Felix Salmon

It’s May Day, and Henry Blodget is celebrating — if that’s the right word — with three charts, of which the most germane is the one above. It shows total US wages as a proportion of total US GDP — a number which continues to hit all-time lows. Blodget also puts up the converse chart — corporate profits as a percentage of GDP. That line, you won’t be surprised to hear, is hitting new all-time highs. He’s clear about how destructive these trends are:

Low employee wages are one reason the economy is so weak: Those “wages” are represent spending power for consumers. And consumer spending is “revenue” for other companies. So the short-term corporate profit obsession is actually starving the rest of the economy of revenue growth.

In other words, we’re in a vicious cycle, where low incomes create low demand which in turn means that there’s no appetite to hire workers, who in turn become discouraged and drop out of the labor force. Blodget’s third chart is one we’re all familiar with: the employment-to-population ratio, which fell off a cliff during the Great Recession and which will probably never recover. The current “recovery” is not actually a recovery for the bottom 99%, for real people who need to live on paychecks. And today is exactly the right day to point that out.

Conversely, today is exactly the wrong day to declare that these broad and inexorable trends are not really big top-down trends at all, and in fact merely reflect the inability of individual workers to “access learning, retrain, engage in commerce, seek or advertise a job, invent, invest and crowd source”. And yet that’s Tom Friedman’s column this May Day:

If you are self-motivated, wow, this world is tailored for you. The boundaries are all gone. But if you’re not self-motivated, this world will be a challenge because the walls, ceilings and floors that protected people are also disappearing. That is what I mean when I say “it is a 401(k) world.”

This manages to be both incomprehensible and incredibly offensive at the same time. I have no idea what Friedman thinks he’s talking about when he blathers on about disappearing protective floors; I can only hope that he isn’t making a super-tasteless reference to the recent disaster in Bangladesh. But it’s simply wrong that today’s world is “tailored” for anybody who happens to be “self-motivated”. Both the self and the motivation are components of labor, not capital, and as such they’re on the losing side of the global economy, not the winning side.

Friedman is a billionaire* (by marriage) who — like all billionaires these days — is convinced that he achieved his current prominent position by merit alone, rather than through luck and through the diligent application of cultural and financial capital. His paean to self-motivation recalls nothing so much as Margaret Thatcher’s “there is no such thing as society” quote: “parenting, teaching or leadership that ‘inspires’ individuals to act on their own will be the most valued of all,” he writes, bizarrely choosing to wrap his scare quotes around the word “inspires” rather than around the word “leadership”, where they belong.

True leadership, in a society where the workers are failing to be paid even half the fruits of their labor, would involve attempting to turn the red line in Blodget’s chart around, and to spread the nation’s prosperity among all its citizens. Rather than telling everybody that they’re “on their own” and that if they’re not a success then hey, they’re probably just not “self-motivated” enough.

The ultimate Friedman kick in the balls, however, doesn’t come from his lazily meritocratic priors. Rather, it comes from his overarching metaphor: the idea that if you have a 401(k) plan, then you’re somehow in charge of your own destiny. Friedman might be right that we’re living in a 401(k) world, but if he is then he’s right for the wrong reason. In Friedman’s mind, a 401(k) plan is an icon of self-determination: you get out what you put in. “Your specific contribution,” he writes, italics and all, “will define your specific benefits.”

In reality, however, a 401(k) plan is an icon of futility and the way in which the owners of capital extract rents from the owners of labor. Yves Smith is good on this, as is Matt Yglesias, although the real expert is Helaine Olen: the 401(k) is a way for both your government and your employer to disown you, and to leave your life savings to be raided by the financial-services industry and its plethora of hidden and invidious fees. The well-kept secret about old-fashioned pension funds is that, for the most part, they’re actually very good at generating decent returns for their beneficiaries. They tend to have extremely long time horizons, and are run by professionals who know what they’re doing and who have a fair amount of negotiating leverage when they deal with Wall Street. Savers are always strengthened by being united: disaggregating them and forcing them to take matters into their own hands is tantamount to feeding them directly to the Wall Street sharks.

Yglesias says that in a 401(k) world, “you’ve got to save a lot of money for retirement. More than you think.” This is true for five big reasons. Firstly, because wages are shrinking, any given level of savings will constitute a steadily-increasing proportion of any given worker’s GDP-adjusted paycheck. Secondly, because the employment-to-population ratio is shrinking, all workers need to save to support not only themselves in retirement, but also a number of dependents which is also growing over time. Thirdly, because 401(k) plans have lower returns than traditional pension plans, you need to save more in order to make up the difference. Fourthly, life happens: while the money in your 401(k) is nominally there for your retirement, in practice there’s a good chance that you’re going to tap it, at some point, to pay some kind of large and unexpected bill, whether that comes from unemployment or divorce or ill health. And finally, 401(k) plans don’t have the clever cross-subsidy that traditional pension plans have, where people who die early cross-subsidize people who live for a long time. With a pension plan, you get income when you need it — when you’re alive — and you don’t get money when you’re dead, and don’t need it any more. With a 401(k), by contrast, you have to save more than you really need, because there’s always a chance that you’re going to live to 102.

Add them all together, and to a first approximation you arrive at our current world, where pretty much no one relying on their 401(k) is actually saving enough for retirement. If you’re rich today, you’ll probably be fine when you retire. But if you’re someone who (in contrast to Tom Friedman) actually lives on your paycheck, then there’s almost no chance that your retirement savings will be enough, when the time comes. That’s not your fault: the reasons are deeply systemic. And as a result, the solutions cannot possibly be the kind of bottom-up schemes that Friedman is extolling. They have to come from the top: from real leaders, rather than jumped-up “thought leaders“.

*Or was, anyway. Maybe he isn’t any more.

Last year, I said that states should not adopt defined-contribution pension schemes: they should stick instead to the defined-benefit plans they’ve had until now. I still believe that — but I’m also a big fan of SB 1234, a bill making its way through the California legislature. The bill would create the Golden State Retirement Savings Trust — a kind of pooled defined-contribution pension plan for the millions of Californians who lack access to a workplace retirement plan.

The point here is that the state of California itself is a good employer, providing retirement benefits to its employees. But not all Californian employers do likewise, and many Californians, especially those on low wages, have no retirement savings at all.

SB 1234 would change that, by asking employers to place 3% of their employees’ paychecks into the Golden State Retirement Savings Trust. This would be an opt-out scheme: if you didn’t want to take part, you wouldn’t have to, but the default would be that you would. The money would be invested conservatively; one detailed paper reckons that the mix might be 47% Treasuries, split equally between bills, notes, and bonds; 43% in the S&P 500; 7% in small-cap stocks; and 3% in corporate bonds.

There are two big distractions here, and it’s all too easy to get caught up in things which don’t matter, and miss the big thing which does matter. The first distraction is the question of investment guarantees. Because these workers can’t afford to lose this money, it would have to be guaranteed, either by the public sector or the private sector. If you’re investing over a long time horizon, and guaranteeing only very modest returns of between 0% and 2%, such guarantees are cheap — but that doesn’t stop alarmists from talking about “another potential pension disaster” in terms of guarantor losses.

The second distraction is the question of investment returns: will the money be invested well, or does California have “a poor record of managing its existing public pensions” which should somehow disqualify it from looking after even more retirement funds? Frankly, this doesn’t matter much at all. Big pension funds nearly always have higher internal rates of return than individuals get on their 401(k) plans and similar, and that’s really all that matters.

The main thing to focus on here is the same thing I told savers with 401(k) accounts: the best way to save money is to save money. If you take 3% of your paycheck and you put it somewhere which is very difficult to get ahold of, then over time that sum will grow to a nice little nest egg — even if the internal rate of return is zero. And if you want to get millions of largely low-wage Californians to save money, the mere existence of savings accounts and IRAs at banks and credit unions isn’t enough. Those involve effort, while the genius of SB 1234 is that it’s effortless. All you need to do is nothing, and you automatically start saving money.

Anybody who would rather use their own IRA is more than welcome to do so, of course. And anybody who is happy going without retirement savings at all can simply opt out of the scheme and receive their paycheck in full. But most of us want some kind of retirement security beyond Social Security; the problem is that we procrastinate, and we have bigger priorities, and there are short-term expenditures we need to make, and there’s never any spare money in the account, and, well you get the picture.

The financial-services industry is lobbying hard against this bill, for obvious reasons: it provides a simpler, cheaper, better alternative to their own savings products. As a result, this idea will probably never happen. But it makes sense for California, and it makes sense for the rest of the country as well.

As for the details, they can be ironed out relatively easily. But the final scheme could be a bit of a mix between defined-contribution and defined-benefit. Like DC plans, the amount you got out would entirely be a function of the amount you put in. But like DB plans, more would go into calculating your final payout than simply the investment returns on your money. Instead, there would be some kind of a collar: in return for giving up infinite upside, you would be protected on the downside. For instance, the returns might have a floor at 2%, and a ceiling at 8%. The scheme could simply pay excess returns over 8% into a reserve fund which would be used to protect the downside for savers seeing returns of less than 2%.

Similar products exist elsewhere in the world: Denmark, for instance, has a nationwide mandatory defined-contribution pension plan with a minimum return guarantee. This is America, so a mandatory program wouldn’t fly. But a voluntary, opt-out program could. Let’s give it a try.

Bob Litan, formerly of the Kauffman Foundation and the Brookings Institution, has recently taken up a new job as director of research for Bloomberg Government, where he’s going to have to be transparent and impartial. But one of his last gigs before moving to Bloomberg — a paper on the subject of people borrowing money from their 401(k) accounts — was neither of those things.

To understand what’s going on here, first check out Jessica Toonkel’s article from Friday about Tod Ruble and his company, Custodia.

Tod Ruble is trying to sell retirement plan insurance that employers say they do not want and their employees may not need.

But the Dallas-based veteran commercial real estate investor is not letting that stop him. Since late 2010, he has started up a company, Custodia Financial, and spent more than $1 million pushing for legislation that would allow companies to automatically enroll employees who borrow from their 401(k) plans in insurance that could cost hundreds of dollars a year.

Once you’ve read that, go back and check out a spate of stories that hit a series of major news outlets in July. Alan Farnham of ABC News, for instance, ran a story under the headline “401(k) Loan Defaults Skyrocket”:

A new study estimates that such defaults might total $37 billion a year, a sharp increase from 2007, when defaults totaled only $665 million.

Similarly, check out Walter Hamilton, in the Chicago Tribune (and LA Times): the headline there is “Defaults on 401(k) loans reach $37 billion a year”. At Time, Dan Kadlec also ran with the $37 billion number, saying that “the default rate on these loans has skyrocketed since the recession”. Similar stories came from Blake Ellis at CNN Money (“Loan defaults drain $37 billion from 401(k)s each year”), Mitch Tuchman at MarketRiders (“401k Loan Default Time Bomb Is Ticking”), and many others.

The only hint of skepticism came from Barbara Whelehan at BankRate. She noted that the study cited Kevin Smart, CFO of Custodia Financial, as a source — and she also noted that “it would be a boon for the insurance industry to get the rules changed, and it is working behind the scenes to do just that. In April, Custodia Financial submitted a statement to the House & Ways Committee arguing for automatic enrollment into insurance coverage for 401(k) loans.”

Whelehan also smelled something fishy in the way the paper was paid for:

This paper by Navigant Economics, which made a big splash in the press, was financially supported by Americans for Retirement Protection. That organization has a website, ProtectMyRetirementBenefits.com, but no “about us” link. It does give you the opportunity to sign a petition demanding protection of retirement funds through insurance. Take a look at it, and see if you think the website was created by average Americans or by the insurance industry.

Whelehan was actually breaking news here: there’s no public linkage between Americans for Retirement Protection, the organization which paid for the paper, and the astroturf website. In fact, Americans for Retirement Protection seems to have no public existence at all, beyond a footnote in the paper, which was co-authored by Bob Litan and Hal Singer.

Enter Toonkel, writing her story about Custodia. In the course of her reporting, she discovered — and Custodia confirmed — that Americans for Retirement Protection, and ProtectMyRetirementBenefits.com, are basically alter egos of Custodia itself. Custodia would welcome other organizations joining in, but that’s unlikely to happen, because Custodia owns the patents on the big idea that the paper and the website are pushing — the idea that 401(k) loans should come bundled with opt-out insurance policies.

Once you’re armed with this information, it’s impossible not to look at the Litan-Singer paper in a very different way. Its abstract concludes: “We demonstrate that the social benefits of steering (but not compelling) plan participants towards insurance when they borrow are likely positive and economically significant.” And yet nowhere in the paper is there any indication that it was bought and paid for by the very company which has a patent on doing exactly that.

And what about that $37 billion number? Are defaults on 401(k) loans really as big a problem as the paper says that they are? After all, the smaller the problem, the less important it is to introduce an expensive fix for it.

The simple answer is no: 401(k) loan defaults are not $37 billion per year. But the fact is that nobody knows for sure exactly where they are, which makes it much easier to come up with exaggerated estimates. As the paper itself admits, “the sum total of 401(k) defaults ought to be an easily accessible statistic, but it is not”. And the $37 billion, far from being a good-faith estimate, in fact looks very much like an attempt to get the largest and scariest number possible.

So how did Litan and Singer arrive at their $37 billion figure? Let’s start with the only concrete numbers we have — the ones from the Department of Labor, whose most recent Private Pension Plan Bulletin gives a wealth of information about all private pension plans in the country. Every pension plan has to file something called a Form 5500, and the bulletin aggregates all the numbers from all the 5500s which are filed; the most recent bulletin gives data from 2009.

This bulletin has two datapoints which are germane to this discussion. First of all, there’s Table A3, on page 7 of the bulletin (page 11 of the PDF). That shows that loans from defined-contribution pension plans to their own participants totaled $51.7 billion in 2009. Secondly, there’s Table C9, the aggregated income statement for the year. If you look at page 32 of the bulletin (page 35 of the PDF), you’ll see a line item called “deemed distribution of participant loans”, which came to $670 million for the year. If you borrow money from your 401(k) and you don’t pay it back, then that money is deemed to have been distributed to you, and counts as a default. So we know that the official size of 401(k) defaults in 2009 was $670 million — a far cry from Litan and Singer’s $37 billion.

Now the $670 million figure does not account for all 401(k) defaults. Most importantly, in some situations, if you default on a 401(k) loan after having been fired from your job, then the money is counted as an “actual distribution” rather than as a “deemed distribution”.

The Litan-Singer paper goes into some detail about this. “According to a recent study by Smart (2012),” they write, “although Form 5500 reflects actual distributions, there is no way to determine the amount of actual defaults.” They then look in detail at Smart’s figures, footnoting him five consecutive times, and treating him as an undisputed authority on such matters. Their citation is merely “Kevin Smart, The Hidden Problem of Defined Contribution Loan Defaults, May 2012.”

Where might someone find this paper? Here, since you ask: it’s helpfully hosted at CustodiaFinancial.com. And on the front page of the paper, Kevin Smart is identified as the “Chief Financial Officer, Custodia Financial”.

There’s no indication whatsoever in the Litan-Singer paper that the “Smart” they cite so often is the CFO of Custodia Financial, the company which has the most to gain should their recommendation be accepted. And there’s certainly no indication that he’s essentially their employer: that Custodia paid them to write this paper. In fact, the name Custodia appears nowhere in the Litan-Singer paper at all.

It’s instructive to look at the Smart paper’s attempt to estimate the magnitude of the 401(k) default problem. I’ll simplify a little here, but to a first approximation, Smart assumes that 12% of people with 401(k) loans lose their jobs. He also assumes that if you lose your job when you have a 401(k) loan, there’s an 80% chance you’ll default on that loan. As a result, he comes up with a 9.6% default rate on 401(k) loans. He then multiplies that 9.6% default rate by total 401(k) loans of $51.7 billion, adds in some extra defaults due to death and disability, and comes up with a grand total of $6.2 billion in loan defaults per year, excluding the “deemed distributions” of $670 million. Call it $7 billion in total, of which $6 billion could be protected by insuring loans against unemployment, death, and disability.

Now remember that this is a paper written by the CFO of Custodia Financial — someone who clearly has a dog in this race. It’s in Smart’s interest to make the loan-default total look as big as possible, since the bigger the problem, the more likely it is that Congress will agree to implement Custodia’s preferred solution.

But when Litan and Singer looked at Smart’s paper, they weren’t happy going with his $6 billion figure. Indeed, as we’ve seen, their paper comes up with a number six times larger. So if even the CFO of Custodia only managed to estimate defaults at $6 billion, how on earth do Litan and Singer get to $37 billion?

It’s not easy. First, they double the total amount of 401(k) loans outstanding, from $52 billion to $104 billion. Then, they massively hike the default rate on those loans, from 9.6% to 17.9%. And finally, they add in another $12 billion or so to account for the taxes and penalties that borrowers have to pay when they default on their loans.

It’s possible to quibble with each of those changes — and I’ll do just that, in a minute. But it’s impossible to see Litan and Singer compounding all of them, in this manner, without coming to the conclusion that they were systematically trying to come up with the biggest and scariest number they could possibly find. It’s true that whenever they mention their $37 billion figure, it’s generally qualified with a “could be as high as” or similar. But they knew what they were doing, and they did it very well.

When the Chicago Tribune and the LA Times say in their headlines that 401(k) loan defaults have reached $37 billion a year, they’re printing exactly what Custodia and Litan and Singer wanted them to print. The Litan-Singer paper doesn’t exactly say that defaults have reached that figure. But if you put out a press release saying that “the leakage of funds in 401(k) plans due to involuntary loan defaults may be as high as $37 billion per year”, and you don’t explain anywhere in the press release that “leakage of funds” means something significantly different to — and significantly higher than — the total amount defaulted on, then it’s entirely predictable that journalists will misunderstand what you’re saying and apply the $37 billion number to total defaults, even though they shouldn’t.

But let’s backtrack a bit here. First of all, how on earth did Litan and Singer decide that the total amount of 401(k) loans outstanding was $104 billion, when the Department of Labor’s own statistics show the total to be just half that figure? Here’s how.

First, they decide that they need the total number of active participants in defined-contribution pension plans. They could get that number — 72 million — from the Labor Department bulletin: it’s right there in the very first table, A1. But the bulletin isn’t helpful to them, as we’ve seen, so instead they find the same number in a different document from the same source.

That’s as much Labor Department data as Litan and Singer want to use. Next, they go to the Investment Company Institute, which has its own survey, covering some 23 million of those 72 million 401(k) participants. According to that survey, in 2011, 18.5% of active participants had taken out a loan; Litan and Singer extrapolate that figure across the 401(k) universe as a whole.

Finally, Litan and Singer move on to Leakage of Participants’ DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income, a 2011 report from Aon Hewitt which is based on less than 2 million accounts, of the 72 million total. According to the Aon Hewitt report, which doesn’t go into any detail about methodology, when participants took out loans, “the average balance of the outstanding amount was $7,860″. Needless to say, that number was never designed to be multiplied by 72 million, as Litan and Singer do, to generate an estimate for the total number of loans outstanding.

If you want an indication of just how unreliable and unrepresentative the $7,860 number is, you just need to stay on the very same page of the Aon Hewitt report, which says that 27.6% of participants have a loan. If Litan and Singer think that the $7,860 figure is reliable, why not use the 27.6% number as well? If they did that, then the total number of 401(k) loans outstanding would be $7,860 per loan, times 72 million participants, times 27.6% of participants with a loan. Which comes to $156 billion.

But of course we know that there were just $51.7 billion of loans outstanding in 2009; evidently Litan and Singer reckoned that it just wouldn’t pass the smell test if they tried to get away with saying that number might have trebled in a single year. So they confined themselves to merely doubling the number, instead.

Litan and Singer give no reason to mistrust the official $51.7 billion number, except to say that it’s “outdated”. But if it’s outdated, it’s only outdated by one year: it’s based on 2009 data, while the much narrower surveys that Litan and Singer cite are generally based on 2010 data. At one point, they cite the ICI survey to declare that there is “an estimated $4.5 trillion in defined contribution plans”, despite the fact that the much more reliable Labor Department report shows that there was just $3.3 trillion in those plans as of 2009. This, I think, quite neatly puts the lie to the Litan-Singer implication that the problem with the Labor Department numbers is merely that they are out of date, and that when we get numbers for 2010 or 2011, they might well turn out to be in line with the Litan-Singer estimates. There’s simply no way that total DC assets rose from $3.3 trillion to $4.5 trillion in the space of a year or two.

In other words, whatever advantage the ICI and Aon Hewitt surveys have in terms of timeliness, they more than lose in terms of simply being based on a vastly smaller sample base. Litan and Singer adduce no reason whatsoever to believe that the ICI and Aon-Hewitt surveys are in any way representative or particularly accurate, despite the fact that the discrepancies between their figures and the Labor Department figures are prima facie evidence that they’re not representative or particularly accurate. If the ICI and Aon Hewitt surveys were all we had to go on, then I could understand Litan-Singer’s decision to use them. But given that the Labor Department already has the number they’re looking for, it just doesn’t make any sense that they would laboriously try to recreate it using less-reliable figures.

It’s true that the Labor Department’s figures do undercount in one respect: they cover only plans with 100 or more participants — and therefore cover “only” 61 million of the 72 million active participants in DC plans. If Litan and Singer had taken the Labor Department’s numbers and multiplied them by 72/61, or 1.18, that I could understand. But disappearing into a rabbit-warren of private-sector surveys of dubious accuracy, and emerging up with a number which is double the size of the official one? That’s hard to justify. So hard to justify, indeed, that Litan and Singer don’t even attempt to do so.

That, indeed, is the strongest indication that the Litan-Singer paper can’t really be taken seriously. For all their concave borrower utility functions and other such economic legerdemain, they simply assert, rather than argue, that they “believe” it is “more appropriate” to use private-sector surveys rather than hard public-sector data. Such decisions cannot be based on blind faith: there have to be reasons for them. And Litan-Singer never explain what those reasons might be.

Now the move from public-sector to private-sector data merely doubles the total size of the purported problem, while Litan-Singer are much more ambitious than that. So their next move is to bump up the default rate on loans substantially.

There’s no official data on default rates at all, so Litan and Singer, following Smart’s lead, decide to base their sums on a Wharton paper from 2010. Once again, they have to extrapolate from a very small sample: the Wharton researchers had at their disposal a dataset covering 1.5 million plan participants (just 2% of the total). Looking at what happened over a period of three years, from July 2005 to June 2008, the researchers found that the number of terminations, and the number of defaults, remained pretty steady:

These are the numbers that Smart used in his paper: roughly 12% of loan holders being terminated each year, and roughly 80% of those defaulting on their loans.

But these are not the numbers that Litan-Singer use. Instead, they notice that the overall default rate, as a percentage of overall loans outstanding, was roughly double the national unemployment rate at the time. And so since the unemployment rate doubled after June 2008, they conclude that the default rate on outstanding 401(k) loans probably doubled as well.

Do they have any evidence that the default rate on 401(k) loans might have doubled after 2008? No. Well, they have a tiny bit of evidence: they look at the small variations in default rates in each of the three years covered in the Wharton study, and see that those variations move roughly in line with the national unemployment rate. Never mind that the default rate fell, from 9.9% to 9.7%, between 2006 and 2008, even as the unemployment rate rose, from 4.8% to 5.0%. They’ve still somehow managed to convince themselves that it’s reasonable to assume that the default rate today is nowhere near the 9.6% seen in the Wharton survey, and in fact is probably closer to — get this — 17.9%.

This doesn’t pass the smell test. The primary determinant of the default rate, in the Wharton study, was the percentage of loan holders who wound up having their employment terminated, for whatever reason. And so what Litan-Singer should be looking at is the increase in the probability that any given employee will end up being terminated in any given year.

Remember that in any given month, or year, the number of people fired is roughly equally to the number of people hired. When the former is a bit larger than the latter for an extended period, then the unemployment rate tends to go up; when it’s smaller, the rate goes down. But the churning in the employment economy is a constant, even when the unemployment rate is very low.

When the unemployment rate rose after 2008, that was a function of the fact that the number of people being fired was a bit higher than normal, while the number of people being hired was a bit lower than normal. But looked at from a distance, neither of them changed that much. In terms of the Wharton study, what we saw happening to the unemployment rate is entirely consistent with the percentage of loan-holders being terminated, per year, staying pretty close to 12%. Of course it’s possible that number rose sharply, but it’s really not possible that number rose as sharply as the unemployment rate did. And so I find it literally incredible that Litan and Singer should decide to use the national unemployment rate as a proxy for the number of people whose employment is terminated each year.

Well, maybe not literally incredible — the fact is there’s one very good reason why they might do that. Which is that they were being paid by Custodia to use any means possible to exaggerate the number of annual 401(k) loan defaults.

Litan and Singer do actually provide a mini smell test of their own: they say that their hypothesized rise in 401(k) loan defaults is more or less in line with the rise in, say, student-loan defaults or in mortgage defaults over the same period. But those statistics aren’t comparable at all, because Litan and Singer are already assuming that the default rate on 401(k) loans, among people who lose their job, was a whopping 80% before the financial crisis. There’s a 100% upper bound here: you can’t have a default rate of more than 100%. Remember that the whole point of this paper is to provide the case that people taking out 401(k) loans should insure themselves against unemployment: any rise in the default rate from people who don’t lose their job (or die, or become disabled) is more or less irrelevant here. And when your starting point is a default rate of 80%, there really is a limit to how much that default rate can rise; it’s certainly going to be difficult to see it rise by more than 85%, even if you allow a simultaneous increase in the number of people being terminated.

All of this massive exaggeration has an impressive effect: if you take $104 billion in loans, and apply a 17.9% default rate, then that comes to a whopping $18.6 billion in 401(k) loan defaults every year. A big number — but still, evidently, not big enough for Litan and Singer. After all, their number is $37 billion: double what we’ve managed to come up with so far. We’ve already doubled the size of the loan base, and almost-doubled the size of the default rate, so how on earth are we going to manage to double the total again?

The answer is that LItan and Singer, at this point, stop measuring defaults altogether, and turn their attention to a much more vaguely-defined term called “leakage”. Once again, they decide to outsource all their methodology to Custodia’s CFO, Kevin Smart. The upshot is that if you borrowed $1,000 from your 401(k) and then defaulted on that loan, the amount of “leakage” from your 401(k) is deemed to be much greater than $1,000. Litan and Singer first add on the 10% early-withdrawal penalty that you get charged for taking money out of your plan before you retire. They also add on the income tax you have to pay on that $1,000, at a total rate of 30%. (They reckon you’ll pay 25% in federal taxes, and another 5% in state taxes.) So now your $1,000 default has become a $1,400 default.

How does that extra $400 count as leakage from the 401(k), rather than just something that gets added to your annual tax bill? Smart explains:

Most participants borrow from their retirement savings because they are illiquid and do not have access to other sources of credit. This clearly demonstrates that participants who default on a participant loan do not have the financial means to pay the taxes and penalty. Unfortunately, their only source of capital is their retirement savings plan so many take the remaining account balance as an additional early distribution to pay the taxes and penalty, further increasing the amount of taxes and penalties due. These taxes and penalties become an additional source of leakage from retirement assets.

Smart’s 16-page paper has no fewer than 24 footnotes, but he fails to provide any source at all for his assertion that “many” people raid their 401(k) plans in order to pay the taxes on the money they’ve already borrowed. In any event, Smart (as well as Litan and Singer, following his lead) makes the utterly unjustifiable assumption that not only many but all 401(k) defaulters end up withdrawing the totality of their penalties and extra taxes from their retirement plan. And then, just for good measure, because that withdrawal also comes with a penalty and taxes, they apply a “gross-up” to that.

By the time all’s said and done, the $1,000 that you lent yourself from your 401(k) plan, and failed to pay back in a timely manner, has become $1,520 in “leakage”. Add in some extra “leakage” for people who default due to death or disability (apparently even dead people raid their 401(k) plans to pay income tax on the money they withdrew), and somehow Litan and Singer contrive to come up with a total of $37 billion.

It’s an unjustifiable piling of the impossible onto the improbable, and the press just lapped it up — not least because it came with the imprimatur of Litan, a genuinely respected economist and researcher. Custodia hired him for precisely that reason: they knew that if his name was on the front page of a report, that would give it automatic credibility. But for exactly the same reason, Litan had a responsibility to be intellectually honest when writing this thing.

Instead, he never even questioned any of the assumptions made by Custodia’s CFO. For instance: if you’re terminated, and you default on your 401(k) loan, what are the chances that the money you received will end up being counted as an “actual distribution” rather than as a “deemed distribution”? Smart and Litan and Singer all implicitly assume that the answer is 100%, but they never spell out their reasoning; my gut feeling is that it’s not nearly as clear-cut as that, and that it all depends on things like when you lost your job, when you defaulted, and who your pension-plan administrator is.

Custodia’s business, and the Litan-Singer paper, are based on the idea that if people who borrowed money from their 401(k) plans had insurance against being terminated from their jobs, then that would have significant societal benefit. In order for the societal benefit to be large, the quantity of annual 401(k) loan defaults due to termination also has to be large. But right now, there’s not a huge amount of evidence that it actually is: in fact, we really have no idea how big it is.

I can say, however, that Custodia has already won this battle where it matters — in the press. “Protecting 401(k) savings from job loss makes a lot of sense,” said Time’s Kadlec in his post — and so long as Custodia can present lawmakers with lots of headlines touting the $37 billion number and supporting their plan, Litan and Singer will have done their job. The truth doesn’t matter: all that matters is the headlines, and the public perception of what the truth is.

Come to think, maybe this makes Litan the absolutely perfect person to run the research department at Bloomberg Government. On the theory that it takes a thief to catch a thief, Bloomberg has hired someone who clearly knows all the tricks when it comes to writing papers which come to a predetermined conclusion. And he also has a deep understanding of the real purpose of most of the white papers floating around DC: it’s not to get closer to the truth, but rather to stamp a superficially plausible institutional imprimatur onto a policy that some lobbyist or pressure group desperately wants enacted. I can only hope that in the wake of using his talents in order to serve Custodia Financial, Litan will now turn around and use them in order to serve rather greater masters. Like, for instance, truth, and transparency, and intellectual honesty.

Matt Yglesias wonders whether he should invest some of his 401(k) in John Hancock’s International Value Fund. Naturally, one of the key pieces of information about the fund that he wants to know is its expense ratio: what kind of fees does it charge?

Yglesias eventually found the relevant bit of the John Hancock website; it runs to 421 more or less incomprehensible words. (Exempli gratia: “For internally-managed Funds advised and sub-advised exclusively by John Hancock’s affiliates, the total fees John Hancock and its affiliates receive from these Funds may be higher than those advised or sub-advised exclusively by unaffiliated mutual fund companies. These fees can come from the Fund or trust’s Rule 12b-1, sub-transfer agency, management, AMC or other fees, and may vary from Fund to Fund.”)

The upshot of all the prose? If you want to find out the fund’s expense ratio, you have to phone up John Hancock and ask them to send you its most recent “Returns and Fees” document — which of course isn’t simply available online, and which is subject to change in unpredictable ways in future.

This kind of thing seems tailor-made for the Consumer Financial Protection Bureau to crack down on. Arthur Levitt, for one, would surely approve:

For years, I have pressed for “plain English” in financial documents that go to the investing public, but with only mixed success. The problem, it appears, is that such efforts get tugged into the ditch by the irresistible pull of legal jargon. The language of lawyers is not spoken by Aunt Edna, who rightly senses that if something sounds complicated, it is. The advice of Will Rogers comes to mind: “I love words but I don’t like strange ones. You don’t understand them, and they don’t understand you. Old words is like old friends—you know ‘em the minute you see ‘em.”

You wouldn’t buy an investment from a stranger, so why buy one wrapped in strange language?

It’s not just the mutual fund companies who deserve the blame here — it’s also the 401(k) administrators at places like Yglesias’s employer, who ignore the degree to which the options they’re choosing are readily comprehensible to their employees.

There are three main reasons why investments in 401(k) plans significantly underperform investments in defined-benefit plans. The first is that 401(k) investors have to rotate into relatively low-risk fixed-income instruments as retirement approaches and their risk appetite declines; defined-benefit plans never need to do that. The second is that defined-benefit plans have the ability to diversify into many more asset classes than 401(k) plans can. And the third is that there are multiple points at which 401(k) performance can be scuppered: at the fund-manager level, at the corporate-benefits level, and of course at the individual level. Bad choices at any one of those levels are enough to result in severe underperformance; and it’s entirely possible that you can have bad choices at all three points.

Will the CFPB have the power or the inclination to clean up the mess that is the 401(k) system? I doubt it. But if it doesn’t, no one will. And the likes of John Hancock will continue to obfuscate their customers for no good reason.

Update: Stephen Lubben points out that under Dodd-Frank, the CFPB has no oversight of investments: there’s no way they can be of use here.

Steven Greenhouse has a long article in today’s NYT about an attempt by the states to deal with their “strained” pension funds by moving to defined-contribution pension plans. Here’s the lede:

Lawmakers and governors in many states, faced with huge shortfalls in employee pension funds, are turning to a strategy that a lot of private companies adopted years ago: moving workers away from guaranteed pension plans and toward 401(k)-type retirement savings plans.

What’s a “huge shortfall”? Amazingly, nowhere in the 1,500-word article does Greenhouse actually say. Instead, we get incomprehensible tales like this:

Utah decided to adopt a 401(k)-type plan after the stock market plunge in 2008 caused the shortfall in the state’s pension plan to balloon to $6.5 billion…

Under the new plan, [state senator Dan] Liljenquist said, the state’s retirement contributions for new workers will be roughly half that for current employees, potentially saving $5 million a year for every 1,000 new workers hired.

So, the state of Utah has been putting insufficient money into its pension plan, and now there isn’t enough money there to meet upcoming liabilities. And the solution here is for the state, in future, to contribute “roughly half” of what it’s been spending up until now in pension contributions.

Needless to say, this makes no sense on either front. The liability to existing workers doesn’t go away if a different plan is adopted for new workers, so the problems at the pension plan aren’t being addressed. On top of that, it’s hard to see how contributing much less to new workers’ retirement is going to help them at all, either. From a pensions perspective, there’s no winner at all: the only entity better off is the state, from a cashflow perspective.

On top of that, Greenhouse makes no attempt to put numbers like $6.5 billion or $5 million in any kind of context. Are they big? Who knows.

The only way I could make any sense at all of Greenhouse’s article was to read it in parallel with Dean Baker’s paper on the origins and severity of the public pension crisis. The table he includes, which includes all state public pension funds, is invaluable; here, for instance, is Utah.

What this shows is that the Utah pension fund, at the end of 2009, was about $2.8 billion in the hole. If it rose by 15% in 2010, which is a pretty reasonable assumption given the performance of the stock market, the gap is likely to have been all but eliminated. But even the gap at the end of 2009 was less than one tenth of one percent of Utah’s state income.

All of these numbers are fuzzy, of course. Valuing assets is hard enough; coming up with a present value of future liabilities is much harder, and depends crucially on which discount rate you use. But Baker’s numbers are pretty reasonable, and show that there really isn’t anything to panic about here.

More generally, as Teresa Ghilarducci notes elsewhere on the NYT website (but not in the paper), the idea that moving from defined-benefit to defined-contribution plans is going to help anybody at all is highly problematic.

401(k) plans are bad deal for taxpayers. Dollar for dollar, a traditional pension plan yields more pension benefits than do 401(k) plans because 401(k) management and investment fees are three times higher. And professionals who manage money in pooled pension funds usually get higher returns than workers who manage their own 401(k) accounts. The only clear winners when pensions switch over to the 401(k) plans are brokers and bankers…

The unintended effect of widespread 401(k) plans is more volatility. In contrast to traditional pensions and Social Security, 401(k) plans fuel bubbles and make recessions worse. When the economy is booming, 401(k) plan asset values soar, making people spend more and work less. Not what you want in an expansion.

Worse, when the economy plummets and takes 401(k) assets with it, people do the opposite; they cling to the labor market and rein in spending – again, two things you don’t want in a recession.

On top of that, defined-benefit plans have a mutual-insurance component to them: shorter-lived workers subsidize longer-lived workers, helping to increase everybody’s standard of living.

The fact is that the states’ move to defined-contribution plans is a blatantly political one, born of Republican ideology conflating such plans with individual freedom and choice. For rich professionals who jump from job to job every few years, 401(k) plans do make a certain amount of sense. For public servants spending a lifetime in the police force or in elementary schools, by contrast, they emphatically don’t. As for the state pension plans, the only way that the state governments can help them make up their actuarial liabilities is if they pour more money into them. Not less.

Dan Ariely had an interesting column in the latest issue of HBR, talking about how Chile forces its citizens to save money and annuitize their pensions:

When employees reach retirement, their savings are converted into annuities. The government auctions off the rights to annuitize retirees in groups of 250,000…

Institutionally, Chile has cracked an age-old problem with annuities. It’s risky business to predict how long people will live, so insurance companies charge a high premium to cover that risk, which makes for an inefficient market. Annuities also suffer from an adverse selection problem… By pooling the risk, the Chilean government makes annuities an attractive business with more competition and better prices. And since everyone is forced to annuitize, the adverse selection problem simply disappears.

This is rather clever, if it’s true. But a Chilean technocrat, Axel Christensen, responded on the HBR website, saying that Ariely misunderstood what he’d been told. The groups of 250,000 are allocated to fund managers, he said, not annuity providers.

At retirement, Chileans may choose between a fixed inflation-adjusted annuity offered by an insurance company or a variable annuity from by the same company that managed their retirement account. It is an individual decision, with no pooling as you stated. The insurance companies have to bid for the contributor´s savings that increases competition, but the system does has its flaws, like the adverse selection you identified.

This doesn’t clear things up a lot: it seems to me that if you have to pick an annuity, then adverse-selection problems are minimized even if there’s no pooling at all. After all, the problem with adverse selection is that people who buy annuities will live longer than people who don’t buy annuities. If everybody buys an annuity, there isn’t a problem.

And when Ariely republished the column on his blog after Christensen had made his comment, the column was unchanged. I don’t know what to make of that: maybe Ariely didn’t see the comment, or he thinks that for some reason it’s unimportant.

Ariely says that schemes like Chile’s wouldn’t go down well in the U.S., where Americans would consider it “heavy-handed and limiting”. I daresay he’s right. But it would be great if there were some way of allowing people to voluntarily commit to annuitizing their pension fund upon retirement. One of the problems with pension funds is that nobody actually needs some big multi-million-dollar nest egg at age 65. What they need, instead, is a healthy income in retirement. But converting a nest egg into an income is non-trivial. You want to maximize your income by spending principal as well as interest, but you also want to make sure you don’t run out of money if you live a long time.

Annuities solve that problem, but they do suffer from adverse selection: people who buy them live longer than people who don’t, and so insurance companies have to make allowances for that. If everybody in a big pool was committed to annuitizing, then the insurance company could ensure that people who died at a younger age would help to subsidize those who live a very long time — as should happen in any good pension system.

This, indeed, is one of the central problems with defined-contribution pensions rather than defined-benefit pensions. When we “save up for retirement”, we’re conflating two things: the savings, on the one hand, and our retirement income, on the other. If we die before we retire, then our retirement income is zero, but the savings are still there, and the only retiree they’re likely to benefit is our spouse, if we have one.

Are there any numbers on the amount of money which is paid in to Social Security against which no benefits are ever drawn? I’d include people working in the U.S. on temporary work visas, here, as well as people who die before retirement while unmarried. On top of that, of course, people who die early in retirement end up taking out of the system much less than they put in. And the benefits of that cross-subsidy accrue to the long-lived, who need money to live on in their 90s and beyond. It’s a humane and sensible system: the living need money more than the dead do.

Off the top of my head, I can’t think of a way of replicating anything like this on a voluntary basis. I could invest my retirement savings in a fund which automatically annuitizes with everybody else in the fund when I turn 65, for instance. But if I get cancer when I’m 64, I’ll surely move those savings into cash instead of meekly accepting a short-lived income.

So the Chilean system of mandating annuitization for certain types of retirement assets makes sense to me, if indeed there is a mandate there. Maybe people could have a choice: they can invest pre-tax dollars in retirement funds which are forced to annuitize, but if they want to retain control over whether or not they annuitize, they have to invest only post-tax dollars.

And then, of course, we’d have to look to see whether the insurance companies actually improved their annuity rates significantly in response to the new mandate. Is there any data from Chile on that? All of this government interference might make sense in theory, but the real world is nearly always much messier.

Aviva has a huge new project up online on what it calls Europe’s pension gap: the problem that the continent’s pension systems are inadequate to the needs of an ageing population. Between them, Europe’s pensions systems need extra funding to the tune of a whopping €1.9 trillion a year, it concludes — a sum which is impossible to raise, and which is only growing.

There’s definitely a problem here. But equally it’s a very hard problem to quantify, because the statistical data needed to do so simply doesn’t exist. The Aviva report is based on the assumption that “on average, people need 70% of their pre-retirement income to provide an adequate standard of living in retirement” — but if you try to work out where that number comes from, you rapidly run into a very fuzzy mess.

For one thing, the average seems to encompass a large variation across income groups, with low-income people assumed to need 90% of their pre-retirement income, dropping to just 55% for high-income people.

But more importantly, the number is entirely normative: it’s the amount that the OECD and Aviva reckon that people should target if they want an adequate standard of post-retirement living. It’s not empirical.

In order to come up with solid answers to important questions, we’d ideally need to be able to look at large populations around the world, and measure their pre-tax and post-tax income and consumption levels both before and after retirement. We’d look at what kind of drop-offs in such levels are normal, and what are excessive; we’d ask retired people whether their income is adequate to their needs; and we’d look at how all these things are changing over time.

But in reality, none of this is possible: the statistics simply don’t exist. In Europe, the national statistical offices and tax authorities do give some, conflicting, information on post-retirement income — but only in the UK and Ireland. There are also still pension schemes which are explicitly based on a percentage of final income; that percentage seemed to rise over the 1980s and stay steady over the 1990s before falling back a bit in the 2000s, but even those numbers are hard to pin down with any accuracy.

And then on top of all that are questions which by their nature are unknowable: what are future investment returns going to be? What are future annuity rates going to be? What kind of tax rates will retirees pay in future?

What’s more, by the time that people have a pretty good idea what their final salary is going to be, it’s far too late to set up a retirement plan which will generate x% of it post-retirement. For that, you need to start early — ideally in your 20s, but certainly in your 30s or early 40s — and when you’re at that stage in your career, you have no idea how much you’re going to ultimately end up earning, or how much consumption your future self will consider an adequate standard of living.

Big-picture trends, however, are not good. For one thing, there’s demographics: the population is ageing, which makes it harder for the working population to support the retired population. What’s more, the rate of unencumbered homeownership is falling: people are less likely to own their houses outright at retirement and more likely to still have a substantial mortgage. And on top of that, people are having children later, and child-related expenses can continue right up to, and even after, retirement.

Oh, and did I mention rising medical costs?

Some things don’t change. You’ll probably need a smaller home once you’re retired; you won’t have commuting costs; you certainly won’t need to continue to make pension-fund contributions. And there will be some kind of state pension, too, although its size is uncertain.

But the fact is that all of these factors are so unknown, or unknowable, that to a first-order approximation all we can reasonably do is save as much as possible, and hope for the best. Any retirement planner who tries to work backwards from a fixed sum needed at age 65 is making so many assumptions that the number is almost guaranteed to be meaningless. But that kind of silly exercise is how retirement planners make their money. So it’s not going to stop any time soon.

Since I’m interested in the value of a guaranteed real income, this sentence jumped out at me from Arnold Schwarzenegger’s recent WSJ op-ed:

Few Californians in the private sector have $1 million in savings, but that’s effectively the retirement account they guarantee to public employees who opt to retire at age 55 and are entitled to a monthly, inflation-protected check of $3,000 for the rest of their lives.

The problem is, I can’t make the math work. You can argue until you’re blue in the face about proper discount rates, but at the very least any pension plan should be able to invest its money to keep up with inflation. But let’s see what happens with a 0% real discount rate, not least because it makes the math easier.

California’s life expectancy is 77.9 years, so let’s say the average retiree lives for 23 years after retiring at 55*. If they earn $36,000 a year in real terms for 23 years, that sums to $828,000. And the minute you start assuming even the most modest of real investment returns, the less realistic Schwarzenegger’s number becomes: if you invest $1,000,000 at a 5% yield while paying out $3,000 a month with 2% annual inflation, that’ll support payments for 682 months, or about 57 years, taking our hypothetical retiree to the plump old age of 112.

To put it another way, I’m sure that any life insurer in the world would happily take Schwarzenegger’s bargain and accept $1 million of public funds in return for the obligation to pay a 55-year-old California retiree $3,000 a month, in real terms, for life.

The rest of the op-ed is misleading, too: see Paul Kedrosky’s elegant fisking of Schwarzenegger’s chart. But as ever in California, political rhetoric always tends to trump economic reality. California’s finances are indeed pretty gruesome, and it’s true that the state has been making pension promises it can’t afford for decades. But given how bad reality is, there’s no need to exaggerate it for the sake of politics.

Update: Many thanks to all my commenters. First, as many of them pointed out, life expectancy at age 55 is actually somewhere in the 25-28 year range, not 23 years. And especially thanks to DanHess, who actually found a private-sector quote:

I got some quotes for how much a million dollars will buy for a fifty-five year old in terms of a fixed annuity starting presently and going for life. They were generally in the range of about $5000 per month, some a bit more, some a bit less.

I just got off the phone with the Vanguard annuity sales department, where I was told that for a 55-year-old, inflation adjustment knocks off approximately 30% to 35% off the payout of the annuity.

$5,000 minus 1/3 for inflation adjustment brings you down to around $3330 per month. But I’m not convinced that the inflation adjustment should be so expensive these days, given that any life insurer should be able to hedge the inflation risk very cheaply right now.

Finally, there’s the question of survivor benefits, which I admit I hadn’t considered. I don’t know exactly how California pensions work, but if they essentially end up being paid until both of two spouses have died, rather than until the recipient has died, then that obviously increases their value significantly.

Well done to CalPERS for responding forcefully to a rather silly Stanford policy brief which gets very alarmist about California’s pension liabilities. There are so many enormous and immediate fiscal problems facing California right now that it seems utterly pointless to put out a paper saying that the state should inject $200 billion into its pension funds — especially when the logic of the paper is as confused as this:

The CalPERS portfolio has had returns averaging 7.91 percent over the last 25 years, with a standard deviation of 11.91 percent. As expected, the high standard deviation means that 68 percent of the time, returns range from –4.0 percent to 19.82 per­ cent. Historically, if CalPERS had simply invested in investment­ grade corporate bonds, the fund could have earned 7.25 percent, only .66 percent less than it has earned with its highly volatile portfolio. This small reduction in earnings would have allowed CalPERS to reduce volatility by a full 7.68 percentage points.

Therefore, in order to avoid future severe underfunded scenarios, we recommend that CalPERS, CalSTRS, and UCRS allocate more of their investment portfolios to fixed income asset classes, thereby reducing risk with a minimal loss of long term investment performance.

I’m not entirely sure where to start on this, but are the Stanford wonks really unaware that the rate of return on fixed-income investments over the past 25 years is largely a function of the fact that interest rates have been declining steadily over that time? And that now they’ve reached zero, they can’t really continue to do so for the next 25 years?

On top of that, the Stanford types seem to think that it makes sense to use a risk-free discount rate to calculate pension-plan liabilities, while even they admit that the assets shouldn’t be invested in a risk-free manner.

I do like the way that the Stanford paper tries to look at the probability of a shortfall of various magnitudes, rather than simply boiling things down to one number. But I’m not convinced by the methodology it uses to arrive at those probabilities, or by the way that the paper ignores all the political realities surrounding pension contributions and payouts.

The fact is that a defined-benefit pension scheme is always going to run the risk that it won’t be able to meet its liabilities as they come due. The California pension plans constitute an attempt to save hundreds of billions of dollars to pay for the pensions of the state’s workers; the attempt might succeed, or it might not.

But right now there are clearly more important and urgent things to do with California’s tax revenues than throw them into a pension pot to support the retirees of the 2040s and beyond. CalPERS might not be perfect, but it’s a lot less dysfunctional than most of the rest of the state government. Let’s get our priorities straight here.

David Merkel is insightful when it comes to a huge status-quo bias in retirement funds. If we have a lump sum, we’re loathe to convert it to a guaranteed income, even when we value the guaranteed income that we do have extremely highly:

I have long been a fan of immediate annuities, particularly those that are inflation indexed, as retirement products for seniors. Yet, they do not get bought by retirees. Why? Well, insurance products are sold, not bought, typically, and when the agent sells an immediate annuity, that is his last sale on that money. They would rather sell a less suitable product that offers them another sale down the road. And, people like having flexibility with and control over their investments, even if that leads to less money for them in the long run. Annuitizing a portion of one’s lump sum lowers risk, and takes the place of investing in bonds in the asset allocation.

Most people like the reliability of their pensions, and Social Security, should it be paid, but do not seek the same thing when investing their private money.

I suspect that one of the problems here is that it’s almost impossible to tell whether or not you’re getting ripped off when you’re buying an annuity. Unless and until a vibrant and competitive market emerges in such things, you might end up buying a million-dollar lemon with substantially all of your life savings, and no one wants to do that.

I’m not sure how much the issue of having a rainy-day fund for unexpected medical costs comes into play here: at the margin it might actually be better to be on a fixed income than to have a large lump sum which could easily get eaten away by medical bills.

I do think however that people massively overestimate the returns they can get on their money, and they often dream of leaving their heirs more money than they retired with. Such dreams almost never come true, but they also never die. The question is, how much are they worth.

Mike Konczal (he’s come out now) says, plausibly enough, that the most important financial innovation of the past 30 years is the 401(k). Which is not to say, of course, that it’s a good thing.

Mike says the 401(k) is “the creation of a loophole in a tax bill”, which I think is doing it something of a disservice — the move from defined-benefit to defined-contribution pensions is a global one, and Mike’s really just using the 401(k) in particular as a proxy for defined-contribution pensions in general. Those would have taken off regardless, even if that particular tax bill hadn’t existed.

Mike’s right that such plans aren’t an obvious improvement on what went before. In fact, looking at his arguments in favor (“it’s a plus that consumers can directly manage their retirement finances”), one in general isn’t very impressed: there’s no reason to believe that consumers are particularly good at managing their retirement finances, and quite a lot of reason to believe that they can be extremely bad at it. That said, Mike’s right that there’s an air of historical inevitability to the whole thing. You might not like it, but it was bound to happen sooner or later.

There’s also however an air of historical inevitability about individuals schooling and working longer before they have families; I don’t think that the 401(k) was an important cause of that particular trend, although the hypothesis is intriguing.

In any case, Mike’s done nothing to counteract my thesis that financial innovation over the past couple of decades has been, on net, a bad thing. The 401(k) might be very important. But I’m far from convinced that Americans are better off for it.