For years, many opponents have seen the notion of Social Security privatization as a thinly veiled make-work project for Wall Street. Trillions of dollars, they said, would flow into stocks and mutual funds, producing a huge windfall for brokerages, money managers and, perhaps, even for financial advisors. Though opponents may have valid arguments against the privatization of Social Security, the specter of a giant give-away to the financial services industry is no longer one of them.
“These accounts are going to be so small for so long — 270 million accounts with little or no money — that it's a 15-, 20-, 25-year story before Wall Street might look to get involved,” says Lou Harvey, president of Dalbar, a Boston-based research firm.
Despite the alarm sounded by the AARP and others opposed to it, the Bush Administration's plan is modest. Although it would cost an estimated $1 trillion to $2 trillion to implement, the actual amounts that individuals would have in private accounts — and which Wall Street would manage — are puny. As it stands, the plan is for workers 55 and under to be given the option of diverting up to 4 percent of their payroll taxes, capped at $1,000 annually (rising either with wages or prices over time), into some type of index fund. That's not the kind of money that stirs the hearts of money managers or financial advisors. “The average person is going to be putting in $800, maybe $1,000 a year,” says Bob Pozen, head of MFS Investments and a member of the president's Commission to Strengthen Social Security, the bi-partisan group of public and private thinkers that designed the proposal. “So after five years the average account balance is going to be maybe $5,000. I don't know about you, but I don't know a lot of financial firms that are going to be salivating over $5,000 accounts. I'd be surprised if after 10 years, accounts have more than $12,000 in them. So these are not very large accounts.”
To minimize management and administration fees, the president said in his State of the Union Address that he plans to piggyback the management of these accounts on the Thrift Savings Program (TSP), a government-sponsored retirement plan. That means, a very select few asset managers would ever see this new money as the proposal stands. And those managers would get the privilege for small amounts of remuneration. Barclays Global Investors, which runs the government's TSP accounts, is believed to be paid a mere 6 basis points on assets in the program.
“It's a relatively short list of managers capable of managing millions of small accounts,” says Guy Moszkowski, an analyst with Merrill Lynch, in a November report. Moszkowski thinks T. Rowe Price, Fidelity and Vanguard, firms which handle a substantial chunk of 401(k) record keeping already, would be best positioned to win government business.
One economist says that the industry would stand to reap $425 billion in fees from the combined accounts over 75 years — assuming a management fee of 30 basis points. But the SIA, assuming lower participation rates of 70 percent to 75 percent, reckons the fees paid to Wall Street would approximate $39 billion — over 75 years. Compare that amount to the net present value of the entire financial sector over that time: $3.3 trillion, according to estimates made by Rob Mills of the SIA. Very little would trickle down to individual financial advisors, experts say, given the choice of products (index funds only) and the small amounts that can be contributed annually.
No wonder Wall Street, by and large, has been so quiet on this issue. Mercer Bullard, a former SEC attorney and founder of Fund Democracy, a leading advocate for mutual fund shareholders and outspoken critic of high fees, says the industry is simply laying low. “It would be foolish not to want these accounts and position yourself to get them, but it would be more foolish for firms to show how much they wanted them,” he says.
Not so, says Pozen. In fact, in his discussions with Wall Street executives, he repeatedly hears that associating with privatization is a no-win situation: not much to gain but a lot to lose. “They're concerned they'll be hit on both sides,” Pozen says. “On the one hand they'll be accused of windfall profits. But in reality, they won't be making much money.”
Another factor is the unpredictable trajectory of any eventual plan. Tony Mattera, spokesman for Wachovia Securities, says his firm is in this camp. “The president laid out one thing, but there could be 20 more of them coming, so we don't know where it will land yet,” he says. The other wirehouses declined to comment on the proposal.
One thing's for sure: Had the president adopted the Commission to Strengthen Social Security's full recommendation, the story for the Street would be much different. In its recommendation to the president, the Commission to Strengthen Social Security called for a second level of investment options that would have made Social Security reform more interesting for asset managers and advisors, because it did not limit the investment choices to index funds. The commission recommended allowing investors that reached a certain account balance threshold in the index option to move the balance and any future contributions into a broader array of “qualified private-sector funds.”
Pozen says the fate of this portion of the recommendation lies with Congress now. Given the political opposition to privatization per se, Congress is unlikely to opt for the higher-risk plan. But, Pozen says, he wouldn't make a bet either way.
The privatization of Social Security has become a political hot potato. Just the notion of Wall Street getting any money has a lot of folks bringing out the pitchforks. The AARP, for one, in January launched a multimillion-dollar campaign, taking out full-page newspaper ads that inaccurately depicted Bush's proposal as gambling when the program would merely give private citizens a TSP-like program that government workers currently enjoy. The AARP ad read, “Winners and losers are stock market terms. Do you really want them to be retirement terms?”
So, despite capping contributions and limiting investment choices to index funds, Bush's modest private account proposal is in for a political dogfight. Senate Minority Leader Harry Reid (D-Nev.) has said all 45 Senate Democrats are firmly opposed to his private account proposal, because of the benefit cut “of up to 40 percent” it would cause, and the “$2 trillion” it would add to the deficit. Meanwhile several Republicans, including moderate Senator Arlen Specter (R-Pa.), have expressed concern or opted to withhold judgment until more details are set in stone.
For political observers, this kind of opposition doesn't make for good political math. “I'm not persuaded we're going to get Social Security reform at all,” says Greg Valliere, a political economist at Schwab. “Bush needs 60 votes to get anything through the Senate, and I don't see many, if any, Democrats wavering on this.”
Valliere says part of the Bush Administration's problem is that private accounts, in the opinion of not only Democrats, but economists in general, don't address the solvency of the Social Security program. “For that there has to be some legitimate combination of benefit cuts, tax increases, something more,” says Valliere.
But while the politicians horse trade, what should advisors do? Regardless of whether Bush's private account proposal survives or not, it would behoove advisors to make use of what it has inspired: a national debate on retirement savings. “One thing this debate has highlighted to a great degree is that the responsibility of saving and providing for your retirement lies with the individual,” says Dan Moisand, president-elect of the Financial Planning Association and a partner in Spraker Fitzgerald Tamayo & Moisand. “No matter what happens with the plan, the focus on retirement savings is going to be healthy for the public and good for the advisory business.”
The SIA's Mills concludes: No matter which plan is ultimately approved, “the outcome for Wall Street will not be the feast of fees some have been keen to predict. Investment managers hungry for fees will need to look elsewhere for their free lunch.”