(Note: Before I start this, I want to make it clear that I'm not an economist, not a stock broker, not an expert on fiscal dealings of any kind. I'm a dunderhead who just sat there and watched most of the money I had in the world evaporate over the last few months. So please, please, please don't consider anything I'm about to say as investment advice. Thank you.)
Imagine for a moment you're onstage for that least common denominator of all game shows, Deal or No Deal. Unlike, say, Jeopardy! or even Wheel of Fortune, this is a show that strips away all pretense at skill, knowledge, or strategy. The universe of Deal or No Deal is bounded only by blind chance and equally blind greed.
So here's my offer: you have one case in your hands that may contain either $0 or $1,000,000. I'm offering you $200,000 cash money right here and right now. Are you going to take it?
If you said "no deal" and stuck with the case in hopes of finding the million dollar payday, you're not alone. It even makes a sort of sense – there are decent odds of coming out far ahead, odds good enough that the sure-thing alternative looks a little stingy. As an individual, it's an understandable decision. As a society, it's suicide.
And here's how we all drank the Kool-Aid.
In 1975, Ronald Reagan declared that the great majority of Americans were not capitalists. That may seem surprising, considering that most of us would consider America a capitalist society, but Reagan had a purist's approach to the subject. He said, "Roughly ninety-four percent of the people in capitalist America make their living from wages. Only six percent are true capitalists in the sense of deriving their income from ownership of the means of production."
What the "Great Communicator" is trying to communicate to you here is that you're a peon. You work for a living. Real capitalists own for a living. But don't worry -- Reagan and his friends among the market fundamentalists had a fix in mind, one that was already underway.
A year earlier, the Employee Retirement Income Security Act had been passed to tackle serious problems with the pension system in America. Laws at the time made it hard to see into what were considered internal dealings of companies. Still, it was increasingly clear that many companies were not investing anything close to enough in their pension plans. They dealt with this the old fashioned way -- they lied about it. The ERISA opened up pension systems to much greater scrutiny, and put stricter requirements on how companies funded their plans. ERISA was, and is, one of the most complex, technically difficult, pieces of legislation ever crafted.
Along with regulating pensions, this legislation introduced something new to American life – the Individual Retirement Account. There were two unique features of these plans. First, they encouraged average Americans to take ownership of stocks and other investment instruments. At the time, few Americans owned any sort of investment vehicle more elaborate than a savings account. Mutual funds had been around since the Great Depression, but fewer than 5% of households owned them, ditto stocks. That changed quickly as IRAs went into use. The second important feature of the IRA was the factor of time. The savings accounts that Americans were used to were open-ended affairs, money went in and came out regularly as it was needed, but the IRA was built with penalties against taking out money "early." It was designed to take money, put it in stocks, and leave it there for decades at a time. IRAs and 401(k) plans are so well known these days that explaining them is a bit like explaining breathing, but in short these plans allow employees to avoid immediate taxes on income that's taken out at retirement. They are "deferred compensation" plans.
Initially, IRA plans were limited to individuals who didn't have pension plans available through their employer. However, within three years they had been made more generally accessible. In 1980, the first 401(k) plans rolled out. These plans were initially aimed at the boys in the boardroom and seen as an executive perk, but as IRA plans spread sideways, 401((k) plans moved down the totem pole. Eventually nearly every American worker was eligible for one plan or the other – and sometimes for both. Three years after the law went into effect, nearly half of America's largest corporations were offering the plans. A few years after that, large companies not offering such plans became the rare exception. Currently, over 400,000 companies provide 401k plans. Most companies pay into these plans in the form of "company match" where companies contribute some percentage of what employees put into the plan.
Here's a question: why? Why would companies so rapidly expand these programs? The answer is, because it saves them massive amounts of money.
When 401(k) plans entered the landscape, nearly all the companies that offer them today instead offered "defined benefit" retirement plans, generally in the form of pensions. In most cases, these plans paid at a rate defined by the employee's years on the job and/or salary. So, for example, an employee might retire after 30 years and receive 70% of her average pay over the last five years, or she might get $100 a month for each year of service. As 401(k) plans entered the scene, this type of pension plan gradually faded from the landscape and were no longer the norm. Even where they were kept, the benefits of these plans were often reduced in exchange for being paired with some form of deferred compensation plan.
Moving from "defined benefits" plans to "deferred compensation" plans may seem like a subtle distinction. It's not. This was a societal change – a revolutionary change that has rewritten America more completely, if more covertly, than the Great Society era, and perhaps as much as the New Deal.
Corporations have certainly benefited from this change. That's because to maintain a defined benefit pension requires a corporation to set aside enough investment to cover its retiring workers, and to manage those funds to keep them available in good times or bad. The funds that companies are required to put in can be relatively small if they get a good return on investments, but they can be much higher in times like those we've experienced over the last eight years. To meet the certainty required under ERISA, corporations would have had to invest much more money into pensions. Even with most corporations no longer offering pensions or offering reduced plans, 2008 saw pension funds go underfunded by $358 billion.
With a 401(k) plan, the employer is out only the much smaller (and more predictable) matching funds, and even those can be changed quickly. Unlike requirements on pensions, the commitment of employers to contribute to a deferred compensation plan is not subject to being locked in place. Matching funds can quickly be cut back or dropped in a down year, and (perhaps) restored when times are better. Even if the matching rate isn't reduced, in tough times employees tend to reduce their own compensations in order to make more cash immediately available, which means they don't get the matching dollars. When you don't invest, they don't invest.
Deferred compensation plans are also easier for companies to manage. In most cases, a corporation negotiates with a financial institution to manage these accounts for them. The fee they pay for this is relatively tiny, especially so because employers pass on much of this cost to the employees. Changing from defined benefit to deferred compensation means that corporations invest less money, less effort, and take on less risk. They have every incentive to make this move.
There was another reason corporations loved deferred compensation plans than just the straightforward reduction in cost. Part of the reason that pension plans were in trouble previous to the ERISA was that many companies treated the pension plans as just money with which to buy their own stock. Turning the pension plan into company stock helped the company control its own stock price and put employees over a barrel – if the company did poorly, the funds in their pension could vanish. ERISA changed this by limiting the amount of a pension funds that could be invested in the parent company to 10%.
No such limit was initially placed on deferred compensation plans. Many companies offered their own stock as part of the 401(k) plan, sometimes providing an incentive to encourage employees to make this part of their plan. This had the same benefits as keeping pension funds in company stock: it raised stock prices by adding a new pool of purchasers, and it made employees feel a close connection to their employer. On that second count, 401(k) plans actually worked much better, simply because of their visibility. The result was a sharp punch in the nose for organized labor. Multiple studies have shown that when employees own a company's stock, they feel as if they are going to share directly in any gains the company makes. They're more likely to be in agreement with company officers, more likely to "increase productivity" by working harder and putting in more unreported overtime, and perhaps most important of all – employees who own company stock are less likely to be involved in labor actions against their employer. 401(k) plans offering company stock are a significant factor in the damage done to labor over the last thirty years.
If companies benefited from moving to deferred compensation plans, how about employees? The answer is: sometimes. For the people buying into the plans, the idea was that they were being provided with a way to enter retirement with a bigger wad of cash than their defined benefit package would ever have paid out. Millions of employees were shown charts that reflected the average 8% yield of the stock market over the long term, and shown how by investing into a 401(k) plan or IRA throughout their work lives, they would leave their place of employment as millionaires. It's even true – so long as the employee starts young and can invest steadily in the plan over enough decades, and they manage their funds with some care, and that their account isn't handled by an institution charging high fees. Oh, and provided that the stock market doesn't enter a major dip from which it takes a decade or more to recover just as the worker is approaching retirement. In defined benefit plans, employers had to worry about contributing more money when the market declined. In deferred compensation plans... not so much.
Deferred compensation plans moved most of the cost and all of the risk to the employee, and through the employee to the society as a whole. Just as with that case on Deal or No Deal, employees now had the chance to become millionaires, but to get there they had to give up the sure thing. There is one big difference from the game show: most employees didn't get a choice.
There's one other party involved in this deal. If corporations benefited, and employees sometimes benefited, the real boost went to the markets and to the organizations that handled these plans. Thanks to deferred compensation plans, stock and mutual fund ownership went from less than five million households in 1980, to 45 million households two decades later. In 2004 (the last year for which the Federal Reserve Board's Survey of Consumer Finances is currently available), 52.2% of American families had some form of tax-deferred retirement account.
From this rapid growth, the markets certainly made money. Individuals plowed trillions into the markets over the last few decades (at the start of this year, IRA assets were estimated at $3.5 trillion, a similar amount was in 401(k) plans – no estimate on where those amounts stand today) contributing directly to the increase in stock prices and market assets over the last thirty years.
The fees that have been collected from these funds are equally beneficial to the markets. When the AARP queried their members, more than 80% did not know how much they were paying in fees on their deferred compensation accounts. If you're a participant in one of these plans, take this test: find your latest account statement (try not to wince too hard at the fall in prices) and look for the "expense" column. Odds are, there is no such column. Even if there is, it may well say "zero." But especially for those whose accounts are held by general service brokerages and investment banks, the fees can be amazingly high. For an account holding $100,000 you can easily be paying out more than $1000 in fees, whether the stocks and funds in that account go up or go down. That in turn has an enormous impact down the road, so much so that, over the lifetime of the account, financial institutes charging fees at this level are almost certain to make more money off your investments than you will.
But there's a third factor, one that is more important to the markets than even the cash deferred payment plans pump into the system. The real reward for them has been the in the feeling that the markets are at the center of the economy. When 5% of people invested in the market, making the connection to the average American could be difficult. But when 52% of households have their retirement tied up in the markets, Wall Street owns Main Street. As a result, media coverage of issues related to the stock market has expanded greatly, and no mention of the stock market is now complete without a discussion of how many "ordinary folks" have their investments on the line.
Broad ownership of deferred compensation plans has greatly changed how we view the stock market and made us more willing to take action that benefits the market. It's likely that not only the $700 billion bailout, but much of the deregulation that made that bailout necessary, would not have been possible without the change in attitude created through deferred compensation plans. We were willing to let them get away with being weasels, because we thought we would gather part of the benefit from their activities.
This is, of course, an illusion. This impression that stocks are now in the hands of average Americans is a thin veneer over the situation as it has always existed. The median amount of money Americans hold in retirement accounts is around $35,000 – hardly a stock market bonanza -- and even this number fails to capture the real situation. For Americans below the 60th percentile on income, the amount held in retirement accounts is around $15,000. For the top 10%, the number is $182,000. Similar numbers apply to direct stock ownership. Around 85% of all stock is owned by those families in the top 10% income bracket. The top 1% owns over half.
What Reagan said in 1975 is still true – a very small number of Americans own the means of production, while the rest work for them. The difference now is that we think we are among the owners, which has been a tremendous benefit to that handful of "real capitalists."
They turned the pension system into a weapon that worked to their benefit, both at the bank and in the polling booth. Which is why they're so anxious to do the same for Social Security.
Source Material For these Sunday ramblings, I generally don't include the links I put into everyday posts, which earned me some bruises after my last piece. This article was strung together from a number of sources and slathered with enough of my personal interpretation and decidedly non-journalistic slant that I still didn't want to link sources as if they endorsed my onions, but I thought I'd list out some of the places where figures, quotes, etc. were sourced. On some of these sources, I disagreed strongly with the underlying premise of the author -- which was part of what made them useful.
Stock Ownership and Work Dynamics, Organizational Dynamics, Volume 30, Issue 1
The Rise of Worker Capitalism, Richard Nadler
Organizing for Social Change, Kim Bobo
What Ownership Society? David Gross, Slate, 06 Feb 2006
2004 Survey of Consumer Finances, Federal Reserve Board
The High Cost of 401(k) Fees, Mary Beth Franklin, Kiplinger.com
And as always, the army of folks at Wikipedia.
Finally, there's one other factor that American workers should never forget. Investing your money in the stock market is gambling. Yes, over the last century and a half, the general trend is very close to that 8% gain, and it's even hard to find a thirty or forty year period in which you might come out with little benefit. But as they say on TV "Past Performance is No Guarantee of Future Results." When you're looking at an work life measured in decades, a century is miserable basis on which to stake your judgment. It's like saying "hey, this coin has come up heads three times in a row, it must always come up heads." This is the opposite of a sure thing.
Which is why if someone offered me that deal back at the beginning, I'd take the cash. Too bad, for American workers, fewer and fewer seem to be offering.