Ghilarducci's Guaranteed Retirement Account Plan & The Macroeconomy

The last couple of weeks there's this rumor that's been floating around that the Government plans to do away with 401K and replace them with what is being called Guaranteed Retirement Account. The idea apparently originates from an economist, Teresa Ghilarducci, who put forward a paper "Guaranteed Retirement Accounts Toward retirement income security" in November 2007. A year after the paper was published, in the wake of one of the worst financial crises in the history of the US, the author was apparently called to testify before Congress as the paper caught the government's eye. The paper proposes that workers "not enrolled in an equivalent or better defined-benefit pension" be enrolled in a "GRA" plan that combines the best features of defined-benefit and defined-contribution plans, offering workers guaranteed (?) retirement benefits- contributions will earn a rate of return guaranteed by the federal government. Upon retirement these funds will convert into annuities. Ghilarducci claims that combined with Social Security, these annuities will replace 70% of pre-retirement earnings (I thought most of the folks who entered the workforce within the past decade had given up ever seeing their Social Security benefits?). Participants would be guaranteed a fixed rate of return that exceeds inflation by 3 percent (but remember you are foregoing the opportunity to generate market returns on your investment- not amounting much today, which is why we are even entertaining this discussion I guess). Assuming this thing works and the Feds will be able to deliver on their promise, what will be the fallout from pulling that kind of capital out of the investment markets? Of the total $17.1 Trillion in U.S. retirement assets, mutual funds managed $2.2 Trillion, while IRAs accounted for $4.5 Trillion (data as of March 31, 2008 from Investment Company Institute). If a $0.75 Trillion bailout was going to pull us out of the financial crisis, what will be the outcome of withdrawing $6.9 Trillion out of capital markets? Or am I missing the math completely?

Credit Card Payment Systems: To Interchange or Not To Interchange!

Not too many people are aware of how the money they charge on their card at the Credit Card Machine in their favorite store makes its way to their monthly statement and who the intermediaries that are involved in this transaction trail are. In simple words, there are basically open networks like MasterCard and VISA that have different parties, like issuing banks (card issuers), merchant banks (that pay the merchant) and associations that process the transactions. Then there are closed networks like Discover and America Express that do the full-cycle from issuing cards to processing payments to paying merchants (although Amex may now be considered ‘open-loop’ since other banks like MBNA and Citibank have started issuing Amex cards). An important part of this entire transaction is the ‘interchange fee’, which is a percentage of the purchase amount that is charged by the Association (VISA/MasterCard) to push the transaction through. There is some justification in the interchange being charged; they are the costs of processing the transactions and absorbing the risk until the consumer pays for their transaction. This is why Associations like MasterCard and VISA retain part of the interchange (processing costs) and the issuing bank gets a large share of the interchange fee (risk-based costs). But nobody has really done a proper valuation on whether the fees are truly reflective of the transaction costs and risk premium involved. So in the interests of the consumers, some regulation in this area might be a welcome change. A substantial portion of the interchange goes back to the issuing bank. Issuing banks factor these into their cash-flows while evaluating credit risk from extending or increasing credit for cardholders. In the absence of this compensation, issuing banks will most probably get more restricted in extending or increasing credit since now they will have to bear the entire credit risk of the transaction until the payment comes through from the cardholder.
On the other hand, banks could pass these costs on to the cardholder in the form of increased rates and fees or lesser rewards. To quote James M. Lyon, First Vice President, Minneapolis Federal Reserve Bank, "In some of these countries, card associations have responded to declining interchange fees by generating revenue through other means that regulators may not have foreseen or desired. In Australia and Spain, for instance, where interchange fees have declined due to regulatory pressure, annual cardholder fees have increased; in Australia, interest-free periods have shortened and rewards programs have become less generous. On the other hand, in the United Kingdom, while interchange fees have fallen, both annual fees and introductory rates remain relatively low."
If issuers pass these costs on to cardholders, consumers will probably be less motivated to spend, since credit card transactions represent a very significant portion of consumer spending, which may have an adverse effect on the economy, which is very much dependent on consumer spending.