Former Fed Chair Yellen: Senior Housing Could Feel Pain of ‘Root Canal Economics’

Economic trends suggest that the senior living industry should prepare for pain.

Low interest rates have become the new normal and could soon go even lower, and this will continue to hurt seniors’ ability to bankroll their retirements, former Federal Reserve Board Chair Janet Yellen said Thursday at the National Investment Center for Seniors Housing & Care (NIC) fall conference in Chicago.

At the same time, the United States is on an unsustainable trajectory with regard to the national debt, and the problem will become more severe as the population ages. The only cure could be painful “root canal economics,” Yellen said.

In the shorter term, an ongoing trade war could tip the United States into a recession, she believes — although she is not convinced that the recent yield curve inversion should be taken as a dire omen.

In light of Yellen’s remarks, and her own analysis of economic conditions, NIC Chief Economist Beth Mace thinks that the industry should be proceeding with caution.

“I’m not saying that we’re necessarily slipping into a recession, but I think there are a lot of things to be concerned about,” she told SHN. “It’s time, if you’re a business person, to put out a plan, ‘What happens if [there’s a recession]?’”

Recession fears

Next year could be a telling one for senior living. On the one hand, owners and operators have predicted that occupancy could finally start to meaningfully increase, as supply and demand better align after a wave of new construction hit the market in recent years. But there are also rumblings that a recession could start to take hold.

In particular, alarm bells began going off due to an inversion in the yield curve, meaning that yields for long-term bonds have fallen below returns for short-term bonds. Every recession since 1950 has been preceded by an inversion, although not every inversion has been followed by a recession, Mace noted.

Yellen struck an optimistic note on this topic, saying that this is not a typical inversion scenario. That’s because the Federal Reserve responded to the financial crisis in part through quantitative easing, buying trillions of dollars in government bonds and mortgage-backed securities between 2008 and 2015. 

Doing so brought down the “term premium” on long-term bonds — the additional yield that investors typically demand for locking in their money over a long time period. There has also been an influx of foreign capital buying up U.S. bonds, further driving down the term premium, which typically adds at least 100 basis points to long-term interest rates.

Thus, Yellen proposed that the spread between short-term and long-term rates has been narrowed, making a yield inversion occur more quickly than it otherwise would.

Still, there are other reasons to be concerned about a potential recession.

In fact, new tariffs imposed by the Trump administration — which have sparked a trade war with China — could be enough to tip the U.S. economy into a recession, Yellen said.

Normally, recessions are caused by out of control inflation or by some financial crisis, such as the bursting of the tech bubble. But “other kinds of shocks” can also cause recessions, she said.

Uncertainty over trade policy is already causing a global slowdown, given the international nature of supply chains, Yellen noted. And this comes against a backdrop in the United States of weak investment spending by businesses.

Other economists — including Lawrence Summers — have put out more dire predictions about the economy than Yellen articulated at NIC, Mace told SHN. And Mace described herself as “more worried” about a recession than Yellen appears to be.

In addition to the trade war, there are a variety of geopolitical concerns at the moment. Brexit, the protests in Hong Kong, and tension between India and Pakistan are among the issues that could dislocate the economy, Mace noted.

And even though senior housing is “recession resilient” — particularly in more needs-based products like assisted living — it is not “recession proof,” Mace said.

During the Great Recession, senior housing outperformed other types of real estate such as office buildings, but investor returns and occupancy both declined, she emphasized. Considering that assisted living occupancy is currently at its historical low point, a recession in 2020 decidedly would not be a welcome development.

‘You’re destroying my retirement’

If 2020 could bring a reckoning in the form of a recession, the longer term outlook is arguably even more troubling.

The country is on an unsustainable trajectory with regard to the national debt, in Yellen’s view, and the only cure might be painful, including reforms to programs that affect seniors — and senior living — like Medicare, Medicaid and Social Security.

“This is root canal economics,” she said, referring to the changes needed.

Since 2007, the federal debt to gross domestic product (GDP) ratio has spiked from 32% to 78%. Still, today’s debt level is manageable, in Yellen’s view. The picture changes dramatically in the future, however, given that the federal government is spending beyond its means and running up trillion-dollar deficits.

Without even taking the aging population into account, interest payments on the debt could leave future Congresses with little additional money to spend. But the reality is that the demographic wave is going to basically double spending on Medicare, Medicaid and Social Security over the next 30 years.

The country is on a “completely unsustainable budget path,” but no one wants to discuss — much less address — the problems. Politicians don’t want to reform entitlements or raise taxes to drive revenue, and the markets don’t seem concerned, either. At least, not yet.

“Markets don’t focus on things until, one day, they start to worry,” Yellen said.

When that happens, interest rates could shoot up and the overall dislocation could finally prompt Congressional action, although the costs of waiting until this comes to pass could be steep.

This troubling picture of the future should further fuel the senior housing industry to create a viable, scalable middle-market option, Mace said. Doing so is imperative, given that Medicaid clearly will not be able to fund housing and care for the huge cohort of boomers who do not have enough money to pay for market-rate senior housing, and might instead have to spend down their assets to qualify for assistance.

The Fed’s own interest rate policies add another wrinkle, as they have compromised the ability of older adults to save money.

During her time on the Federal Reserve Board, Yellen heard directly from a great number of older adults with a dire message: “You’re destroying my retirement.”

The issue was that the Fed kept interest rates at zero for seven years during and after the financial crisis and Great Recession. Seniors — many of whom do not want to risk their retirement savings in the stock market — were not able to get any return by placing their money in insured accounts in banks.  

Eventually — compelled by an angry letter on this topic from Ralph Nader — Yellen wrote a public defense of the Fed’s policies, arguing that they were necessary given big-picture economic concerns and Congressional mandates.

“I don’t want to apologize for this, but did it hurt savers? Absolutely,” Yellen said Thursday.

In fact, she still finds it “incredibly worrisome” that the continued low interest rate environment means that savings is not incentivized, and that even young people who want to save for retirement face steep costs to buy an annuity.

Furthermore, she believes that low interest rates could be the new normal, or at least will persist for the foreseeable future. That’s due to several factors, including that inflation has not significantly risen even as the economy has been on an historically long boom, with low unemployment.

Here in the United States, the Fed has signaled that it likely will cut rates to maintain economic stability in light of concerns over trade. And around the globe, other countries are pursuing similar monetary policies, with countries such as Switzerland even pushing interest rates into negative territory. With inflation far below targets, “no one wants to be Japan,” Yellen said, referring to that country’s struggles with deflation.

The upshot of all this is unusual: a world in which people actually pay a premium to store their money safely over the long term.

“It’s hard to get one’s head around it,” Yellen said.

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