Windfall On Wall Street?

As Washington begins to battle over letting workers invest a portion of their Social Security in private accounts, Wall Street's big guns are staying silent. Private accounts could pump vast sums into the markets -- $54 billion a year, by the Social Security Administration's estimate. Yet financial firms aren't endorsing the accounts, and their legions of lobbyists haven't descended on Congress. The reason: Financiers argue that running those accounts would be a low-margin, high-regulation business that's hardly worth the effort.

But don't think for a minute that the Street is giving up on that gusher. Private accounts could be a boon for some firms -- and their impact on stock trading will pump up the entire industry. Reform would further extend and entrench the equity culture that has taken root over the past 20 years.

Financial executives know that if their scandal-plagued firms lead the charge, they'll hand opponents of private accounts a killer issue. The AFL-CIO has already put 46 financial firms on notice that Big Labor will hammer them if they stump actively for the plan. "Social Security privatization is a risky scheme for America but a sure bet for the financial-services industry," argues AFL-CIO President John J. Sweeney.

So Wall Street is lying low. A few firms -- notably brokers UBS Financial Services and Edward Jones -- and industry trade groups are joining forces with business coalitions and conservative groups that will run grass-roots campaigns to marshal support for the plan. Financiers will lobby in earnest in Round 2 -- likely to start several years after the private accounts are established. By then, workers' deposits -- which under many plans would be capped at $1,000 a year -- will start to add up. If lawmakers grow more comfortable with the accounts, they'll be willing to let workers branch out beyond simple index funds. So securities firms, banks, and money managers will agitate for an ever-wider array of investment choices for account holders -- and as much leeway as possible on fees. The decisions made in Round 2 on how private accounts ultimately are structured will determine the real winners and losers on Wall Street.

No question, there's big money to be made down the road. The estimated $54 billion that could pour into the markets is roughly a quarter of stock and bond mutual funds' annual take now. "In 30 or 40 years, the assets in these accounts will be on the order of the entire present-day stock market of Japan," says Austan Goolsbee, a University of Chicago economics professor.


With the new money will come a huge new crop of potential customers for Wall Street -- the 50% of U.S. households that currently don't own stock. Most of the newbies will be low-wage families who will never amass significant savings -- but others will be young workers who eventually will. That's an opportunity for mutual funds, though probably not for the full-service brokers that increasingly cater to the rich.

Financial firms scoff at suggestions that they stand to make a killing on private accounts. A report by the Securities Industry Assn. argues that Wall Street firms could pocket at best $279 billion in fees over 75 years from managing the accounts -- an 8.5% increase in the financial sector's projected $3.3 trillion in total revenue over that time. "I don't see it being in any way, shape, or form a windfall for the industry," says James S. Riepe, vice-chairman of T. Rowe Price Group Inc. (TROW ) and chairman of the Investment Company Institute, a fund industry group.

Why? Industry executives point out that, at least initially, Social Security accounts would be modeled on the retirement plan for federal employees, which allows individuals to invest in only a clutch of low-fee index funds managed by a handful of firms. That could be a boon to such big index-fund managers as Barclays Global Investors, which has run the federal worker plan's index funds since 1988, and State Street Global Advisors (STT ).

But as accounts grow, the Bush Administration tilts toward letting owners put their money, 401(k)-style, into actively managed funds. Under that scenario, fee income could balloon. Goolsbee says that if funds charged 0.8% of assets -- close to the average for big equity funds -- Wall Street could rake in $940 billion in investment fees over 75 years. It would be "the largest windfall gain in American financial history," says Goolsbee.

Vanguard Group, Fidelity Investments, T. Rowe Price, and other big fund families that know how to manage small accounts while keeping costs down could be major players. But others will want in, and not just for the fee income: Managers could use the accounts as a base from which to sell other products and services, from capturing rollovers of individual retirement accounts to planning estates and trusts. "The cross-selling opportunities are the brass ring," says Robert M. Hegarty, vice-president for securities and investments research at TowerGroup, a financial-services research firm.

Every sector of financial services will be looking for a piece of the action. Banks will lobby hard to get certificates of deposit into the asset mix. Insurers will argue that retirees should be forced to convert their private accounts to annuities, which offer a guaranteed stream of monthly payments for life. "You don't want lump-sum payments that people can blow right away," says Frank Keating, president and CEO of the American Council of Life Insurers.

A key battle will be over investment fees. Wall Street will argue for as much leeway as possible, but a ceiling is probably inevitable. "To make the cut, you'll have to accept a cap on what you charge," predicts Kim Wallace, managing director and chief political strategist at Lehman Brothers Inc. (LEH ) Higher-priced firms worry about getting caught in a squeeze -- demand for more services but pressure to keep costs low.

For now, Wall Streeters are focusing on the downside -- and giving the reform cause a wide berth. But if private Social Security accounts become a part of American life, financiers won't hesitate to elbow in for a share of the pie. The land rush of lobbyists will happen -- just later.

By Amy Borrus

With Suzanne Woolley, Diane Brady, and Emily Thornton in New York

— With assistance by Suzanne Woolley, Diane Brady, and Emily Thornton

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