The Great 401(k) Hoax: Why Your Family's Financial SecurityIs at Risk, and What You Can Do About It By William Wolman and Anne Colamosca. Perseus Publishing, 246 pages, $26.00
Since the Enron corporation imploded, Americans havegotten quite an education in the corporate chicanery, accounting gimmickry, WallStreet scams, and feckless regulation that helped sustain the roaring 1990s stockmarket.
But there are still more lessons to be learned about the directeffects of the stock bubble on ordinary employees. The savings of thousands ofEnron employees were wiped out by the company's collapse because employees'401(k) plans were filled up with Enron stock. An obvious question, then, is: Justwhat impact did the 1990s financial excesses have on the lives of those millionsof workers whose retirement plans have recently come to hinge on the popular butcontroversial savings account known as the 401(k)?
In The Great 401(k) Hoax, former BusinessWeek staffers William Wolman and Anne Colamosca have written a searing critique that debunks the notion, aggressively promoted by Wall Street, that 401(k) plans offer an easy road to riches. Their book warns of the growing risks that Americans face from overreliance on these loosely regulated plans and points the way to potential reforms.
"The American public has been hoodwinked by political and corporate forcesinto relying on the 401(k) as the primary long-term investment mechanism," theauthors write. The story is one of Wall Street -- aided and abetted by theClinton administration, academic cheerleaders, and the Federal Reserve -- sellingthe country on the stock market as the best way to save for the future, whileminimizing the downside. "Romancing the baby boomers was at the center of WallStreet's advertising message in the 1990s and has shown no signs of abating inthe postmillennial decade," Wolman and Colamosca contend.
What was in it for employers? "The 401(k) is dirt-cheap," the authors write."It costs the employer 50 percent less than the traditional pension. And to makeit even better, the 401(k) relieves the company of any 'sticky' long-termobligations to retired workers." In other words, worries about rising pensionliabilities for employees, particularly in older industries such as steel,prompted many companies to trim their costs by jettisoning the kind of"defined-benefit plans" that guaranteed retirees regular monthly checks. Instead,corporations shifted increasingly to "defined-contribution plans," and especiallythe tax-advantaged 401(k), where management has been able to call many of theshots and employees have often been given narrow choices. From 1980 to 1996, thenumber of people covered by the older plans grew by only three million (to atotal of 41 million), while in the same period the number of Americans with401(k) plans went to 50 million from 20 million.
But the 401(k) comes with risks: Enron wasn't the only company whose planswere heavily concentrated in company stock. Such firms as Procter and Gamble,Sherwin-Williams, and Abbott Laboratories have recently made matchingcontributions consisting of 90 percent stock. And there are other disturbingtrends: Last year, facing a recession and new financial uncertainties afterSeptember 11, several big companies -- including Bethlehem Steel, Enron, andLucent -- announced they were cutting back on providing the matching funds thathave made the 401(k) attractive to workers.
Clearly 401(k) plans have taken real hits in the last few years, as the markethas slid from its peak. The value of the average 401(k) was $55,000 in 1999 buthad declined to $49,000 in 2000. Wolman and Colamosca see scant prospect that thenext two decades will deliver the kinds of healthy returns of 7 percent annuallythat Wall Street likes to promise. Based on their reading of other periods thathave followed stock booms, the authors forecast that average stock returns in thenext two decades, adjusted for inflation, will be closer to 1.9 percent -- thelevel that has prevailed for more than a quarter century.
That assessment is bolstered by the authors' telling comparisons between the1990s and the 1920s: Both periods suffered from what they describe as an "excessof 'techno-optimism.'" There's no denying that both decades witnessed stunningadvances in technology that contributed mightily to economic growth and themarket's performance; but the market's rise was also spurred by some degree ofhype, fed by what Yale economist Robert J. Shiller calls "amplificationmechanisms," which the authors say "turn a good story into a story that is toogood to be true."
So the reliance on 401(k) plans as they're presently structuredand regulated seems like a pretty risky bet. And compounding the problem is thatthe United States has long lagged behind Germany, Great Britain, Canada, andothers in offering decent public-pension benefits. In Germany, for instance,retirees usually receive between 75 percent and 85 percent of their salariesthrough that country's equivalent of Social Security.
Wolman and Colamosca, in offering advice to individuals, recommendthat people put more money into bonds -- and particularly inflation-indexed bondsissued by the U.S. Treasury -- as a central strategy for the slow-growth marketthey foresee. The key to investment success, the authors say, "is to drown outthe noise that comes from the Street on the cable financial channels, in thepersonal investment magazines, and, above all, from the investment housesthemselves."
But they also acknowledge that employees are often limited in their investmentchoices by their company's 401(k) plans, which too often are shaped by"managerial arrogance" and attempts "to copy the investment strategies followedby the wealthy." The book thus calls for Washington policy makers to overhaulprotections for 401(k) plans to ensure that workers don't get short shrift.Spurred by concern about the instability and fragility of the American pensionsystem, the writers conclude that "an FDR-style New Deal for the nation's pensionsystem" could go a long way toward remedying the problems with private pensions.
The authors propose several sensible, though politically difficult, ideas forreformers to push. For starters, there's a need for employees to haveunrestricted choices of investment options in their plans. Wolman and Colamoscaemphasize that those choices should apply to both a worker's own investments andto the employer's matching contribution. They also suggest that laws need to bechanged to eliminate conflicts of interest that can arise between employees andemployers when a company chooses an investment house to administer plans.Further, the kinds of restrictions that limited Enron employees from sellingtheir stocks need to be eliminated.
Perhaps the most difficult change, but also the most crucial one, is to ensurethat companies' matching contributions not be made in stock but in cash, toenhance employee control over investments. Unfortunately, the ability to makecontributions in stock is one of the driving forces behind the growth of 401(k)plans, because it looks better on companies' bottom line. The only plausible waythat companies might be weaned from using stock would be if Congress passed newtax incentives to induce firms to make their matches in cash.
As a more modest alternative, Wolman and Colamosca suggest limiting the amountof company stock to 10 percent in any one plan. That proposal seems on target,but one recent Senate measure that would have capped company stock at 20 percentprovoked furious business opposition and has been dropped by Democratic SenatorsJon Corzine of New Jersey and Barbara Boxer of California.
In the end, the authors note that 50 percent of American workers don't haveany private pensions to supplement their Social Security benefits. They wonderwhether it's time to find the political will to increase Social Security "for themillions of Americans who will soon be retiring with little savings at all." Thatquestion, like many this book raises, needs to be put on Washington's agenda.
