Today I’m going to revisit a theme that I believe is the most important of all — the revolution in the empowerment of the individual investor to make his own decisions and take his own risks. It’s critical that we look at this now, because with the recent volatility of stock markets — and even more so over the last week with the collapse of Enron — the critics of empowerment are seizing the opportunity to try to turn back the revolution.
In a previous column I called reform of the Social Security system — to include private accounts that people can manage on their own — the Next Big Thing. And it’s the next logical step in the revolution in investor empowerment, following naturally on the widespread adoption of 401(k) plans and do-it-yourself online investing.
And it just happens to have the power to rescue America from the greatest single threat to our long-term prosperity: the metastasizing cancer of the insolvent current Social Security system. It’s already the single largest government program in the world, and every day it gets both larger and increasingly unable to meet its obligations. Solving this problem by putting power over investment decision-making into the hands of program participants is not only necessary — it’s the right thing to do for the sake of freedom and human dignity.
But the current bear market in stocks — intensified by the drop following the Sept. 11 terrorist attacks — has given the critics of reform the chance to fret that markets are just too risky for ordinary people’s retirement safety nets. And now the collapse of Enron, many of whose employees have lost money in company stock held in their 401(k) plans, has given the critics even more to wag their fingers at.
But as I wrote in a column questioning the “401(k) gospel of equities,” the long-term case for earning superior returns by bearing the risk of investing in stocks is hardly altered by the unsurprising fact that there has been yet another bear market. The vibrant recovery since the lows of September shows how important it is not just to stay diversified, but to stay invested and stay the course.
And now, several thousand Enron employees — employees of a single company out of thousands — have lost a chunk of the value of their 401(k) savings because that portion voluntarily contributed by their employer in the form of its own stock has become worthless. I’m very sympathetic to their plight, but Enron didn’t have to contribute that stock in the first place, and employees had the choice of working somewhere else where such risky gifts were not given. And the majority of their 401(k) savings, which they had the power to invest in a variety of totally unrelated and well-diversified investment options, is totally unaffected by Enron’s problems. Yes, on a localized basis, it’s tragic. But the system works.
And what is the alternative?
In the good old bad old days before 401(k) plans, Enron would have offered a “defined benefit” plan — much like a corporate form of Social Security — in which it would promise particular payments for an employee’s lifetime after retirement. The employee would have had no say in how much risk Enron took as it invested in order to meet that promise. If Enron’s investments went bad, or if Enron itself went under, there would be some assets held in trust to at least partially meet the promise. And the government-backed Pension Benefit Guaranty Corp. — a kind of FDIC for pension plans — would probably pick up at least some of the slack at taxpayer expense: solving the problem that way would be cold comfort, indeed. And if we can’t trust the Enrons of the world enough to be thankful for some of their stock contributed to augment our own independently managed 401(k) contributions, then how can we trust them to manage 100% of our retirement savings?
The same goes for Social Security, only more so. Yes, with individual accounts each investor is at risk for the consequences of his own decision-making, and if he is terribly foolish or if there is a string of horrific bear markets, it’s possible that he would end up with an inferior investment return over his lifetime. But right now the rate of return offered by the Social Security system is less than 2% a year — and that’s presuming that the government doesn’t lower that rate of return by raising payroll taxes or cutting benefits (both of which it has done repeatedly in the past) or simply abandoning the whole system altogether at some point when the budget pain gets too great. So how much worse could the average guy or gal do on his or her own?
When those quarterly 401(k) statements showed up at the end of June it was a disappointment for many investors used to the endless fountain of bull-market returns from stocks. When the statements showed up at the end of September it was a downright shock. And Enron employees — or ex-employees, to be more precise — won’t have a very merry Christmas imagining the drop they’ll see at the end of December. But none of that alters the fact that the promises of the Social Security system simply cannot be kept. It’s a comforting fantasy, but it’s a fantasy. You can’t get there from here. We can’t tax people enough today to pay the benefits promised twenty years from now — at least not without fomenting armed revolt.
And it’s not because the Social Security system isn’t taking enough risk with its investments. Indeed, it’s taking the ultimate risk — the risk of not investing at all. The so-called Social Security Trust Fund simply buys government securities very much like Treasury bonds — which is the precise equivalent of the Enron pension plan funding its promises by buying bonds issued by Enron. That’s money that simply gets spent — by the government, just as it would be by Enron. So when it’s time to pay the benefits, the bonds come due. And what if the government — or Enron — can’t pay?
Well, the government can do something that Enron can only dream about — it can print however much money it needs to pay back those bonds when they are due. But that’s not money: that’s paper.
So it all comes down to this: there’s no riskless solution here. It’s just a question of which kind of risk you want to take. Do you want to take the risk of millions of different people each pursuing their own independent investment strategies, some doing brilliantly, some doing poorly — or do you want to take the risk of all of us doing precisely the same thing at the same time, pouring our tax dollars into current government spending disguised as investment, so that if everything goes as well as possible the government will print money to pay us someday at a rate of return of less than 2%?
Between those two risks, I’ll take the risk of empowering individuals to make their own investment decisions and make their own investment mistakes in a heartbeat. Besides, even if the two risks were precisely equal (and they’re not: one’s a legitimate investment risk with a commensurate expected return, and the other is simply throwing money down the memory hole), I’d pick the one that maximizes the freedom of the citizens of a free country.
On December 5, 2001, the Department of Labor announced that it was investigating Enron for possible violation of rules under ERISA, the federal regulations that govern corporate pension funds. The rules are clear and so are the penalties. If Enron has broken the law, it and its executives must pay the same price as any lawbreaker. But this development only strengthens my arguments. Employees investing their own money through 401(k) and other pension plans that allow personal control of investment decisions is the best way to avoid this kind of alleged corruption. The cry to return to “the good old days” when paternalistic companies — and government — does the investing for you would be to invite further abuses of this type.
And that means taking the challenge of retirement investing out of the hands of the government, and out of the hands of Enron, and putting it where it belongs: in our hands.