Kenneth R. Szulczyk
profitable, the company pays the promised benefits and retains the remaining funds that are not
paid to the retired employees. If the pension fund is unprofitable, then the company pays the
promised benefits out of its own pocket.
Federal and state governments regulate the pension funds. Regulations require the managers
of the pension funds to disclose all investments. That way, employees know which securities the
pension fund managers have invested in. Regulations help prevent fraud and mismanagement.
Unfortunately, a pension fund will bankrupt, when the company where the employees work
bankrupts. Consequently, Congress created the Pension Benefit Guaranty Corporation that
insures pension fund benefits up to a limit if the company cannot meet its obligations. Some
economists believe a pension fund disaster will occur for state and local government retirees
after 2012. Many state and local governments offered generous defined-benefit plans to public
employees, and they have not placed enough money aside to fund the pension plans.
A recent trend in pension funds allows employees to manage their own pension plans,
which are the 401(k) plans. The 401(k) refers to a section of law in the Internal Revenue
Service’s regulations, and the benefit of this pension plan is the employee can take his pension
plan with him when he switches employers. However, the 401(k) has one risk. Amount of
money a person has accumulated at retirement depends upon how much money he invested in
the plan and how well the investments have done.
Depository Institutions
Depository institutions accept deposits and make loans. Thus, they include intermediaries
that link the savers to borrowers. Commercial banks are the largest and dominate the depository
institutions. Many borrowers seek bank loans for mortgages, car loans, or credit cards. Savers
have three reasons to deposit their savings in a bank than invest directly into the financial
markets. First, the bank deposits are liquid. A depositor can quickly exchange his bank deposit
for cash. Second, the banks gather information about their borrowers, lowering the risk of loan
default. Banks hire financial specialist who monitors investments. On the other hand, an investor
would spend much time and effort to monitor his or her investments in the financial markets.
Finally, banks reduce the risk by lending to a variety of borrowers. Consequently, commercial
banks are important for a community because its role of accepting deposits and granting loans.
Savings institutions are another depository institution. Originally, these institutions
accepted deposits and granted low-cost mortgages for homebuyers. During the early 1980s,
many savings institutions experienced financial crisis because of higher interest rates. For
example, if you borrowed $10,000 at a 5%, interest rate and loaned it out at 10%, then you earn
a profit. However, if you borrowed $10,000 at 10% interest rate and loaned it out at 5%,
subsequently, you earn a loss. Unfortunately, this happened to the saving institutions. Interest
rates rose during the 1980s as the savings institutions paid a greater interest rate to the
depositors than the amount of these institutions earned on the mortgages. Mortgages are usually
30 - year loans, and savings institutions were locked into low interest rates from the 1960s.
Currently, savings institutions are similar to banks, except different government agencies
regulate the savings institutions.