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Wednesday, February 27, 2013

The Fed's policy of keeping interest rates ultra low could be an attempt to encourage investments and spending in the US. But the strategy is having an unintended side effect. Or should we say the policy is revealing its dark side. This unwanted effect is nothing but the soaring pension gap across the US corporate landscape. You see, there are promises made by US companies that they will pay their workers a certain amount of pension after they retire. And these promises when taken cumulatively reflect on the liabilities side of a company's financial statement. Now the problem is with interest rates at all time lows, there has been a huge increase in these liabilities. The reason being that the discount rate that is calculated to arrive the present value of pension liabilities has gone down, resulting into a corresponding rise in pension liability. So, how do the companies deal with this problem? Well, they simply take a one-time charge on their P&Ls (profit and loss statement s) which then affects their bottom line. Of course, the charges could also be reversed if interest rates start to climb. But this is yet another instance of how artificially manufactured interest rates lead to wrong valuations of assets and liabilities and cause anxiety to firms.

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