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Brad DeLong's Thoughts of the Moment on Economics, and on Other Topics as Well
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July 30, 2002
Why Senators (and Others) Have Lost Confidence in OMB Director Mitch Daniels
Paul Krugman reads what the Center on Budget and Policy Priorities says about Mitch Daniels's inability to report what his own organization's documents say:
Our Banana Republics
...The latest antics of the White House Office of Management and Budget have even the most hardened cynics shaking their heads. It's not just that projections for fiscal 2002 have gone from a $150 billion surplus to a $165 billion deficit in the space of a few months; it's not just that the O.M.B. projects a much smaller deficit next year, when everyone else -- including the Republican staff of the Senate Budget Committee -- says the deficit will increase. It's also the fact that O.M.B officials simply lie about what their own report says. "The recession erased two-thirds of the projected 10-year surplus. . . . The tax cut, which economists credit for helping the economy recover, generated less than 15% of the change." So reads the agency's press release. Yet as the Center on Budget and Policy Priorities points out, the actual report attributes 40 percent of the budget deterioration to tax cuts, only 10 percent to recession. Maybe dishonesty in the defense of tax cuts is no vice...
Our Banana Republics
By PAUL KRUGMAN
New Jersey has always been a good state for scandals, and last week provided two. One, the case of Web-snooping by a Princeton admissions officer, which involved a total of 11 applicants to Yale, was the subject of front-page stories across the nation. (Disclosure: I'm a Princeton professor.)
The other — further revelations about the way dishonest budgeting by former Gov. Christie Whitman crippled the state's finances — has dire implications for all of the state's eight million people, who face the prospect of higher taxes on their houses, more potholes in their roads, fewer teachers in their children's classrooms and worse medical care for their parents. This story received no national coverage at all.
Experts already knew that the Whitman administration had used creative accounting to justify a series of tax cuts. Last year New Jersey Policy Perspective, a local think tank, released a study of fiscal policies in the 1990's titled "Take the Money and Run." Among other things, the state stopped contributing to its pension funds. This made the budget look a lot better, but created a financial hole. In an attempt to fill that hole Governor Whitman violated the basic principles of pension funds by having them engage in stock arbitrage, borrowing money to speculate on the market.
Now the state's taxpayers must make up for an investment loss of $22 billion, most of a year's tax receipts. But don't cry for New Jersey; Mrs. Whitman wasn't alone in her misbehavior.
For one thing, many corporations with pension plans used a similar trick to inflate their bottom lines. As the current issue of Business Week explains, the pension time bomb involves large numbers; I'd say it's the equivalent of at least 50 WorldComs.
Furthermore, Mrs. Whitman's policies were by no means the worst among the states. That honor may fall to Tennessee, though Alabama, where a cash crunch stopped all jury trials for awhile, may run a close second.
The fact is that in recent years many states have been run like banana republics. Responsibility gave way to political opportunism, and in some cases to mob rule. When Tennessee considered a tax increase last year, legislators were intimidated by a riot stirred up by radio talk-show hosts. Only when lack of cash forced the governor to lay off half the work force did the state, which has the second-lowest per capita taxes in the country, face up to reality.
The only reason Tennessee doesn't look like Argentina right now is that it isn't a sovereign nation; since the federal budget was in good shape until recently, there's a safety net. And the federal budget was in pretty good shape because the Clinton administration, unlike state governments, behaved responsibly. Budget projections were honest — if anything, too cautious — and boom-year surpluses were used to reduce debt.
But the responsibility era is over. Even as state governments face up to the consequences of cooked books in the 1990's, the Bush administration is following in their footsteps.
The latest antics of the White House Office of Management and Budget have even the most hardened cynics shaking their heads. It's not just that projections for fiscal 2002 have gone from a $150 billion surplus to a $165 billion deficit in the space of a few months; it's not just that the O.M.B. projects a much smaller deficit next year, when everyone else — including the Republican staff of the Senate Budget Committee — says the deficit will increase. It's also the fact that O.M.B officials simply lie about what their own report says.
"The recession erased two-thirds of the projected 10-year surplus. . . . The tax cut, which economists credit for helping the economy recover, generated less than 15% of the change." So reads the agency's press release. Yet as the Center on Budget and Policy Priorities points out, the actual report attributes 40 percent of the budget deterioration to tax cuts, only 10 percent to recession. Maybe dishonesty in the defense of tax cuts is no vice.
State governments turned into banana republics in part because voters didn't realize that a charming, personable chief executive can also be an irresponsible opportunist, seeking political advantage through policies that ensure a fiscal crisis on someone else's watch. Now the same governing style has moved to Washington. And this time there's no safety net.
Posted by DeLong at July 30, 2002 09:12 AM
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Brad
How serious a problem are we headed for in social security and medicare?
Brad,
Krugman's column is really more important than you indicated. We may be playing havoc not only with social security and medicare, but with state and company pension plans:
-- ...further revelations about the way dishonest budgeting by former Gov. Christie Whitman crippled the state's finances — has dire implications for all of the state's eight million people.... This story received no national coverage at all.
New Jersey Policy Perspective, a local think tank, released a study of fiscal policies in the 1990's titled "Take the Money and Run." Among other things, the state stopped contributing to its pension funds. This made the budget look a lot better, but created a financial hole. In an attempt to fill that hole Governor Whitman violated the basic principles of pension funds by having them engage in stock arbitrage, borrowing money to speculate on the market.
Now the state's taxpayers must make up for an investment loss of $22 billion, most of a year's tax receipts. But don't cry for New Jersey; Mrs. Whitman wasn't alone in her misbehavior.
For one thing, many corporations with pension plans used a similar trick to inflate their bottom lines. As the current issue of Business Week explains, the pension time bomb involves large numbers; I'd say it's the equivalent of at least 50 WorldComs. --
"Pension time bomb"???
Wait a minute, Krugman was just telling us that the good old fashioned defined benefit pensions were the safe way to go, because they didn't rely on investments.
I think that Krugman was assuming adequate governmental regulation.
Also, the effect of the pension investment shortfalls is that many corporations will have to make up the shortfalls - the risk is on them. For 401(k)'s, the risk is on the worker. Note that the pensions will be there, due to government regulation.
". Maybe dishonesty in the defense of tax cuts is no vice... " - Krugman
I hope that Krugman has emotionally realized this, that the GOP has adopted a policy of deliberately lying on economic and fiscal matters. And that they have gotten away with it under Reagan. And that they can always find economists to lie for them - Lindsey, Feldstein, Mankiw, etc. Not just Stephen Moores, but tenured professors at great econ departments.
"Bear in mind that ordinary Americans are already more vulnerable to stock market fluctuations than ever before. Twenty years ago most workers had "defined benefit" pension plans: their employers promised them a certain amount per year. During the long bull market, however, such plans were largely replaced with 401(k)'s — "defined contribution" plans whose payoff depends on the market."
Wrote Krugman just last week. And early this year he said the same thing:
"...a little-remarked sea change
in America's retirement system. Twenty years ago most workers were in
"defined benefit" plans - that is, their employers promised them a fixed
pension. Today most workers have "defined contribution" plans: they invest
money for their retirement, and accept the risk that those investments might
go bad. Retirement contributions are normally subsidized by the employer,
and receive special tax treatment; but all this is to no avail if, as
happened at Enron, the assets workers have bought lose most of their value. "
Imagine if Ann Coulter had written something that off-the-wall. TWICE.
And let's not forget that one of the reasons W. went for the steel tariffs was that the federal government is on the hook for both pension and health benefits should American steel corps. go under. (Source: Paul Krugman)
Just in case any lurkers are here looking for information, Krugman's statements about pensions in the USA quoted above are actually broadly accurate (I'll guess that the statement that "most" American employees have defined contribution plans might be a bit hyperbolic), and the reason Patrick Sullivan hasn't explained why they are wrong is that he's blowing smoke.
Krugman is hardly lying, but he poses a curious omission... How is having a defined benefits pension of the old-fashioned kind --founded upon the promises of the employer and the
expectation that employer will continue to be profitable -- peculiarly different from having an IRA/401K --founded upon the public stock/shares of the employers and the expectation that those shares will pay re-investable dividends or increase in trade value?
Suppose Enron had had a U.S. Steel sort of
defined pension plan; and all other features of
their employee/employer relationships were unchanged. A lot of personnel churning, still, right? Anybody been at Enron for less than five
years might not have been vested, so those guys are just purely SOL. The vested employees have a claim, great. Except it's against a bust company with no tangible assents; plus a pension fund that's "diversely" invested in a bunch of dummy/front/paper-only companies spun off from Enron itself to sweethearts of the Enron B.O.D.
What is the particular advantage to the innocent average worker in this situation? An advantage that is so obvious to Dr Krugman that he sees no particular need to explicate it to us laymen?
The only 3 differences between Enron and bust steel companies that occur to me are (a)that IRA/401K dividends are taxable (though tax deferred) as are capital gains, while the yearly increase in value of a pension entitlement is not. (b) The IRA/401K builds wealth for 20-50 year olds who change jobs a lot while tradtional pension tend to accumulate little in the first few decades and pile it on for the (very few) long-time employees. And (c) even a halfway-with-it (hereinafter abbrv. "halfwit") employEE would/could/should (certainly has incentives to) diversify his accumulated retirement savings in a private account; while an employER may/might/shouldn't-but-certainly-has-incentives to, instead, concentrate that savings into re-investment in the company (and clones of) itself.
If we want to attack 401K plans, let's discuss how they permit savings deductions against
INCOME tax instead of PAYROLL tax. The payroll FICA tax is pretty flat, meaning that deductions against it (were any, hypothetically, permitted) would be "fair and flat" as well. But since the Income Tax is "progressive" the incentive to save for retirement in IRAs/401Ks is skewed, too. The higher the wage-earner's income the more incentive he has to divert discretionary income to deferred-tax investments. And all this apart from notions that high-earners are more likely to be ants than grasshoppers; more likely to save for life's winter ANYWAY, without gov't incentives. There is a lot of room for improvement upon overall retirement-savings
policy in our system. It'd be nice to seem some
discussion that is a bit more wide-ranging.
There's a reason defined contribution plans have grown greatly during the last 20 years -- people want them because they are better for them. For one thing defined contribution benefits are portable. You change your job you take your money with you.
In contrast, the typical defined benefit plan is highly back-loaded, the benefit being "defined" by a formula that heavily weights the last few years of a long career on the job. If you change jobs before getting to those last few years the "guranteed" benefit is generally pretty small. Then if you move to another employer with a defined benefit plan you won't be there long enough to get the full benefit because of the time spent at the first one.
If you spend 7 years each a five different employers at retirement you are going to get a *tiny* amount compared to if you spent 35 years at one. Maybe some think it is better for people to lose their retirement benefits by changing jobs? (Even if compelled to so so, as when an employer goes broke or they get fired?)
Many employers now adopt defined benefit plans with the specific intention of shifting benefits towards a small number of veteran "lifer" top execs and company owners, and minimizing benefits for a younger rank-and-file work force where there's turnover and few will stay long enough to earn a significant benefit under the formula. (Krugman hasn't mentioned this? Well maybe it's the sort of retirement plan a liberal Democrat would love.)
However, these days such employers usually are forced by the market to offer defined contribution plans as well, since employees who are increasingly mobile and want the freedom move on to the next good job offered to them know the defined benefit plan is worth zilch to them. So they insist on a 401(k) or the like. They aren't stupid. (When I left an employer with both kinds of plans after 10 years, I got several times more from the 401(k) than the "guaranteed" defined benefit amount, which was paltry).
I strongly suspect the Slate Krugman who wrote about economics would have mentioned the fact that there are real labor market reasons behind the rise of defined contribution plans. It didn't "just happen." But from the Times Krugman who is so highly focused on one political party's agenda issues we can hardly expect it.
It's also true that the "guaranteed" nature of a defined benefit plan is largely a myth regarding companies that get into financial trouble. "Mandatory" employer plan contributions are routinely waived by the IRS if the company can't afford to make them, often for years at a time. See Tax Code section 412 and the list of new waivers issued under it each week. What's the alternative, revoke the pension plans and everybody's pension?
Putting the risk of loss on an employer only works if the employer can afford it. If the employer's business goes south and the investments in its pension plan trust go south at the same time then there you are -- with another steel company to be bailed out.
Poor Sullivan. Never bothers to think just shows off for fellow right wing non thinkers. Just ignore.
Jim Glass,
Criticisms that you have made of defined benefit plans, I share. However, there are significant problems with defined contribution plans as well. Right now there are problems with defined benefit palns that Krugman, Warren Buffett, and others have pointed out will have to be addressed since the plans still cover large numbers of workers. Similarly, markets losses in defined contribution loom as a problem for older workers.
Jim
Have you ever worked for a company that turned over from a defined benefit plan to a contribution plan. I have. It was not well received by the employees -- crammed down our throats was more like it. The compromise ended up being that the older workers kept the defined benefit plan, the younger workers got a 401k. The reason why 401ks are replacing pensions is because it serves the interest of the companies. About 15 years ago, they started figuring out how expensive the benefits they were doling out really were, and they started slashing them.
Jim Glass,
Thanks. I appreciate your contributions to the discussion a great deal. If you ever start up your own blog, I want to know.
Suppose we take a look at retirement plans in Europe and compare. I would be surprised if the French and Germans, Dutch and Swedes do not have generous and flexible plans. Trying google.
Problems with defined benefit seem to boil down to portability and significant benefits gained only towards the end. These problems could be solved by legislation, but companies have fought such legislation in the past when the programs were more widespread and companies feel they can cut costs by going to defined contribution plans.
The risks in defined contribution plans however must be addressed. Remember Enron would not let employees sell Enron shares before the age of 55. Diversification is an issue, employee finanical savvy and advcie is an issue, diversification is an issue.
Poor anonymous posters...
Never bother to take credit for their genius, just accuse and assert from the ether. Their spines as weak as their identities are mysterious. Just ignore.
Sorry Mr. Delong, it was a good post, and I apologize for using the comment section to mock the anonymous.
'Remember Enron would not let employees sell Enron shares before the age of 55.'
Wow. That's not a 401k, that's a company town
Two points:
>>How is having a defined benefits pension of the old-fashioned kind --founded upon the promises of the employer and the
expectation that employer will continue to be profitable -- peculiarly different from having an IRA/401K --founded upon the public stock/shares of the employers and the expectation that those shares will pay re-investable dividends or increase in trade value? <<
Because a defined benefits pension is, in Anglo-Saxon economies, *funded*, and there is no reason to suppose that Enron would have been in the highly unusual situation of having a pension fund which was actuarially insolvent without support from the parent. There are many cases when a company is insolvent but its pension fund is not. This objection can only be based on a misunderstanding about the nature of defined benefit pensions; it might be a more solid objection to German-style "book reserve" company pensions, but I'm not aware of anyone complaining about them.
The question of "portability" of defined benefit pensions is also a red herring. The fact that you lose a lump of pension benefit by changing jobs is not an intrinsic characteristic of defined benefit pension funds; it's a more or less conscious decision of the plan provider to rip off a chunk of the assets of departing employees in order to help the company boost the fund and perhaps take a pension holiday in the future. If employers were to play nice, there is no reason why departing employees could not be given their actuarially determined asset share and no reason why they would have to be worse off than under a DC scheme.
d^2
My observations at Ford:
A plan with a steep ramp-up at the end served to lock in senior employees ('senior' being defined by time in service, not rank).
An employee with 20 years in on a 30-year plan would basically take whatever he/she had to, because quitting would cost too much. To switch employers without losing a massive amount of anticipated earnings would require the new employer to either 'grandfather' the hiree in, or to pay a very large signing bonus/raise. Probably on the order of a couple of $100K.
When Visteon was broken off from Ford (about 25% of the company), the employees with 20 or more years of service were promised that they'd retire under the Ford plan. This meant that virtually none of them left for other companies, even as things got worse. Those with less than 20 were switched to a Visteon plan, and would be treated as brand-new hires if they managed to get hired on at Ford. This prevented defections in the most likely direction (back to Ford). Most of the 'voluntary attrition' came from people with less than 10 years, usually less than 5.
Davies makes good points. We need stronger labor advocates as in Europe on pension security and benefits.
I can't improve on Jim Glass's post explaining why Krugman's argument is deceptive. So, I'll just add that an employer's "promise" to fund a pension doesn't occur in a vaccuum (which you'd have to believe to say what Krugman did).
And, cutting to the chase, I responded to this from another poster:
"As the current issue of Business Week explains, the pension time bomb involves large numbers; I'd say it's the equivalent of at least 50 WorldComs"
If it's a "time bomb" and "involves large numbers", that refutes Krugman. Contrary to Mr Davies (and anonymous posters) disingenuous attempt to excuse him.
BTW, if Krugman would read his own paper he would have known how bizarre were his claims:
http://www.nytimes.com/2002/04/03/nyregion/03PENS.html?pagewanted=1
<<--------------quote-------------------
New York's Pension Funds Reel After Taking a Dual Blow
By MICHAEL COOPER and ERIC LIPTON
One of the most damaging but least scrutinized causes of New York City's
current fiscal crisis is the city's pension system, which is being forced to
pay out more generous benefits to retired civil servants just as its
investments have lost more than $9 billion in the stock market.
That one-two punch - having to pay more money to retired teachers, police
officers and others when its investments have soured - has made rising
pension costs a giant unexpected drain on the city budget. Only two years
ago, the city estimated that it would need to contribute $817 million to the
pension funds in the fiscal year that begins July 1. Now that estimate has
risen to more than $2 billion.
That expense, nearly $1.2 billion higher than expected and still rising in
the coming years, forms a significant part of the $4.76 billion deficit that
the city is struggling to close by shutting centers for the elderly,
postponing new school construction, scaling back library service and
borrowing money to pay its day-to-day expenses.
-------------endquote----------------->>
Re some comments above:
Yes, another problem with defined benefit plans is, as Warren Buffet has correctly complained, they are subject to financial manipulation. They must estimate net liabilities indefinitely into the future and changing interest rate assumptions by a couple points can have a big impact on a company’s financial statements.
>> Defined benefit plans differ from 401(k)s in that defined benefit plans are *funded*<<
The reverse. Defined contribution plans are always funded. If defined benefit plans were always funded we wouldn’t need Section 412 funding waivers or the Pension Benefit Guarantee Corporation to cover pension defaults.
>>”The question of "portability" of defined benefit pensions is also a red herring. The fact that you lose a lump of pension benefit by changing jobs is not an intrinsic characteristic of defined benefit pension funds; it's a more or less conscious decision of the plan provider to rip off a chunk of the assets of departing employees…”<<
Oh, gee, just the sort of plan liberals endorse! ;-) It may not be “intrinsic” but it sure is reality.
>>Ford using defined benefits to lock a workforce in place.<<
Yes, exactly. On second thought, the ability of employers to use these plans to deny mobility to workers *is* intrinsic to them, an intentional "feature". And no government reform of this is likely because government is one of the biggest offenders.
E.g. the teachers unions’ defined benefit pension plans are exempt even from the federal government’s minimum, slowest vesting requirements for the private sector. You should examine some of the ball-and-chain pension terms those unions have negotiated, exploiting the exemption, to eliminate labor market competition between school districts and lock teachers in place. The worst that private sector firms like Ford can do along those lines seems libertarian by comparison. But does anybody expect to hear Democratic political voices protesting this any time soon? ;-) So, yes, it *is* “intrinsic reality” for these kinds of pensions.
All that said, the big problem with defined contribution plans is that most are self-directed and most people don’t know how to invest, so most people get below market returns through them. They day trade, “play it safe” in T-bills for 30 years, invest when the market is hot-and-high then get scared and sell after it falls and so spend a lifetime buying high and selling low, invest by happenstance, etc.
Of course that’s not “intrinsic” to these plans, and could be largely cured with two simple reforms. (1) Let employers educate employees in investing 101. To date tort law has largely blocked this because employees who lose money after taking such an education course could sue. But leaving employees ignorant makes no sense. The SEC has just taken some steps in this direction but there’s a long way to go. (2) Have a standard “default” plan portfolio that invests in broadly diversified growth assets until age 50 or so then moves gradually into bonds. If people want to invest differently due to their circumstances let them, after they show they’ve had “investor’s ed” like people take “driver’s ed” before driving a car. Or show they’ve married a Rockefeller so the money doesn’t matter.
Those two steps would solve 80% of the problems with defined contribution plans, IMHO, and leave workers happily free and mobile. But as they are common sense and not politically partisan, you won’t be hearing about them.
For people who know investing 101, retirement-threatening investment losses due to a down stock market aren’t an “intrinsic” risk with defined contribution plans. I just checked, and with a very standard diversified portfolio I’ve made 8% real over the last 10 years in spite of the 40% fall of the S&P 500. I can do significantly less than that for the next 20 years and retire quite happily –- the power of compound interest. Of course if I was anywhere near retirement any money I’d need in the foreseeable future wouldn’t be in the stock market, so the market fall would have been irrelevant to me. It’s not much more difficult than that.
Fine Jim - Then a lot of worker education is needed, a lot of long term equity indexing, a lot of knowledge of bond funds and access to fine low cost funds.
Jim - please note that long-term lock-in can be done by companies quite easily with 401(k)'s, as well. JD, above, stated that Enron employees were not allowed to sell their shares of Enron stock until age 55. A long time, in my book.
The URL posted refers to a story about recording artists who find that their employers have never, a promised and required, paid into the industry pension fund. (AFTRA)
Y'know, even the poor schlubs who'd buy high and sell low presumably would get some sort of monthly or quarterly statement over the course of time, showing just where their money was leaking away. The notion of believing in a pension for thirty years and waking up to discover the money was never put in at all is even more pitiful.
Though _that_ is the situation of many who rely upon the prospect of Social Security beyond 2016... But that's another topic.
" Jim - please note that long-term lock-in can be done by companies quite easily with 401(k)'s, as well. JD, above, stated that Enron employees were not allowed to sell their shares of Enron stock until age 55. A long time, in my book. "
[Posted by Barry at August 1, 2002 01:02 PM ]
Sorry, this just isn't true. The only Enron stock that couldn't be sold was the matching stock Enron gifted to its employees. Any they bought with their own money they were free to dispose of at any time (except for the temporary freeze on ANY transactions during the switch of administrators).
It's been nearly 15 years since I worked with pensions, but I believe it's illegal for the employer to place any such restrictions on how employees handle the assets they purchase for their 401Ks. I can't see how there is any way to "lock-in" a work force with a defined contribution plan. Even the restricted Enron stock didn't do that.
'Though _that_ is the situation of many who rely upon the prospect of Social Security beyond 2016... But that's another topic.'
Social security is only insolvent if the government cannot raise taxes, which is obviously impossible in a democracy. :)
'For people who know investing 101, retirement-threatening investment losses due to a down stock market aren’t an “intrinsic” risk with defined contribution plans.'
How on earth, at the macro level, can everyone's stock-composed retirement plan come out ahead when the entire market drops?
" How on earth, at the macro level, can everyone's stock-composed retirement plan come out ahead when the entire market drops? "
[Posted by Jason McCullough at August 1, 2002 03:08 PM]
Is this a serious question? Most people have a working life of 40 years or so, markets rise and fall during that period. Jim Glass just told you that he'd earned 8% per year real return over a decade, even *with* the last two years being downers. Even with the recent drops, the market has doubled in value in the last 8 years.
Jim Glass concedes that the defined contribution plans have a big problem: that they are self-directed and that people don't know how to invest.
This problem is actually bigger than he lets on. Self-direction creates its own portability issue for defined contribution plans. In the studies I've seen, about a quarter of workers eligible for defined contribution plans don't contribute; the figure rises to half for workers in their twenties. Even when younger workers do contribute, the studies show that they have a disturbing habit of cashing out their retirement balances and spending them instead of rolling them over. Thus they defeat the eventual benefit that comes from compounding small amounts over time.
Glass, like any good liberal, thinks these problems can be solved by education -- by teaching people how to invest -- and, failing that, by the compulsory guidance of steering them into a default plan.
I'd like to be optimistic that huge numbers of people can be taught to be savvy investors, but my own experience is that even well-educated people have a hard time making rational decisions about saving and investing. "The do-it-yourself model isn't working," one major investment outfit reported last year, and given the statistics about the number of workers who are investing poorly and not contributing enough, it's hard to disagree. And we haven't even got to the point yet where millions of people, at retirement, are going to have to deal with the tricky problem of figuring out how much -- or how little -- of their nestegg they can safely spend without outliving their savings.
So that leaves Glass' guided investing, which gets awfully close to a defined benefit plan. If we're going that far, why not just reform defined benefit plans to make them fully portable?
Ah, you're right, Patrick, I misread Jim as saying you could beat the market during a drop, not "diversify out of the market so you don't need to beat the market during a drop." Whoops.
I kind of agree with Mark Paul, though, I don't have much of an opinion on whether benefit or contribution plans are "better" for society. If you're going to mandate investment types for a contribution plan, what's the point?
Jim: I am not sure which of your points refer to the economics of pension funds and which are simply about the USA's Democratic Party. Since I know and care about one but not the other, woud you please do me the favour of untangling them? There are a number of points in your post where you seem to be starting off on an intersting point, but halfway through, your argument just seems to disappear into a slam against the Democrats.
One point I can establish is that defined contribution plans are not "funded" in the sense I intended, because there is no fixed liability to fund. I reiterate that the case of a pension fund which is not actuarially solvent is rare and pathological; Jim Glass appears to be treating it as a common case. One might as well argue against money in the bank on this basis, because banks "sometimes" go bust.
" Jim - please note that long-term lock-in can be done by companies quite easily with 401(k)'s, as well. JD, above, stated that Enron employees were not allowed to sell their shares of Enron stock until age 55. A long time, in my book. "
[Posted by Barry at August 1, 2002 01:02 PM ]
"Sorry, this just isn't true. The only Enron stock that couldn't be sold was the matching stock Enron gifted to its employees. Any they bought with their own money they were free to dispose of at any time (except for the temporary freeze on ANY transactions during the switch of administrators).
"It's been nearly 15 years since I worked with pensions, but I believe it's illegal for the employer to place any such restrictions on how employees handle the assets they purchase for their 401Ks. I can't see how there is any way to "lock-in" a work force with a defined contribution plan. Even the restricted Enron stock didn't do that."
Posted by Patrick R. Sullivan at August 1, 2002 01:35 PM
I don't have the cite for it, but, IIRC, the stock dropped 99% while the employees were '
temporarily' locked in, due to a switch in plan administrators. This was ~90 days, during which Enron management had an interest in limiting sales of Enron stock (futilely, in the end).
So a well-timed 'temporary' lock-in can do the same damage as a permanent lock-in.
Barry
Barry writes:
" I don't have the cite for it, but, IIRC, the stock dropped 99% while the employees were '
temporarily' locked in, due to a switch in plan administrators. This was ~90 days, during which Enron management had an interest in limiting sales of Enron stock (futilely, in the end).
" So a well-timed 'temporary' lock-in can do the same damage as a permanent lock-in."
The reason you don't "have a cite" for this is that it is NOT TRUE. In fact, it is wildly inaccurate.
Enron made a decision to switch administrators, something like six months before the actual switch. Everyone was notified of this, several times, as the day for the switch approached. The actual period in which no transactions of any kind could take place was, iirc, two weeks (10 working days).
During the two weeks Enron's stock went from about $14 to $9-something.
Now that we have established you don't have a clue as to the facts, what do you suppose the chances are that your (now revised) claim:
"a well-timed 'temporary' lock-in can do the same damage as a permanent lock-in"
is similarly accurate?
For those of you who have revised and extended your anti-Defined Contribution arguments in light of the destruction from Mr. Glass's empirical wrecking ball, here's what the Canadian Govt's policy is:
http://www.hrdc-drhc.gc.ca/isp/ris/cris_e.shtml
<<--------quote------------
Canada's retirement income system has three levels:
Old Age Security (OAS) provides the first level, or foundation. If you meet certain residence requirements, you'll be entitled to a modest monthly pension once you reach the age of 65.
The Canada Pension Plan (CPP) is the second level of the system. It provides you with a monthly retirement pension as early as 60, if you have paid into it. The Canada Pension Plan also offers disability, survivor and death benefits. Quebec has a similar plan, called the Quebec Pension Plan.
The first and second levels of Canada's retirement income system make up Canada's public pension system. Today, these pensions form a significant part of the income of Canada's seniors. But public pensions are not intended to meet all your financial needs in retirement. Rather, they provide a modest base for you to build upon with additional, private savings.
The third level of the retirement income system consists of private pensions and savings.
Many employers help you build your retirement income by providing pension plans. But perhaps you are self-employed or have no employer plan. Maybe you want to supplement your pension income.
You can build your own nest egg through Registered Retirement Savings Plans (RRSPs) . Or you can earmark for retirement other investments such as mutual funds or the equity in your home.
The Government of Canada provides tax assistance on savings in Registered Pension Plans (RPPs) and RRSPs, which encourages and assists saving for retirement.
One of the strengths of Canada's retirement income system is that the risks and responsibilities are shared by individuals, employers and governments. The result is a balanced, flexible system that responds to the different financial needs of individuals and families over the course of their lifetime.
------endquote------->>
http://www.salon.com/tech/feature/2002/01/17/401k/
They imply about 50%, not 99%. My error.
And it was shorter than I thought - again, my error. In the end, though, employees were prevented from selling their stock, by management, during a critical time (when the market consensu was clearly on 'dump!'). I'd consider a near 50% cut a bad thing, myself.
My apologies for the inaccuracies. I have posted corrections.
Now, since my comment "a well-timed 'temporary' lock-in can do the same damage as a permanent lock-in" clearly stands on it's own two feet, I'd like an apology from you, Patrick. Claiming a loss of reliability due to misinformation is clearly fair, but trying to extend that to things which are clearly not covered by that verges on ad hominem.
The late Robert Eisner was also in favor of Defined Contribution plans. From; Social Security, More Not Less:
http://www.tcf.org/Publications/Social_Security/More_Not_Less/Chapter4.html
<<----------quote----------
Those who contribute to individual retirement accounts (IRAs) are generally
limited to $2,000 per year per person. Many would at various times, if not
steadily, contribute more to retirement were an appropriate vehicle,
particularly a tax-exempt one, available.
[snip]
If a voluntary, supplementary Social Security program with a few simple
options were put into operation, and if it were adequately publicized, it
seems reasonable to believe that it would become enormously popular. For
those anxious to minimize risk, an option of investment in Treasury
securities would be attractive. For the more ambitious, looking for somewhat
higher returns, a bond index fund could be made available. For those still
more adventurous, hoping for even higher returns, there could be a passive
stock index fund. And all could have the actuarially fair annuities and
cost-of-living adjustments not available in the private market.
[snip]
Contributors to supplementary accounts would have a choice of the following
investments: 1) a fully passive stock index fund; 2) a fully passive bond
index fund; 3) Treasury securities; 4) any combination of the above. The
returns on these investments would be credited to the OASDI Trust Funds but
earmarked to the individual accounts of the investors. The new accounts
would represent public counterparts of private Keogh plans, IRAs, and
401(k)s, 403(b)s, and 457s.
[snip]
I would predict that, with sufficient publicity, many millions of
participants in the Social Security system would make major voluntary,
additional contributions and would significantly raise their prospective
retirement income.
----------endquote-------->>
In the interests of honesty, I have to make a correction on my last post - during the time of the lock-down, the price decline was on the order of from $14 to $9 per share. However, the high in that article was quoted at $90 per share. Therefore, the lock-down didn't take ~50% of the value, but much less.
If you want an apology ask the Salon writer who waited til late in the article to tell this crucial fact:
"By the time the lockdown started, Enron's stock had fallen by a lot, at least two-thirds...."
Which understates it. I make a drop from a high of $90 to $14 and change, to be about 85%.
But I'm really interested in how a decision to switch administrators at least six months before it actually happened, qualifies as "well-timed", when the stock is dropping steadily (and can be sold) during the period leading up to the freeze?
Patrick, when were the actual lock-in dates decided?
I don't mean to assert that Enron uppers anticipated the fall that far ahead. More of
a 'while we're scrambling, here's a switch we can flip'. If management has the power, many will choose to abuse it.
The simple economics here is that of risk-pooling: can it really be better for investment risk to be born individually by each employee than for the risks to be pooled and managed? Anyone arguing that there is something wrong with defined benefit plans is going to come up against the central limit theorem sooner or later.
Give it up, Barry. You're simply wrong. The company decided to change administrators months before they actually did it, and sent at least four messages to the workforce notifying them. Read about it here:
http://www.opinionjournal.com/editorial/feature.html?id=95001781
And, note that Enron employees had a choice of a Defined Benefit Plan too!
Btw, this discussion reminds me that Krugman misrepresented this too. In early December, 2001 he wrote:
<<...workers across the country have been cajoled or coerced into holding a
high proportion of their retirement assets in their employers' own stock.
The exploitive nature of this financial incest was emphasized by Enron's
now-notorious "lockdown," in which - purely by coincidence, say executives -
new rules forced employees to remain invested in the company's stock just as
the firm began its death spiral. So much for freedom of choice.>>
So much for Krugman's credibility.
Daniel Davies writes:
" The simple economics here is that of risk-pooling: can it really be better for investment risk to be born individually by each employee than for the risks to be pooled and managed? Anyone arguing that there is something wrong with defined benefit plans is going to come up against the central limit theorem sooner or later."
Well, yes, indeed it can better. Are you suggesting the risk profile for the 20 year old receptionist is the same as for the 50 year old full charge bookkeeper? Or for an employee with nothing invested other than in his 401K compared to someone who has extensive real estate holdings too?
You manage risk by diversification. And invidual situations vary greatly.
And it is not a question of whether there is "something wrong with defined benefit plans". The question is one of comparing the benefits and shortcomings of ALL types.
Defined contribution plans have been winning in the marketplace, because (as Mr. Glass has pointed out) they meet many peoples' needs better. And Krugman used to be astute enough to know things like that.
>> There are a number of points in your post where you seem to be starting off on an intersting point, but halfway through, your argument just seems to disappear into a slam against the Democrats<<
Sorry, but politics is intrinsic to real reform, and I sometimes forget that the Web isn’t a local US forum.
The attempted reasoning I failed to communicate: The charge that DC plans are unfairly risky to workers has been raised mostly in a political context, by Dems. I mean, it’s a hardly a new story. And it’s true that DC plans have faults.
But choices must be made relative to alternatives, and DB plans can act seriously against workers’ interests even in the best of times, as I’ve described. IMHO the test of genuine concern over an issue is being willing to address all the problems around. But the critics of the DC plans haven’t said “boo” about the problems of DB plans. And to the extent they are Dem partisan, as most that I’ve seen are, they aren’t likely to because the teachers unions are their #1 constituency. To me this is indicates political opportunism rather than concern – and more importantly, is an indicator that real reform, which would have to be bipartisan, is not being considered. We’re seeing showboating.
When a Repub questions self-directed 401(k)s and a Dem questions these the teachers unions plans (if only in light of school reform) I’ll think somebody is being serious, politically.
Answering a few points and then bowing out:
>>Fine Jim - Then a lot of worker education is needed, a lot of long term equity indexing, a lot of knowledge of bond funds and access to fine low cost funds.<<
Yes. Or many can use defined benefit plans. Or hybrid plans, there are many out there. And new plan models are being developed all the time.
To be clear, my point has *not* been that defined contribution plans are inherently better than defined benefit plans – they aren’t. Rather it’s been to answer the charges that they are inherently worse.
Fixing plans and developing new ideas, such as hybrids, to meet the real challenges is a *practical* matter. Politicizing it as a good/bad controversy does not help, it hurts. That’s my real point.
>> … about a quarter of workers eligible for defined contribution plans don't contribute; the figure rises to half for workers in their twenties … studies show that they have a disturbing habit of cashing out their retirement balances and spending them.<<
All true. But DB plans give very little to workers in their 20s who become mobile and change jobs, as most due. And people borrow against them and cash them out as well.
Under-saving is a problem across the board. One step to alleviate it was taken by the Clinton Treasury (Prof. Delong may take a bow?) by allowing employers to automatically enroll employees in 401(k)s at a set savings rate, requiring employees to actively elect not to save in them.
>>Glass, like any good liberal
Fighting words!!
>>thinks these problems can be solved by education -- by teaching people how to invest -- and, failing that, by the compulsory guidance of steering them into a default plan.<<
I think if more people learn how to act in their own interest, and the cost (difficulty) of doing so is reduced, more will do so. To what degree? I don’t know. All we can do is improve the world, not perfect it.
>>my own experience is that even well-educated people have a hard time making rational decisions about saving and investing. <<
Very true. Fortunately, what people have to /be taught is to do is *less* -- do diversify, then *don’t* trade, speculate, market time with a 30-year horizon, etc., -- which is easier than more. And I don’t see why the market can’t produce low-cost products to caretake investments and diversify appropriately in light of age and horizon. I think it is. “Invest and forget”.
>> Glass' guided investing, which gets awfully close to a defined benefit plan [so] why not just reform defined benefit plans to make them fully portable<<
Portable benefits for defined benefit plans are being developed. Now if you also get rid of the back-loading, you’ve almost got a 401(k). ;-)
>> I reiterate that the case of a pension fund which is not actuarially solvent is rare and pathological; Jim Glass appears to be treating it as a common case. <<
“Insolvent” is a strong word I didn’t use – it means *all* assets can’t meet even *today’s* liabilities. I was talking about being “under-funded”. Many plans are under-funded. A quick look finds the pension assets of the Dow companies fell 14% last year – and how much more this year??
Now, think of the many thousands of smaller businesses that strive to be *just* funded – they are supposed to be actuarially funded, but over-funding is a deadweight loss to them. Say they started 2001 just funded right, then they lost 14%, then how much more this year? They’re under-funded! Now some go broke in the recession, underfunded. It’s not as rare as you think, check the stats – not “pathological”. Most don’t, but must get the lost money from somewhere, which puts them at a competitive disadvantage -- which costs jobs and wages to workers.
E.g .: General Motors was $9 billion underfunded going into this year and expected pension expense this year exceeding 100% of earnings. That was *before* the stock market crash. And now? That affects how many workers it can hire and how much it can pay them!
There’s no free lunch for workers, even with defined benefit pensions.
And with that happy thought, I wish everyone a good weekend.
'Very true. Fortunately, what people have to /be taught is to do is *less* -- do diversify, then *don’t* trade, speculate, market time with a 30-year horizon, etc., -- which is easier than more. And I don’t see why the market can’t produce low-cost products to caretake investments and diversify appropriately in light of age and horizon. I think it is. “Invest and forget”.'
The market doesn't produce those products because its in the interests of this market to encourage as many trades as possible. You're spitting into the wind, here: no matter how much education you shovel at workers, the street will spew more about how great day-trading is to them, because they make a hell of a lot more money no that.
I'm not being some conspiracy-minded socialist here, I just think there's an entire industry in the way of producing a nation of well-educated investors. Something Needs To Be Done! :)
Patrick - O.K. I give up. I was wrong.
>>Well, yes, indeed it can better. Are you suggesting the risk profile for the 20 year old receptionist is the same as for the 50 year old full charge bookkeeper? Or for an employee with nothing invested other than in his 401K compared to someone who has extensive real estate holdings too?<<
Sullivan is once more, completely blowing smoke here, in the hope of confusing any lurkers who understand the issues as badly as he does. In fact, the diversity of needs is an equally strong argument for risk-pooling; consider that if the differences between individuals really meant that everyone ought to have completely different assets, the life assurance industry would look radically different from how it does at the moment.
The "existing investments" of a 20 year old receptionist or a 50 year old clerk would only be relevant to the issue if those two individuals were bearing the risks of those investments, and the whole damn point of a defined benefit plan is that they don't.
And finally for me too, I'd just note that, coming from a different country, I use the term "actuarially insolvent" to mean what Jim means by "under-funded". I dimly seem to remember that US companies are often quite a lot worse than UK ones at maintaining funding of pensions, but still would be pretty surprised if underfunding was particularly common. I maintain the view that the shortcomings of DB plans are actually the result of ongoing encroachment on employees' assets by corporations, and further venture that this encroachment reached its logical conclusion in the move to DC. Pace Sullivan, defined contribution plans "won in the market" because they allowed a small group of financially sophisticated players (companies and their advisors) to shift a whole load of risk onto a large group of less sophisticated players. In other words, they "won in the market" in the most pathological sense of the term.
On those of Jim's points which relate to specifics of US pension funds, I can't comment, but as the holder of a pretty derisory 4 years worth of DB from a major UK institution, I'll confirm that the public sector can be pretty bad at giving pension fund members anything approaching their fair asset share on departure.
>>The market doesn't produce those products because its in the interests of this market to encourage as many trades as possible.<<
It's in the interest of market suppliers to produce what consumers want.
One will note the fastest growing and most successful mutual fund group of recent years, and now the 2nd largest, is Vanguard, which specializes in index funds with a very low 0.2% annual fee. It constantly pushes the mantra "don't trade, keep costs low".
Just out of curiousity I looked up how many defaulted defined-benefit plans the PBGC is running now. About 3,000, with 600,000 pensioners, of whom 300,000 are currently receiving more than $1 billion in benefits annually. Not a huge number, but also not 'pathologically' few in what has been a boom economy for near a decade. As the annual report says, "In the past year alone, PBGC took over the retirement plans of some of the best known businesses in America, including Trans World Airlines, Grand Union and Bradlees Stores."
I also looked up the Democratic legislative proposal for pension plan reform now being considered by Congress. It's big element is to let employees diverisfy by moving funds from their 401(k)s into IRAs -- which, of course, are defined contribution plans even *more* self-directed than 401(k)s! Though it also makes statutory stock options permanently exempt from employment taxes.
So it does indeed seem that the reforms the Democrats are proposing -- and actually willing to vote for -- regarding defined contribution plans are rather meek compared to all the noise they are making about the purported inherent problems and unfairness of them. Was I cynical enough earlier to say anything about "political posturing in an election year"?
'It's in the interest of market suppliers to produce what consumers want.'
I wasn't arguing against the growth of low-load mutual/index funds for people who know what they're doing.
I was arguing that consumers will have a damn hard time figuring out that's what they should be putting their money in because the street (or some components of it) will actively oppose education along those lines. Either through lobbying, hijacking of education programs from employers, or just lying PR in the financial press.
Something I thought of while thinking about this last Friday, driving home: mutual fund manager incentives are screwy. You're paying them to make you money, yet they make money through their fees whether you gain or lose. Wouldn't a more optimum solution be for their fees to come out of the value increase, not total assets?