Hijacking the Future
How Wall Street Is Taking Over Workers' Pensions
This article is from the September/October 1999 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/1999/0999ridgeway.html
This article is from the September/October 1999 issue of Dollars & Sense magazine.
In the Huntingdon, Pennsylvania, fiberglass plant owned by the French firm, Groupe Porcher, workers in their off moments are encouraged to use nearby computer terminals and check out the stock market.
Like those in thousands of other plants and offices across the nation, the 450 workers here at the former Owens Corning plant are in the midst of a seismic change. They are being nudged—some would say pushed—into a new-fangled 401k pension scheme and away from the old reliable pension plan. Under the old plan workers were assured of a set payment every month. Under the new scheme, the payment depends upon how well they can play the market. If they're smart, maybe they can make a million and retire. But if they're like most people, plodding along, then they'll just get by. And if they have bad luck and the market crashes, that's their problem. In fact, it's all very much their problem.
Baffled by the new arrangement, representatives from UNITE, the union which represents the Porcher workers, are pouring over the books, reading nearly incomprehensible pension filings made with the government, scouring the newspapers to help the local figure out how to proceed. The local itself has hired a consultant and already unearthed "administration" fees charged to its members without their knowledge. The payment of these fees has become the basis of a union grievance.
UNITE is grappling with one of the most dramatic changes in the American economy over the last decade: The quiet elimination of the pension, long regarded by organized labor as a virtual worker's right, and its transformation into a Wall Street speculation device. This is an extraordinary public relations triumph for corporate leaders and a huge potential defeat for labor. Basically, the modern corporation, with only recent and sporadic opposition from labor or government, has shifted the costs of retirement from employers onto the workers. The signposts along the way to this revolution are few and far between.
Brief Moment in Time
Employers shouldered the burden of paying pensions to their non-salaried workers for only a brief moment in U.S. history. In the 1940s, powerful unions began negotiating company pensions for their workers—or, like the Teamsters, they demanded that employers pay into a union pension fund. They won these concessions from employers through collective bargaining after retreating, defeated, from promoting a broader agenda at the federal level—an agenda that would have enacted national health insurance and expanded public pensions for all workers, not just their own members.
The company pension schemes now being supplanted by 401ks are far from perfect. For instance, a parent company is under no obligation to pay the debts of a subsidiary that goes under. And through shell companies and slick lawyers, some multinationals avoided paying out pensions to rustbelt workers left jobless by the plant closings of the 1970s and 1980s. In Which Side Are You On?, labor lawyer Thomas Geoghegan tells of securing only $14 million out of the $65 million in pension money that International Harvester owed those who once worked for its bankrupt subsidiary Wisconsin Steel.
The shift to 401ks provides a host of other opportunities to milk workers of their pensions. This time, the milking is done as much by Wall Street as by the company.
401k Pension plans
One of every four Americans has a 401k, with 200,000 employers offering plans whose assets have grown from $91 billion in 1984 to $1 trillion today. The share of employers offering 401k plans jumped from 34% in 1981 to 75% in 1996, according to a recent study by Teresa Ghilarducci, an economics professor and pension expert at Notre Dame. A great deal of this money ends up in the stock market where it is invested through mutual funds—pools of stocks and bonds managed by professionals—that increasingly dominate this new pension industry.
The 401k is different from a traditional pension plan. In an old fashioned pension plan, workers are entitled to set monthly payments by the company into a pension fund. They receive a guaranteed payout when they retire. But under a 401k, a worker must put his or her own money into an account before the company adds a usually small matching amount. If the stock market bottoms out when they retire, too bad.
The shift toward 401ks can be seen in the numbers. In 1981, 37% of workers were covered by a traditional pensions. That figure had dropped to 23% by 1995 at the same time those contributing to 401k and other stock plans grew from 9% to 23%.
For well-heeled workers, the tax exempt feature of 401ks offers a way to save on taxes. But lower income employees who are fighting to make ends meet are apt to pass up the 401k. In effect, it works against retirement savings by the group most likely to need a nest egg to keep going. It becomes another device that helps to widen the breach between rich and poor.
Close to half of all participants nationwide have less than $10,000 in their plans—not even a pretense of a retirement fund. As Ghilarducci points out, for workers to maintain their living standard into retirement, one rule of thumb suggests they need to contribute between 15% and 20% of their pay. But the average annual contribution is under $2,000, about 5% of average pay.
The plans do little to ensure that more people are covered. Latinos are least likely to have any pension plan at all—according to the census, only 28% of Latinos, compared to 42% of whites and 41% of blacks, have a pension.
There are plenty of other drawbacks. First, workers are put at the mercy of the market with little protection. The Labor Department oversees traditional pensions and provides a modicum of insurance. If the plan goes bankrupt or the company fails, you'll get something. But with the 401k there is no insurance of any sort. If the market crashes, your retirement goes down the drain.
Of course, one can always hope the market will remain sound. The Securities and Exchange Commission (SEC) has the legal authority to regulate the actual stock markets in which 401ks are invested. But in practice, the SEC has no more than a handful of people nationwide to supervise consumer complaints. Traditionally the SEC has relied on the industry to police itself through such trade groups as the National Association of Security Dealers.
Second, neither the Labor Department, which oversees the 401k plans, nor the SEC, which nominally regulates the securities industry that underlies the plans, has taken much interest to date in the fees that are loaded onto the plan participants. Doping out the 401k fee structure can be nightmarishly complicated. Plans differ from one to another, but as a rule you'll end up paying two sets of fees. First you'll be charged a recordkeeping fee by the company that runs the plan. Second, like all mutual fund investors, you'll have to pay fees charged by the mutual funds governing sales and administrative costs.
You can't ever count on these fees being one thing or another. They entirely depend on how the plan is put together. If, as is increasingly popular, the plan is "bundled" by one of the big mutual fund families, then that company, say a Fidelity or Vanguard, will keep the records and invest the money in one or another of its family of funds. To get you in, the fund may reduce or even waive altogether recordkeeping fees. And to make their product more attractive, the fund family will set up "alliances," with other fund families, thereby offering you a wider choice of things to buy. In that case, both fund families will make money by adding on brokerage fees.
In a second, "unbundled," method of organizing a 401k, a third party administrator will run it, taking care of record keeping and offering participants investment possibilities in numerous fund families. This has the appeal of more independence and hence a competitive edge. But watch out. The administrator may well rip you off by charging a brokerage fee for the different transactions. In one case last year, 401k members ended up paying their administrator over $1 million in brokerage fees.
A Labor Department study reports that "the trend in recent years has been for plan sponsors to shift administrative and non-mutual fund expenses of the plans to plan participants. These fees cover the cost of audits, lawyers, recordkeeping and internal administration of different sorts." In short, the actual cost of running the plan is shouldered not by the employer, as would be the case with a standard pension, but by the participants.
Add to this another Ghilarducci finding: from 1993 to 1996, the average employer contribution to 401k type plans has fallen. As she points out, a boom in the market can actually lead to a further decline in employer contributions since a company can maintain its benefit payouts without putting more of its own capital into the mix.
The Labor Department study makes another key point: the plan sponsors don't know what their costs are. According to the Labor Department, a study in 1992 "shows that 78% of plan sponsors did not know how much their costs were, largely because there are about 80 different ways in which vendors charge fees." One reason for this situation, the Labor Department notes, is because "there is generally no requirement in the law or Federal Code for a complete disclosure of investment expenses to plan participants."
This game of smoke and mirrors persists because banks and insurance companies, which have avoided requirements for strict disclosure, also manage plans—and they are adamant in opposition to disclosure of fees. For decades, the insurance industry has successfully fought off all efforts to place it under federal regulation. Today its operations are policed sporadically at the state level.
In sum, financial services companies charge higher fees for managing 401ks than they do for traditional pensions. These fees are often hidden in small print or stated in misleading fashion. Thus, it is usual for the person participating in a 401k to pay a set annual fee to the manager of anywhere from 2% to 3% of total asset value. Most of this is accounted for in the cost of investing in mutual funds. Half of all money invested in 401ks goes into mutual funds. Today, there are more mutual funds than stocks listed on the New York Stock Exchange. And by one count, Americans have more money in funds ($3.7 trillion) than in banks.
Mutual funds charge investors several different sorts of fees for managing, operating and advertising. And while economies of scale in this rapidly expanding industry ought to bring fees down, they in fact are rising. On average, the fees add up to 1.3% of the value of an account, but they can be as much as 3% a year. This means that a fund showing a 10% gross return has a net return of 7% after taking into account a 3% fee.
These fees can really add up. The average annual expense for funds that invest in U.S. stocks stands at 1.43%, or $14.30 for every $1,000 invested, and the average for taxable bond funds is about $.98% or $9.80 per $1000 invested, according to Bloomberg last year.
Proponents of 401ks argue that workers will make more money in the free marketplace by careful supervision of their plans than if they were stuck with a traditional pension with its low, fixed rate of return. They point to an average annual return on the stock market of 17.5% from 1982 to 1997 as ample indication of what you can expect from investing in stocks. But over the long haul, as Bloomberg Personal Magazine reported in 1997, after accounting for taxes and inflation, the annual return on a balanced portfolio of stocks, bonds, and cash amounts to just 2.5% over the last 25 years. Subtract the hidden transaction costs—what it costs to buy and sell stocks in a rapidly gyrating market—and returns are even less. Even John Bogle, the outspoken founder and chairman of the mutual fund Vanguard Group, notes, "We are spending all this money on ‘management' and getting funds that don't beat the market."
Incidentally, while mutual fund profits might not be all they are made out to be, the stocks of the mutual fund companies, whose profits have been bolstered during the bull market by high fees, have performed well. So well, in fact, that investors would do better buying them, rather than inching along with one of the mutual funds they manage. Bloomberg, for example, cited the three year return on Franklin Resource stock at 33.83%, while in contrast the company's diversified US equity funds brought in 18.86%.
Reforming the SEC?
In another time there might have been hopes for regulation and control of the 401k industry by the Securities and Exchange Commission. Once the symbol of the New Deal's determined regulation of Wall Street, the SEC is now a lifeless symbol of a former time. Congressional conservatives cut its already low budget by denying the commission the right to charge Wall Street fees for floating new securities (stocks and bonds). They said the fees would interfere with the pooling of capital for investment. And Congress took steps to get some aggressive states, like Texas, out of securities regulation by denying them authority to intervene by scrutinizing registration statements.
The SEC loosened advertising regulations over mutual funds, and it has lax standards governing fund managers. Basically, anyone who can fill out a form and pay a $150 filing fee can get the job.
The traditional recourse in the mutual fund business is not government regulation but lawsuits by disaffected stockholders. Currently, suits are challenging the lack of independence of directors of the mutual fund, who theoretically under the law are supposed to represent the interests of the fund holders, not the management. Suits against Fidelity, Prudential, T. Rowe Price, BlackRock, and BEA Associates claim directors consented to high fees only after being "coopted" by fund management companies through high compensation and appointment to multiple boards within the same fund company. The industry generally dismisses the suits as without merit. A judge in New York has thrown out one suit, but left open the possibility of challenging multiple board memberships in Maryland and Massachusetts where, because of favorable tax laws, most mutual funds are registered.
Even worse, nearly 20% of 401k participants bought stock in their own companies, according to a Employee Benefits Research Institute study. This helps support the stock price by creating demand for the stock—a goal for CEOs who want to keep their jobs. But if the company fails, the employee won't just lose her job but her investments as well.
Operating below any rudimentary regulatory radar, the industry prospers on high fees, minimal returns, and hidden costs in large part because of weak unions and insufficient knowledge. The lack of worker control over this industry is bound to grow because the 401k industry itself is becoming highly concentrated with a smaller and smaller number of companies dominating the industry.
In 1998, 42% of the assets of 401k plans were managed by mutual funds, according to the Spectrum Group, a Windsor, Connecticut research organization. Insurance companies were second, controlling 22% of plan assets, and banks third, with 20%. Fidelity, the mutual fund giant, recently announced it would begin to offer small companies an Internet 401k plan, noting "the firm is the number one provider of 401k retirement savings plans, the second largest discount brokerage firm, and the third largest provider of 403b retirement plans for not-for-profit institutions in the United States." As of January 31, Fidelity has total managed assets of $781.8 billion.
According to Pensions and Investments magazine, of $1.2 trillion in assets managed by 243 companies, some $435 billion of the money was handled about equally by just two firms: Fidelity, the mutual fund giant, and TIAA-CREFF, the long-time teachers pension program. Following these two were Vanguard which controls $105 billion, State Street Global Advisors, another mutual fund outfit with $90 billion and then Merrill Lynch, with $58 billion. Twenty nine managers handled plans with $10 billion or more. In the face of steadily rising fees, minimal returns, no insurance or other legal protection save for high cost and long drawn out law suits, the 401k industry, like the securities industry, has its own trade groups such as the 401k Council, and the Employee Benefit Research Institute, a nonprofit made up of plan holders. The American Association of Retired Persons (AARP), which one might think would play a beneficial role in shaping the industry, itself manages mutual funds and takes a cautious, hands-off view of the future.
Congress is enthralled with any legislation that promotes IRA-style financial instruments, and within an arena where Wall Street is king, the only real debate is how much of the Social Security kitty should be devoted to the stock market, and how individual IRA-type accounts can best be organized—as either an integral part of the Social Security system or an add-on option. Under this so-called debate over Social Security, enthusiasm for the 401k grows. Delaware's Republican Senator William V. Roth, who chairs the powerful finance committee, and Max Baucus, a Democrat from Montana, are sponsoring legislation to extend the reach of the 401k, encouraging a higher cap on employee contributions and offering tax credits to small firms that set up 401ks. If enacted, this legislation in all likelihood will end up increasing the disparity between rich and poor workers. The well-to-do worker will increasingly view the 401k as a valuable tax shelter, while his less-well-off counterpart, who barely has any cash to put in a retirement plan to begin with, just feels left in the lurch.
The revolution in America's pension system has lacked any hard-nosed critique until recently. The nonprofit Pension Rights Center in Washington, which in the past tried to popularize the subject and pushed for former Ohio Senator Howard Metzenbaum's pension bill of rights, is now back in action and has launched a study on how the 401k system works in practice. Bill Patterson at the AFL-CIO's Center for Working Capital—an educational project for unions on the pension system—is optimistic that Arthur Levitt, chairman of the SEC, will take on 401ks as part of the commission's more vigorous regulatory stance. Levitt supports more disclosure in the securities industry, and he thinks turning Social Security into private accounts runs the risk of fraud. "Substituting" 401ks for defined pension plans is a "real dodge," says Levitt. "401ks may work as a supplement to other forms of retirement plans, but you can't put all your eggs in one basket."
Beginning in 1995 Leo Gerard, international Secretary-Treasurer of the Steelworkers, pulled together an informal group from unions, the finance industry and think tanks to look into capital investment and the role of pensions funds. Last spring's Heartland Labor Capital Conference in Washington dug under the surface of the pension debacle with papers by Teresa Ghilarducci of Notre Dame and others, which in the course of looking at how pension funds could more fruitfully use their vast capital pool to boost industry, also produced new data on how the pension system protects fewer and fewer workers. "Trustees and many other pension professionals who invest billions of workers dollars," Girard says, "are dedicated to certain principles and professional protocol that don't necessarily reflect the interests of working Americans."
A handful of huge mutual funds now use people's retirement money to churn international markets for short term trading gains, not for capital investments, as envisaged at the Heartland conference. Regulatory reform is unlikely as long as Congressional Republicans aim to loosen the restrictions even more.
No amount of disclosure can help make matters much better for workers, who have little chance of influencing such things as fee structures. About the best they can do alone is to make sure the money they put into 401ks is spread across a broad base of companies and industries, thus cushioning a crash in one or another market. Over the long haul, probably the best bet is for unions—which are more successful than individuals in handling pension investments—to take control of the pension funds, and begin to invest them widely across a span of industries they believe provide meaningful and well-paid work.