Copyright 2008 by Thornton Parker
Some of Barack Obama’s challenges come in bunches like grapes. A large bunch includes the aging baby boom, the struggling middle class, and declining manufacturing. Instead of treating each individually with government programs, a better approach is to make capitalism work as it should by using their connecting stems as multipliers. Stems that connect these grapes run through America’s retirement and corporate investment systems.
Most boomers cannot expect to enjoy several decades of retired leisure. Their home values are shrinking, they haven’t saved enough, and their 401(k) stocks are down. Financial advisors say the stocks will rise again because they always do. But as boomers start to reach their mid-60s in the next four years, they will realize the advisors are wrong and stocks can’t support them.
Since the Internal Revenue Services issued its ruling at the end of 1981 that led to today’s 401(k) plans, companies have been replacing their pension systems with what has become America’s Accidental Retirement System. No one designed the 401(k) system and there has never been a published feasibility study or due diligence analysis that explains how it can work.
The mortgage problem shows why it can’t. As Peter R. Fisher explained in “Lending’s Blind Spot” (The Washington Post, Outlook September 20, 2008), lenders assumed that home prices would always rise and ignored the borrowers’ cash flow or ability to make their monthly payments. Retirement plans that depend on rising stock prices are based on a similar faulty assumption, and promoters of 401(k) plans have given no more thought to who will pay the retired boomers than mortgage originators gave to how borrowers would repay.
After the IRS ruling, the goal of retirement became a marketing pitch for selling stocks and mutual funds to millions of people who would not otherwise have dreamed of buying them. Retirement plan purchases helped drive the bull market that began in 1982. At that time, retirement plans of all types owned 29 percent of the publicly held stocks traded on U.S. markets. By the end of 2007, they owned 69 percent.
Most of these stocks pay small if any dividends, and will have to be sold at a profit to provide retirement incomes. Thus, the Accidental Retirement System meets the definition of a Ponzi scheme—one in which investors’ returns must come from the purchases of future investors, not from companies’ earnings. The scheme is doomed to fail because when boomers’ plans gradually shift from buying to selling, the primary domestic buyers will have to be the retirement plans of the same younger workers that some believe may not support Social Security in its present form.
Not only will stocks prove to be bad retirement investments, buying them hurt middle class workers in two ways. First, as savings flowed into pension and mutual funds, the fund managers had to make the money grow. They bought stocks and passed the pressure for growth on to companies. The companies responded by cutting costs, reducing payrolls, downsizing, outsourcing, exporting jobs, ignoring the environment, abandoning communities, promoting globalization, and becoming global themselves—all to inflate stock prices.
Boomers who can’t retire in their mid-60s will need jobs with adequate pay and benefits in order to maintain their standard of living. Creating those jobs will require major investments, but these are just the types of investments and jobs that public companies have been reducing, largely because of pressures from pension and mutual funds. Instead of retirement savings helping companies grow and provide more domestic jobs, they have been used to make companies shrink and export jobs. The investment system is running backwards and workers’ savings are eliminating their jobs.
Federal Reserve data show that despite public offerings, companies bought back or otherwise eliminated $1.1 trillion worth of stocks from 1981 through 2007; little of the money that retirement plans paid for stocks went to companies. Most of it went to “households,” that made far more from stocks than any other group of owners. This leads to second way retirement plans hurt the middle class. When a company that is expected to grow rapidly is formed, it issues large blocks of stock to the founders and early investors—insiders who live in households. The insiders can make huge paper fortunes the day the company goes public and their shares are treated as being worth the market price. When they sell their stock, retirement plans are the primary buyers.
Bill Gates is the outstanding example of this. He took 45 percent of the Microsoft shares before the company went public and has been selling ever since. He received more than $4 billion from selling stock in the past two years and every penny was profit. At current prices, he still has more than $16 billion worth. Nearly all retirement plans own Microsoft stock, and statistically, at least a third of their shares were sold into the market by Gates himself.
Data in The Wall Street Journal showed that during 2006, insiders got 37 times more money from selling stock than they paid to buy. The ratio changes from year to year, but the lopsided pattern is consistent. In mature companies, insiders often get shares through grants, warrants, and options. In most cases, their cost is low and they sell at market prices, often to retirement plans. The plans routinely transfer middle class savings to the richest people in the country and help to increase the wealth gap. The Bush tax cuts reward this wealth transfer by charging insiders only 15 percent on their “capital gains.”
As the Obama team works to reboot the economy and restore the middle class, it must stimulate good jobs for all who will need them, including millions of boomers who will not be able to retire. One of the most direct ways to do this is to have retirement savings to contribute to growth on Main Street rather than buy paper that just adds to the wealth of insiders and Wall Street.
There are few investments other than bonds and money market funds that channel retirement savings to companies that use them to grow and provide jobs. You can test this by asking your broker or financial advisor to recommend a stock or mutual fund that will get your money to a company that will use it productively. Unless you are a wealthy “qualified” investor, you may get a strange look, but not an answer—there are very few.
The economy has been distorted by the wealthy using money to just make money quickly while regulation is lax. To a large degree, they have shunned the productive side of the economy and concentrated on speculating where their profits are losses to others. Their methods include hedge funds, private capital funds, stock options and futures, buying on margin and cheap credit leverage, computer-driven trading programs, derivatives, mergers and acquisitions, avoidable cost cutting, and forcing companies to concentrate on inflating their stock prices. The new administration and Congress should require financial leaders to show which methods benefit the middle class and contribute to a sustainable economy. Those that don’t should be taxed heavily.
A vastly simpler investment system is needed to achieve goals like channeling retirement and other savings to companies, including small ones, that will provide good domestic jobs for people of all ages and abilities; making long term investments in infrastructure and sustainable industries which today’s high performance money shuns; and increasing future cash flows to pay incomes to those who do retire. The system should guide trillions of dollars in retirement plans and other private investments toward the productive side of the economy to create rather than eliminate jobs. It should reward Wall Street, corporate insiders, and fund managers for their contributions to rebuilding the productive economy, and activities that don’t should be isolated from the main economic stream.
The tax system should be changed to reinforce this by penalizing the waste of capital on speculation. Low capital gains tax rates should be for investments after they have produced goods and services the country needs, not for stock price increases that are based on hopes of what may happen in the future.
The mortgage and derivative fiasco shows why creating credit out of thin air must be restricted. Similarly, the practice of issuing company stock at no cost for use as a currency to buy other companies and reward insiders is a form of counterfeiting. It should also be limited. The practice contributed to the tech bubble which collapsed in 2000, and it can weaken retirement plans.
One of the least intrusive ways for the new administration to pursue its economic agenda without increasing the federal deficit is make capitalism work as its advocates claim it does. This can be done by creating simpler investment and tax systems that will meet the needs of Main Street. The systems should align the long term interests of workers, retirees, and the general public with those of retirement plan managers and other investors. If this is not done, trying to solve each problem separately will be like shoveling dry sand uphill.
Thornton Parker is the author of What If Boomers Can’t Retire? How to Build Real Security, Not Phantom Wealth. His email address is tipparker@mac.com.
