Friday, September 19, 2008

Business Week: Keep Wall Street Out of the Retirement Business

This isn't exactly the most propitious time to defend the idea of personal retirement accounts as part of Social Security. At the same time, when a prominent publication like Business Week publishes an article that's seriously off-base it seems worth a correction. That's the case with "Keep Wall Street Out of the Retirement Business" by Chris Farrell, an economics editor for Business Week as well as a commentator on NPR. A number of Farrell's claims are worth double checking. So here goes nothing:

"Imagine Bear Stearns, Lehman Brothers (LEH), American International Group (AIG), and other titans of finance managing Social Security?" Well, me neither, because Bear Stearns and Lehman Brothers were primarily investment banks and AIG is an insurance company. None of the three would have been called on to manage Social Security accounts. Moreover, even if a firm that did manage accounts went bankrupt the assets held by customers are distinct from the assets of the firm. In other words, you might lose money if the stocks in your account fall, but you won't lose money if the company managing the accounts goes under. Finally, under all personal account-based reform plans I can think of, accounts would be administered by a quasi-governmental agency, not a private firm.

"To be clear, the democratization of stock ownership is a welcome and powerful trend." Except, apparently, for the purposes of retirement saving. Are there other savings goals where stockholding is more appropriate – a down payment on a house, or your children's education? In both cases these have much shorter time horizons, which make the risk of holding stocks larger. Note here that Farrell isn't simply arguing that stocks are a bad idea for Social Security but apparently a bad deal for all ordinary investors.

"The standard advice that individuals fare best when they turn over their money to professional money managers is wrong. It's a bromide guaranteed to lose individuals money, with much scholarly evidence that actively managed mutual funds systematically underperform passively constructed index funds." Which is exactly why all personal account reform plans would base their investment options on index funds.

"Swensen called for government to act 'in loco parentis' and create powerful incentives for companies to put their employees into passively managed well-diversified portfolios, perhaps similar to the low cost, broad-based, limited-choice offerings of the Federal Thrift Plan. But other ideas are worth pursuing. For instance, why not attach to every Social Security number an account consisting of a 60% equity index fund and a 40% Treasury Inflation Protected Securities portfolio? The retirement savings plan would essentially do as well—or as poorly—as the U.S. economy." Um, this is exactly what most reform plans actually do.

Farrell is undoubtedly a smart guy and points out many of the well-known hurdles individual investors face in planning for retirement in a Defined Contribution world. Those hurdles aren't to be underestimated and policies to overcome them – such as auto-enrollment in 401(k) plans and default life cycle portfolios holding index funds – should continue to be pursued. But you're not doing a service to your readers in presenting a caricature of the policy you're looking to critique.

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