ON SEPTEMBER 20, 1980, a Philadelphia benefits consultant named Ted Benna discovered an obscure codicil in the tax code known as section 401(k), under which employees would not be taxed on income they chose to receive as "deferred" compensation—money they didn't use until later. The provision had been passed, without any hearings or public debate, just two years earlier as a favor to bank holding companies—but Benna realized that the wording of the law was not limited to banks. Any company could create a savings account in which employees could sock away a little pretax money every paycheck, money that might or might not be supplemented by the employer.
Some of the early supporters of the 401(k) hoped both to spur personal retirement savings and to encourage companies without any pension plans to start them up; "defined contribution" accounts were also seen as more useful for workers who didn't stay in one job long enough to accumulate a significant pension benefit. Others no doubt recognized them for what they were: a huge boon to corporate America, which quickly moved to replace costly defined-benefit plans with 401(k)s invested in mutual funds.
Unions were pressured to acquiesce to cuts in benefits, and workers were sold the idea that 401(k)s offered more "choice" and the chance of high returns in the market. For employers it was heaven: The more stock touts prospered, the more they could cut back their own contributions to retirement plans as well as the premiums they paid to the federal Pension Benefit Guaranty Corporation (PBGC). Better yet, they could make their contributions in shares of their own stock and channel employee contributions that way as well—a practice that helped Enron, among others, inflate its stock and left employees high and dry when it collapsed.
It soon became clear that 401(k)s were not going to supplement pensions, but replace them. (See "Scrambled Nest Eggs.") Congress did its part, raising premiums for defined-benefit plans (which had to contribute to the PBGC) and thus making 401(k)s (which did not) more attractive. As time went on, more and more companies froze their defined-benefit plans, creating a two-tiered system whereby longtime workers got to keep their traditional pensions while new employees were routed into 401(k) plans. In addition to their advantages for employers, 401(k)s favored wealthier workers in higher tax brackets, who stood to benefit more from being able to set aside a portion of their salaries tax free.
No one seemed much bothered by the move of a vast portion of Americans' retirement funds into risky securities-based funds. The Fed supported the 401(k) boom, just as it later would the housing boom, by championing deregulation and keeping interest rates low. Who would choose to invest their retirement funds in safe but low-interest bonds or T-bills when they could make 10, 15, or 20 percent in the market? In 1983, according to a survey conducted by two securities-industry groups, just 15.9 percent of American households owned equities; by 2005, the figure was 56.9 percent. More than half of households that owned stocks had first gotten into them through a 401(k) or similar account.
I PERSONALLY took part in the 401(k) revolution, though not by choice. Through the 1960s and '70s, I worked at The New Republic and a couple of small publications I cofounded. By this time I understood a little more about how finance capitalism worked, having read the footnotes to Marx's Capital—but since I also now had a house and a son and no money to spare, I never faced any moral dilemmas over whether or not to invest for the future via the corrupt free market. By the 1980s, I had landed at the Village Voice, and when the staff formed a union, one of its demands was a pension plan. By then the defined-benefit plans were out of style, and the best we could get was a 401(k) with a small employer contribution.
Like most 401(k) plans, this one was managed by a major financial company, which offered several choices for where we could put our money. For the staid old farts there was the basic fixed-interest-bearing account, eschewed by the knowledgeable high rollers who bet a quarter of their money in growth stocks and a quarter in balanced income, took a flier on small capital start-up companies, and even put a bit of money into some European pharmaceutical company or Asian sweatshop. To me, it all seemed like hedging your bets at the racetrack: Instead of putting money on a single horse, you put it on several, and hoped they would end up at the head of the pack.
At some point, the irritable lady who changed the mix of funds in our 401(k) over the phone gave way to an online system. Now everyone could be his own broker, Las Vegas in your living room. You heard stories of steelworkers turning up on million-dollar yachts in the Caribbean after their plants closed—thanks to their 401(k) winnings. Folk heroes rose out of the mutual fund business, brash young investment advisers who won huge returns, geniuses who ran hedge funds, touting one stock or another. I watched my 401(k) earnings grow, and at some point, I actually began to think that if I were forced out of the journalism business at 65, I might be able to live on the proceeds.
I was far from alone, of course. In 1983, 62 percent of workers relied on a defined- benefit plan; by 2007, only 17 percent did, while 63 percent only had a 401(k) or similar defined-contribution plan. Assets in 401(k)s had jumped from $92 billion in 1984 to $3 trillion. The rise of mutual funds, combined with the '90s boom and America's demographic realities, did in fact help to drive the current financial crisis. While common sense told you that there was bound to be a crash—that there simply couldn't be that large a pool of genuinely secure, high-quality investments with the kinds of yields people had gotten used to in the 1990s—the global economy bought it nonetheless. "Because, you see," writes MSNBC financial analyst Jim Jubak, "it's the only way out for an aging world that's running a huge shortage of the real stuff. So investors were all too willing to buy fake investment-grade paper—at prices commanded by the real investment-grade stuff—until finally the con was revealed."
Even the mutual fund scandal of 2003—prompted by then-New York attorney general Eliot Spitzer's discovery that a number of major funds and investment houses had colluded on buying and selling shares after the close of daily trading, at a high cost to the small-time, long-term investors who had money in 401(k)s—didn't do much to dampen enthusiasm for the industry. Congress considered some legislation that never passed, the SEC did a bit of impotent saber rattling, Spitzer was defanged by a sex scandal, and investments in mutual funds continued to grow.
Then the crackup began—starting with the speculative-grade instruments so often bundled together in mutual funds and passed off as secure places for Americans' nest eggs. That very "bundling," which was supposed to render the funds safer than individual securities by spreading out risk, actually made it easier to bury bad investments amid the good ones. Many of these funds turned out to be like the stacks of 20s proffered by counterfeiters, with genuine bills showing on the outside and the fake stuff sandwiched in between.
Sometime after I was fired from the Voice in the wake of its 2005 takeover by the New Times chain, a cheery young man called from the 401(k) company. He introduced himself as Joe and offered to guide me into switching my funds to an Individual Retirement Account. Having been impressed by my interviews with John Bogle, I told him I was thinking of moving my money to Vanguard. He demurred, saying he would personally provide me with all the help I needed, offering me private phone numbers and so on. I felt like Joe wanted to be friends. He explained how my money was to be invested, much of it in fixed-rate instruments, and I agreed.
Time passed, the market took a downturn, and I noticed on one of my monthly statements that the fixed-rate investments had disappeared, replaced by what looked like a money market account.
I called the company and asked for my old friend Joe. Joe wasn't available, I was told, but another adviser would help me. A man got on the phone and explained that my instruments had "matured." I said that I was nervous and wanted to get into something really safe, even if at a lower rate. The man quickly assured me that the market was fine, just going through one of its temporary corrections. But every investor was different, he said, and he was anxious to find my "comfort level." I said that to be on the safe side, since I'd recently turned 70, I would like to invest in US Treasuries, perhaps of an intermediate term. He was silent for a moment, then finally said, "Let me get a real expert on the phone. You'll be speaking to Robert. He's a veteran of the market and knows bonds in and out."
There was a pause, and Robert got on the phone. I told him I was thinking about Treasuries, and he let out a bellow of laughter. "Good god, no," said Robert. "That would be terrible. Nobody—nobody should put money into Treasuries."
"NO. That would be foolhardy. I have been in this a long time," Robert said. "The market goes up. The market goes down. Don't worry about it." He sounded a lot like Frankie had 45 years earlier on the armory roof. Robert assured me that everything would be all right. In fact, he said, this would be a good time to take advantage of the downturn and buy more stocks while they were cheap.
I said goodbye, not wanting to upset Robert further. He sounded like he might be about to have a stroke. I later learned that Treasuries have a far smaller sales margin than stocks and bonds.
I finally did move my money to another mutual fund company. Following its advice, I put it in a bundle of indexed funds that were supposed to be good for old people who might need to start using the money soon. These so-called target-date funds had relatively low proportions of stocks. Not low enough, as it turned out.
In 2008, the average value of stock mutual funds dropped 38 percent; bond funds dropped 8 percent. Among 401(k) holders, older people who had worked and contributed for 20 years or more, and amassed substantial savings, fared the worst, losing an average of about 25 percent of value, even after counting the money they added through the years. (On top of that, many companies—including Mother Jones—have suspended employer matching for retirement accounts as a result of the economic crisis.)
As for the supposedly safe target-date funds, those designed for investors planning to retire in 2010—less than a year from now—they lost 22 percent. That's about what my losses have come to. If I'd moved into Treasuries, as my instincts dictated, I wouldn't have earned much, but my principal would have been protected.
SO WHAT happens next? George Soros, the genius commodities man, says there is no bottom in sight for the market. Nouriel Roubini, a.k.a. "Dr. Doom," the New York University professor who has been predicting disaster for years, says the American capitalist financial system has collapsed and cannot be revived. Vanguard's John Bogle, who predicted the recession two years ago, sees the market continuing to sink before recovery begins. "This is the most difficult set of market conditions I have seen," he told me. Stocks may recover over the next decade, but by then I may be dead. What do I do? "If you can't afford to lose another red cent," Bogle told me when I interviewed him again at the end of January, "you must get out of the stock market."
But to go where? It's too late for me—but clearly the time has come to reform the system that got us to this point. One substantive idea comes from Teresa Ghilarducci, a professor of economics at the New School in New York City who was asked to draw up a pension-reform proposal for the Economic Policy Institute. The institute's proposal is for a "mixed system" that relies on "a strong defined-benefit pension system and a strong Social Security system." To this it adds what it calls "Guaranteed Retirement Accounts," under which workers who don't have access to a defined-benefit plan would be required to put 2.5 percent of their income (matched with another 2.5 percent from their employers) into investment funds run by Social Security and earning a rate of return guaranteed by the federal government.
Modest though it may be, this proposal sadly represents the outer edge of a political debate that is more likely to end up with yet another wishy-washy compromise. As part of its new budget, for example, the Obama administration in February laid out plans for what it calls "a system of automatic workplace pensions, to operate alongside Social Security, that is expected to dramatically increase" retirement and personal savings. The term "pension" in this case is grossly misleading: The plan does little more than require employers that don't offer retirement plans already to enroll employees in a "direct-deposit IRA account" unless they opt out. This pretty much amounts to 401(k)s for all, with the difference being perhaps some improvement in regulation.
Likewise, Congress, never one to throw up obstacles to the advancement of the mutual fund industry, is considering changes to 401(k) structure to head off a rising chorus of screams from angry geezers, who make up a growing sector of the electorate. Proposals include a tepid remake of the 401(k), adding on portability and preventing companies from using the plan assets to prop up their own stocks and bonds.
"There are all sorts of reforms that could be helpful—but only at the margins," notes Karen Ferguson, director of the Pension Rights Center and a leader in a new coalition called Retirement USA, who has long argued for a change in the nation's retirement structure. These reforms range from disclosure of fees to better conflict-of-interest rules on investment advice to adding a fund that only invests in government securities. But, Ferguson notes, none of these changes would "produce either adequate or secure incomes." And unlike the Economic Policy Institute's plan, all of these approaches preserve the power and profits of Wall Street investment banks.
Some economists find this all needlessly complicated. James K. Galbraith, University of Texas economist and MoJo contributor (see "How Social Security Can Save Us All"), wants to see a simple but decisive change: Increase Social Security benefits to the point that people can live off them, leaving the 401(k)s, in effect, to swing in the wind. Conservatives, on the other hand, want to cut Social Security and other old-age entitlements to prevent the mythical collapse of a supposedly insolvent system. (In fact, as Dean Baker of the Center for Economic and Policy Research has pointed out, Social Security has proved far more solvent and sound than anything Wall Street has produced.)
In any case, with banks hanging by a thread, Wall Street hemorrhaging bailout funds, a growing mass of unemployed workers, and a continuing decline of economic activity, retirement concerns will likely end up last in line. What will older folks do? I can only speak for myself. After getting myself out of the stock market and doing my best to cut expenses (and lower my standard of living), I'm working on accepting the fact that the idea of retirement is over. And I have to wonder if someday the tale of a foolish generation of Americans, who imagined that a lifetime of work would be rewarded with a comfortable and secure old age, will become just another footnote in the annals of the market.