

22. Current Status of Social Security
Trust Fund (from the 2011 Social Security Trustees Report)
n In 2010, Social Security costs exceeded
income from payroll taxes for the first time.
n Recession reduced payrolls.
n Baby boomers started to retire. (We already know this –
they’ve been around for 65 years.)
n After 2012-14, costs will exceed income, so
interest payments from trust fund will be
needed to fund payments.
n After 2022, taxes and interest will be
insufficient so the trust fund corpus will have
to be used to fund benefits.
Strictly Financials 22

23. What About the Trust Fund?
n In 2036, the trust fund will be exhausted.
n But, yearly payroll taxes could still pay about 75% of current
benefits.
n Assuming no new legislation, the “replacement
rate” (Social Security benefits/pre-retirement
earnings) would drop from 41% today to 36% in
2036 to 29% in 2037.
n If payroll taxes immediately were raised by 1.92%,
(i.e.. .96% each for worker and employer), the 41%
benefit level could be maintained to 2086.
Strictly Financials 23

24. Social Security Myth 2
n “I don’t count on Social Security because it
will be broke when I retire.” Not True.
n This is a legal obligation of the U.S. government,
which it really cannot choose not to pay.
n Do you really think the government can renege on
its promise to pay your benefits that you have
already paid for?
n What if your employer decided it was not going to
pay your retirement benefits that you had been
promised?
n A politically explosive issue
Strictly Financials 24

25. What Should Congress Do?
n Increase SS retirement age?
n Originally set at 65 in 1935, but life expectancy has
dramatically increased.
n Increase income tax on SS benefits?
n Currently, if your taxable income exceeds $44,000 (joint),
85% of SS benefits become taxable.
n Uncap the wage level for payroll taxes (set at
$113,700 for 2013)?
n Medicare taxes currently are uncapped
n Increase the payroll tax?
n By 1.96% total as shown earlier
Strictly Financials 25

26. What About Medicare And
New Health-Care Legislation?
n The real economic issue is spending on health
care.
n Future Social Security benefits/costs can be
mathematically determined, so it becomes a
political problem to solve; medical costs
cannot be estimated with any accuracy.
n The real cost and impact of the “Affordable
Care Act” is a great uncertainty.
Strictly Financials 26

27. Mandatory Spending Since 1962
Figure 2. Components of Mandatory Spending
As a Percentage of Federal Spending (FY1970-FY2022)
80%
Other Health Programs
70%
60%
Percentage of Total Outlays
50%
Other Mandatory
40% Other Retirement and Disability Medicaid
Income Security
30% Medicare
20%
Social Security
10%
0%
70 972 974 976 978 980 982 984 986 988 990 992 994 996 998 000 002 004 006 008 010 012 014 016 018 020 022
19 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2
Fiscal Year
Source: Offsetting receipts are excluded. CRS calculations based on data from CBO, Historical Tables and Budget
Projections. CBO baseline projections depicted to the right of the vertical line.
Notes: CBO added the category “Other Health Programs” to its Budget Projections data following the enactment
of PPACA and HCERA. This category includes Health Insurance Subsidies, Exchanges, and Related Spending,
MERHCF, CHIP, and Other health spending. Prior to PPACA and HCERA, MERHCF and CHIP were included in
Source: Congressional Research Service, March 12, 2012
the “Other Mandatory” category.
In an effort to reform the private insurance market and expand health insurance coverage to the 27
Strictly Financials
uninsured as federal spending on health care increases, the Patient Protection and Affordable Care
Act (PPACA; P.L. 111-148) and the Health Care and Education Reconciliation Act of 2010
(HCERA; P.L. 111-152) were signed into law on March 23 and March 30, 2010, respectively.13

28. Strictly Financials 28

29. Information about Social
Security and Medicare
n Center for Retirement Research at
Boston College. http://crr.bc.edu/
n List of publications at:
http://crr.bc.edu/social_security/social
%2520security%3bbriefs.html
Strictly Financials 29

30. Story Ideas
1. Do your readers believe that Social Security will pay
them retirement benefits?
2. Do they favor changes to the system that will ensure
its survival – (1) increase retirement age, (2)
increase taxes, (3) increase taxable wage base?
3. How does Social Security fit in your retirement
planning?
Strictly Financials 30

31. WILL THE COMING CRISIS
IN PUBLIC PENSION PLANS
AFFECT YOUR COMMUNITY?
Strictly Financials 31

32. Grabbing Headlines
n Series by Craig Harris in the Arizona Republic,
2011,”Pension Funds in Arizona Facing Bleak Future”.
n “U.S. Public Pension Plans are Different (and Not in a
Good Way!” Jeffrey Brown, Forbes, June 11, 2012.)
n “New Rules may make Public Pensions Appear
Weaker,” Reuters.com; June 25, 2012.
n An officer earning $150,000/year will retire earning
$140,000/year for the rest of his/her life, for a total
benefit of $5.9 million (to age 85).
Strictly Financials 32

33. Two Principal Types Of
Pension Plans
Strictly Financials 33

34. Defined-Benefit Plans
n Employer assumes obligation to pay retirement
benefits defined by formula.
n Retirement benefits determined by a
calculation:
n e.g. = (years of service*2%*avg. 3 yrs. of highest
salary)
n Most public pension plans are of this type.
n Market risk is carried by the state sponsor, and the
investments are professionally managed.
n No asset available to transfer to heirs.
n $4,357 billion of assets in DB plans (as of Sept. 30, 2009)
Strictly Financials 34

35. Defined-Contribution Plan
n Employer assumes only obligation to pay yearly % of
salary (e.g., 10%) into employee-selected investment
vehicle (think 401-k).
n Individual bears the market risk and is responsible for
selecting investment vehicles.
n Retirement benefits determined by performance of
investment choices.
n Most newer corporate plans are of this type.
n Value of assets becomes part of estate that can be
transferred to heirs
n $1,720 billion of assets in DC plans (as of Sept. 30, 2009)
Strictly Financials 35

36. Ten Largest Defined-Benefit
Funds*
Total Assets in Billions of $
State of New Jersey
Wisc. Investment Brd.
NY State Teachers
Gen. Motors
Texas Teachers
NY City Retirement
Fla. State Board
NY State Common
Calif. State Teachers
Calif. Public Emp.
$0 $50 $100 $150 $200 $250
* as of Sept. 30, 2009,* from Pensions & Investments, Dec. 28 and Feb. 8, 2010)
Strictly Financials 36

37. Typical Pension-Plan Sponsors
n State or municipal employee plans (almost all
are defined-benefit plans):
n Teachers (K-12, community colleges, universities)
n State employees
n Firefighters and police
n Judges
n Local union plans (usually defined-benefit
plans)
n Corporate plans (most have converted to
defined-contribution plans)
Strictly Financials 37

38. Measuring Pension-Plan Health
n Actuaries can project future plan liabilities and
income – key factors are:
n Workforce demographics
n Rate-of-return assumptions
n Mortality rates – and we are living longer
n Size of investment portfolio
n COLAs – “cost of living allowances (e.g., 2% a year)
n The “present value” of projected pension payments
and income to the plan is used to calculate the
“funding ratio”: $ projected payments/$ income
n A funding ratio of at least 80% is considered “safe.”
Strictly Financials 38

39. Strictly Financials 39

40. GASB Changes May Make Public
Plans Look Weaker
n Major changes to be phased in starting June
2013:
n Plan sponsor (e.g., state or school district) must
show pension liability on balance sheet – (previously
shown as a footnote to financial statements).
n Poorly funded plans will have to lower discount
rate (to a municipal-bond rate) on liabilities (which
makes funding ratio worse.)
n Teacher retirement plans are especially vulnerable
to show a weaker financial position.
Strictly Financials 40

41. But Be Skeptical About Studies
Which Predict Plan Insolvency
n Most studies use historical aggregate data, which
may not include recent plan improvements.
n Projections are based on many assumptions. For best
information, use the yearly actuarial report, which all
public plans require.
n Don’t confuse accounting “books” with actual
investment performance.
n In addition to the current “funding ratio,” consider
the
n “Funding horizon” and its trend over the past decade.
n The trend in the funding ratio over the past decade.
Strictly Financials 41

42. States are Acting to Change
their Public-Pension Plans
Yes, there is a problem that should be
addressed sooner rather than later.
Strictly Financials 42

43. The Economist, June 23, 2012
Strictly Financials 43

44. Unfortunately, the Funding
Gap Continues to Widen
The Funding Gap is an actuarially
determined value calculated as
the ratio of the “present value of
promised benefits”/”present value
of assets.”
Strictly Financials 44

45. Strictly Financials 45

46. What Can Be Done to Shore Up
Public Pensions?
n Changing payouts for current employees is
legally difficult to impossible, so states look to
make changes for new employees.
n Bankruptcies by local governments have been
one option. (States cannot use bankruptcy.)
n Typical choices for improving funding:
n Raise retirement eligibility/age
n Increase state/employee contributions
n Replace defined-benefit with defined-contribution
plan – a costly action for most plans.
Strictly Financials 46

47. What the Future Holds
n In 2008, most plans were funded at over 80%, but
by 2011, only 35% were.
n Falling stock market reduced portfolio values
n Reduced contributions from states as they struggled to
balance budgets.
n Alternatives for state and local government plans
n CA, IL, NJ may need to increase contributions to 8-12% of
state budgets to keep plans solvent.
n Most states need to increase contributions an additional 2%
of state budget to get funding up to 80%.
n Experiences of Minnesota and Colorado to change plan
benefits.
Strictly Financials 47

48. Story Ideas
1. What is the financial health of pension plans in your
area? (Public plans have to provide data.)
2. Are plan administrators considering actions to modify
plans? What resistance is expected?
3. What has been the financial performance of the fund
over time? Is it competitive with other plans?
4. What is retirement pay for high-paid employees?
Strictly Financials 48

49. Resources
n “Covering your local pension plan”
n SABEW Teletraining, Dec. 5, 2011
n Detailed tutorial by David Milstead
n Archived webinar with Barlett and Steele
winner Craig Harris of The Arizona Republic
n Archived resources at NewsU from
SABEW’s 2011 public pensions seminar
n Overview from the National Council of
State Legislatures
Strictly Financials 49

50. What about the Euro
And the European Union?
Strictly Financials 50

51. The European Union
n Created by the Maastricht Treaty in 1991
n Introduced the Euro (€) in 1999 at a value of
$1.18 per €1.
n 16 countries now use the €
n Austria, Belgium, Cyprus, France, Finland,
Germany, Greece, Ireland, Italy, Kosovo,
Luxemburg, Malta, Netherlands, Portugal,
Slovenia, Spain.
n Denmark, Norway, Sweden and the U.K. do not
use the € but are part of the European Union.
Strictly Financials 51

52. Why have a Monetary Union?
n Advantages:
n Reduces costs (dramatically)
n Eliminates exchange rate uncertainty
n Promotes trade and political cooperation
n Disadvantages:
n Loss of monetary independence and control
n Tensions between “rich” and “poor” states
n Difficulties in maintaining unified control
Strictly Financials 52

53. Key Criteria for Membership
n Ratio of Budgetary Deficit to GDP ≤ 3%
n U.S. is 10.64% in 2011 budget
n EU is 6.3% in 2010
n Ratio of Gross Public Debt to GDP ≤ 60%
n U.S. is 94.27% in 2010
n EU is 74.0% in 2010
n But, most members violate these measures
and have done so through time.
Strictly Financials 53

54. Strictly Financials 54

55. So, What’s the Problem?
n Sovereign default is possible.
n Greece, Ireland, Portugal and Spain may be
unable to repay or refund debt as it comes due.
n But, because most of the debt is held by
European banks, the EU set up a bailout
fund.
n What impact will the fear of a debt crisis in
Europe have on the international banking
system and interest rates?
Strictly Financials 55

56. Story Possibilities
1. What impact would death of the Euro have on businesses
in your city?
2. What relationship do banks in your area have with global
banks?
3. Do banks/pension funds/investors in your city or state
hold foreign bonds?
4. Do companies in your area do business with Greece,
Portugal, Ireland or Spain?
Strictly Financials 56