As baby boomers pull out funds, will they pull down markets?

MarketWatch

BOSTON — Many wise men have predicted the stock and bond markets will go into a free fall for decades once baby boomers start withdrawing money from their retirement accounts, but a new report by the Congressional Budget Office suggests that won’t happen when boomers retire.

“Some economists have warned of the possibility of a dramatic decline in demand as baby boomers sell off their assets to finance their retirement; they assert that the sell-off could cause a dramatic decline in prices,” Douglas Elmendorf, director of the CBO, wrote in his report.

“An evaluation of the evidence, however, indicates that such a dramatic decline in asset demand and prices is unlikely,” he said.

If only that were true. But some people disagree with at least some of the CBO’s findings.

“The CBO report provides some ideas, but has a long way to go before resolving the question” of whether demand for and prices of assets will fall as boomers retire, said Alan Gustman, a professor at Dartmouth University, and Thomas Steinmeier, a professor at Texas Tech University.

For its part, the CBO said it makes sense in principle that if more people are selling assets to finance their retirement than are buying assets, then stock and bond prices would decline. But the empirical evidence, the CBO said, doesn’t bear that out. Earlier groups of retirees didn’t sell their holdings en masse to the fund their retirement.

Several factors probably explain the evidence, Elmendorf said in the report. “First, retirees generally are cautious about selling assets to finance consumption because they might need those assets in the future: They might live longer than expected, and medical costs, which are likely to rise as people age, could be higher than anticipated. Second, rather than spend all of their assets, retirees might intentionally retain some to make bequests.

“Third, wealth in the United States is highly concentrated: One-third of the nation’s financial assets is held by the wealthiest 1 percent of the U.S. population. The wealthiest people do not spend significant portions of their assets during retirement and in most cases die leaving bequests.”

What’s more, the report said demand for assets will remain high as baby boomers push back the timing of their retirement due to the recent market turmoil. “Some baby boomers who have lost or spent a significant portion of their assets may defer retirement, shortening the duration of retirement and reducing the amount of assets needing to be sold to finance consumption,” the report said.

Will prices fall — or won’t they?

The CBO also said it’s unlikely stock and bond prices will fall as boomers retire. “Empirical evidence has not revealed much connection between demographic trends and the price changes observed in financial markets.”

Some economists agree with at least some of the CBO’s findings.

“Couples in particular do not decumulate [spend down their assets] until late in life, so the immediate effect of boomers retiring will be small,” said Michael Hurd of the Rand Corp.

But he and other economists take issue with plenty else in the report. For one, singles do decumulate early in retirement, Hurd said. What’s more, he said even though boomers may not decumulate assets, they will no longer be saving after retirement. “Thus a change in asset demand will result from people moving from an accumulate phase to a neutral phase,” he said.

To Gustman and Steinmeier, the problems with the CBO’s view of the world are many. “There are three additional factors that we would like to have seen discussed in the CBO report,” they said. “Each of these omitted factors would, in fact, reduce net assets.”

First, according to Gustman and Steinmeier, the CBO incorrectly dismisses the presence and importance of defined-benefit plans. According to Gustman’s and Steinmeier’s forthcoming book “Pensions in the Health and Retirement Study,” most people retiring today have a traditional pension plan. In fact, two-thirds of the pension assets of people near retirement age today are in defined-benefit plans.

In plain English, those retiring today won’t draw down their stock and bond portfolios because they don’t need to. But as more boomers retire without a traditional pension plan, the need for them to draw down their IRAs and 401(k)s will be greater. Thus, the big whooshing sound you hear.

Second, Gustman and Steinmeier say that by focusing only on personal wealth, the study ignores the effects of Social Security’s financial problems. “Over 30 percent of the wealth of those approaching retirement is in Social Security,” they said. “As the boomers retire, that wealth will be drawn down throughout the retirement period, creating additional government debt. Of course, under-funded, government-insured health expenditures will add to these liabilities.”

Third, the effect of the stock-market decline is only one of the factors affecting baby boomers’ retirement picture, Gustman and Steinmeier said. In their paper, “The Retirement Age Population and the Stock Market Decline,” the professors said the stock-market decline alone will lead to an average postponement of retirement of no more than a few months.

However, the effects of layoffs of older workers must be factored in as well. “Layoffs reduce total compensation from full-time work even for those who find another job,” they said.

“As older workers are laid off as a result of the current recession, many will have a great deal of difficulty in finding new jobs that will pay wages nearly comparable to what they earned in the past. That will lead some to retire earlier than they expected. Should net retirements by older persons be accelerated, they may draw down their pensions and other assets earlier than they had planned.”

The net effect of that, Gustman and Steinmeier said, is that there’s likely to be a reduction in net assets.

That suggests a bear market, maybe even a two-decade-long bear market.