401[k]s: A failed experiment

By Chris Hartman

Distributed by Minuteman Media. This version published in the Hanover (Penn.) Evening Sun, August 13, 2002. Also appeared in the Colby (Kan.) Free Press.

We've learned a lot in the past few months about all sorts of arcane financial subjects: earnings restatements, aggressive accounting, stock options, special purpose entities, offshore tax havens, Chewcos, JEDIs, and Raptors.

But we haven't heard much about the role of the 401[k] plan in all this mess. Sure, we heard about the Enron employees who took their CEO's advice and loaded up on company shares, only to lose everything. But there's been comparatively little attention paid to the question of whether or not 401[k] plans themselves are a good idea.

Before we get to that, it's important to clear up a bit of confusion about the stock market's current woes. The accounting scandals are not the cause of the stock market crash. It's the other way around. At the height of the stock market bubble, economist Dean Baker of the Center for Economic Policy Research pointed out that stocks were rising much faster than potential corporate profits, and that this gap could not be sustained forever.

He was right. But the evaporation of retirement wealth in the stock market has been due not so much to the ups and downs of the stock market as to the inherent flaws of 401[k] plans themselves. Since the 1980s, American employers have been eagerly replacing their old-style pension plans with 401[k] plans. Those old-style pensions, known as defined benefit plans, are managed by full-time investment professionals and are subject to federal laws that protect the value of the pension accounts.

In contrast, 401[k]s are cheaper for employers to administer, but as we have seen with Enron, much riskier than employees realized. In the first place, most employees don't set enough money aside in their 401[k] plans [not surprising given that wages have gone nowhere for 30 years]. It also appears many employees got caught up in the stock market mania, putting their entire portfolios in high-flying tech funds or, even worse, in their own company's stock.

But even before the market crash, it was clear that 401[k] plans were a bad deal for American workers. Between 1989 and 1998, the stock market soared, but workers heading toward retirement actually saw their retirement savings decline.

The stock market crash of 2000 to 2002 ought to prompt us to re-examine our disdain for paternalism, the idea that sometimes, in fact, government does know best. Since at least the Reagan administration, paternalism has been a dirty word in American politics. But we benefit from paternalism every day, in the form of speed limits, food inspection, product safety laws, banking regulations, and so on.

Pension systems are especially well suited to paternalism. In the public realm, the highly paternalistic forced savings system known as Social Security has made a decent life possible for millions of seniors, widows, children, and disabled people at a fraction of the administrative cost of private insurance. In the private realm, the similarly paternalistic corporate pension plans of the 1950s, 1960s, and 1970s delivered retirement security to millions of rank-and file employees. Together, Social Security and the defined-benefit pension made up a big part of the worker-owner social compact that raised living standards across the board.

It's time to admit that our great national experiment with 401[k] plans has failed. Even before the crash, retirement wealth had declined for all but the richest Americans due to the shift away from old-style pensions and toward 401[k]s.

It's clear that most of us lack the time and inclination to effectively manage our individual retirement portfolios. And that's as it should be. For the last two decades, instead of effectively managing our portfolios, we were apparently busy doing other things, like working at our actual jobs, raising our families, and volunteering in our communities.

Some in Congress are pushing reforms of 401[k] plans. Given their dismal performance as a source of retirement wealth, even in good times, wouldn't it be more effective to simply outlaw them? Require companies to offer only defined-benefit pensions, regulated by the government and backed by federal insurance. Then, with our public and private pensions in the hands of the pros, workers will focus again on more immediate concerns: improving wages, health care, and working conditions.

Chris Hartman is a researcher at United for a Fair Economy in Boston. The views expressed here are his own.