“A dollar today is worth more than a dollar tomorrow” -- an accepted wisdom in finance. Textbooks preach this for two main reasons – first, because money has a time value, and second, because of risk.
That explains why “a bird in the hand is worth two in the bush” helps to capture finance fundamentals. It takes time to get to the bush, and by the time you get there, those two birds may have flown away.
But wait a minute. Who wants a bird in their hand, anyway? What good is that?
I propose we reframe this analogy, for the purposes of teaching finance, anyway. A beer in the hand is worth two in the fridge. It is good to have a beer in your hand, and by the time you get to the fridge, those two beers may have flown away.
What does this have to do with government finance?
In our Morning Call yesterday, we had a story by Dan Walters in the Sacramento Bee titled “California’s pension liability is huge no matter how it’s counted.” Walters was reporting on new research leading to a website called “Pension Tracker.” The website has been built under the leadership of a Stanford professor, Joe Nation, who calculates the “market basis” and “actuarial basis” of pension liabilities. Walters noted the huge discrepancies between these two numbers.
How can two “truths” be so wildly different?
The main reason is that future dollars in pension obligations are discounted to their “present value,” given the time value of money. And different people have different opinions about the appropriate discount rate. If you believe a risk-free rate is the right way to discount those future obligations, you end with a much higher present value than you do if you discount those future obligations like many state and local governments do. They widely use higher rates, based on their expectations for returns on plan investments.