For people who are approaching retirement, 401(k) plans haven't yet proven to be the wealth-creating machines many had hoped. Steep and prolonged declines in stocks have eaten away at many people's retirement savings. Companies like Enron -- which not only encouraged employees to put the bulk of their savings in company stock but also blocked them from withdrawing it when the company started to implode -- have sparked worry that company-sponsored 401(k) plans are far less beneficial than they seem.
And, of course, most employees now realize their retirement income is more uncertain with a 401(k) than it would have been with the so-called defined benefit plans popular in the past -- where employers promised to provide a set monthly pension, no matter what.
In the midst of this crisis of confidence comes The Great 401(k) Hoax: Why Your Family's Financial Security Is at Risk, and What You Can Do About It, by William Wolman and Anne Colamosca (Perseus Press). The book contends that the woes now plaguing 401(k)s are just the beginning. In the introduction, reprinted below, the authors contend that this "ugly combination of letters and numbers" will prove to be "the greatest systemic financial hoax ever perpetrated on an unsuspecting public."
Wolman (a senior contributing economics editor at BusinessWeek) and Colamosca have a strong point of view that (thankfully) hasn't yet been borne out by the facts. But it's well worth considering as Corporate America comes under increasing scrutiny.
The occasions are rare. But there are times when an ugly combination of letters and numbers penetrates deeply into the American consciousness. There was a time when "4F" was one of the best-known expressions in the American language, connoting a young man who became exempt from the military draft because he had flunked the physical. Catch-22, the title of a book by Joseph Heller about a military snafu in the war against Japan, became famous as a description of a problem with no solution.
A similar fate awaits the combination that defined the hopes and dreams of American families as they celebrated the booming 1990s and looked forward to a new, exciting postmillennial decade: 401(k). Those four symbols had become an American icon, seeming to contain within them the promise that the average American family, neither rich nor poor but middle class, could stake a claim for its share in the prosperity created by the technological wonders that energized the American economy in the 1990s.
The vision of family wealth turned the 401(k) into a cultural icon celebrated in cartoons, fiction, television, magazines, and front-page stories in the nation's most famous newspapers. The 401(k) is a form of retirement plan in which employees are responsible for managing their own pensions and employers voluntarily contribute matching funds or stock. It differs from traditional defined benefit plans, which guarantee a monthly income to retirees. In a defined contribution plan such as the 401(k), the risk of the plan, especially if the stock market declines or the employer opts not to provide matching funds or company stock, is borne by the worker. The 401(k) seemed to be ideally suited to an age in which politicians refused to pay for high-priced government programs and "go it alone" endeavor ruled the day. The 401(k) was portable in a workplace where frequent job changes were fashionable and held to be desirable. It provided some scope for eligible employees to make their own decisions about how to invest their money in an era when investment information dominated the airwaves and Internet. It seemed ideally suited to a world in which it was cheaper and cheaper to trade stocks. And above all, it appeared as a device that made it easy for the average worker to participate in the greatest boom in history. It seemed that the 401(k) would be a perpetual wealth machine for each and every member of the great American middle class.
It felt great while it lasted. But the 401(k) will turn out to be the greatest systemic financial hoax ever perpetrated on an unsuspecting public. The danger inherent in the four characters is, as Vice President Dick Cheney would say, "big time." The problems with the 401(k) suddenly surfaced in late 2001, when a recession that was already underway was intensified by the attack on the World Trade Center. In quick succession, some leading corporations, including Daimler-Chrysler, Lucent, Bethlehem Steel, Wyndham International, and above all, Enron, scaled back their matching contributions to 401(k)s. And Enron and Lucent were shown to have forced their employees to hold company stock even against their will, with catastrophic consequences in a market where those stocks were plunging. Some 30 percent of assets held in 1.5 million 401(k) plans were in the stock of the company sponsoring the plan, putting many people at risk (see Chapter 8). In the wake of these revelations, employees around the country held their breath in case their 401(k)s should suffer a similar fate.
The financial threat of a 401(k) system gone sour goes beyond anything that has yet been seen. By comparison, the Dutch tulip mania of 1637 was a rose tournament in Portland, Oregon; the South Sea Bubble of 1720, a tempest in a backyard swimming pool; the gold rush of 1849, a treasure hunt at an eight-year-old's birthday party; the Great Crash of 1929, the production of an off-Off Broadway play. Protecting the American family from the potential ravages of the 401(k) will require radical changes in both private finances and public policy.
The new approach to retirement offered the family a share of ownership in the great American corporations that dominate the global economy, indeed, in the stock of any company traded on the New York, American, and Nasdaq exchanges. To make it easy, those shares could be gradually acquired on what felt like an installment plan: easy monthly paycheck deductions. A big feature of most 401(k)s was partially matching contributions from employers. And the Internal Revenue Service kicked in, too: The money put into the 401(k) is a deduction from the family's taxable income. The government only gets its money later, after employees retire and begin to live off the stocks that they had so patiently accumulated.
The 401(k) ushered in a revolution in the way Americans were able to think about their financial prospects as they grew older. And as with all revolutions, the 401(k) created serious new risks. In America's traditional pension plans, spanning most of the twentieth century, employees were promised a monthly check by their employers after they reached retirement age. The responsibility for making sure that this all-important check would not bounce rested with companies. And since the size of the check was fixed, the traditional retirement plans came to be known as defined benefit plans. Employers were made liable and assumed the risk that the investments that funded defined benefit plans would be successful enough to guarantee the retirement income of all workers who participated.
The retirement revolution took the risks inherent in investing away from the corporation and put them squarely on the backs of employees. The 401(k) came to be known as a defined contribution pension plan. Theoretically, it left employees free to choose from a menu of their own investments, with the caveat that any risk that investments would turn sour would be the responsibility of workers.
In effect, 401(k)s ask American workers to ape the investment behavior of the rich, even though they obviously do not have the resources to ride out bad markets of the kind that we believe will prevail for the next decade. By law, working Americans own the money in their 401(k) plans and are free to invest it as they will. But in reality, most companies do not include an adequate range of investment choices to safeguard savings in volatile markets. At their core, the choices available in most 401(k)s represent a sometimes subtle, and sometimes not so subtle, implication that the employee would do best by investing in stocks.
The 401(k) is, of course, not the only defined contribution retirement program that is "tax advantaged" -- given a favored tax status -- by the Internal Revenue Service. It is only the best-known member of a family of defined contribution pension plans. We chose to use it in the title of our book because it is an icon of the public culture and also represents similar private-sector programs: all forms of profit-sharing plans, stock bonus plans, employee stock ownership plans (ESOPs), employee Keogh plans, and simplified employee pensions (SEEPs). There are also 403(b) plans, similar to 401(k)s, which cover schools, churches, and other tax-exempt organizations.
By mid-February 2002, American investors had lost $5 trillion or 30 percent of their stock wealth since the spring of 2000. Yet Wall Street's propaganda in favor of the family market continued to be backed by gobs of advertising dollars and millions in campaign contributions and lobbying, along with brokers and analysts hired to promote stocks day after day, no matter how bad things got. Andrew Smithers, the brilliant British financial analyst, once told the authors that he could make a lot more money by being a bull and being wrong than by being a bear and being right.
The same cannot be said of those who depend on their 401(k) programs. The American public has been hoodwinked by political and corporate forces into relying on the 401(k) as the primary long-term investment mechanism. In doing so, the stock market has been put at center stage in providing for a comfortable retirement for the average American. The 401(k) represents an implicit promise to middle-class Americans that they can live off the income that they receive from stock ownership, just like the rich do. It is a promise that is impossible to fulfill: It is the great 401(k) hoax.
From the book, The Great 401(k) Hoax: Why Your Family's Financial Security is at Risk, and What You Can Do About It, by William Wolman and Anne Colamosca. Copyright (c) 2002. Reprinted by arrangement with Perseus Press. All rights reserved