TOPICS > Economy

Stock Market Swings Fuel Rethinking of Retirement Plans

November 20, 2008 at 6:10 PM EDT
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U.S. stocks plunged again Thursday to five-year lows, fueling new concerns of retirement savings and 401(k) plans. Economic analysts mull the risks of stock market investment and challenges to saving for retirement.

JUDY WOODRUFF: Now, a three-part look at the fallout from the economic crisis, beginning with yet another big dive on Wall Street. Jeffrey Brown has the latest on the markets.

JEFFREY BROWN: Yesterday, the Dow closed under 8,000 for the first time in years. And today, a second straight 400-plus-point drop sent it down still further.

Liz Ann Sonders, chief investment strategist at Charles Schwab, joins us for a look at what’s going on.

Well, it seems notable now that the whole financial sector, the target of the rescue plan, continues to be hit especially hard, right, Citigroup in particular?

LIZ ANN SONDERS, Charles Schwab: No question. You’re starting to rival the kind of declines we saw in banks in the 1930s.

And although I don’t think that we have a very high risk of an overall economic depression, clearly what’s happening in the financial system and in the banks in particular does very much mirror what happened back then.

JEFFREY BROWN: Yesterday, there was that report on the sharp drop in prices, and suddenly there was a lot of concern about deflation. Now, explain that for all of us who thought we were supposed to be worried about inflation. What does that mean? And what does it impact — how does that impact the markets?

LIZ ANN SONDERS: Well, you’re right. I mean, it was only this summer where we had very significant concerns about inflation, a little bit less so here in the U.S., but most certainly globally. And, boy, has that changed quite dramatically.

Probably two forces behind that. We’ve got a huge plunge in commodity prices. We’ve taken out $100 out of oil prices, and all of that has been driven by a significant slowdown in the global economy, so we lost that demand support for a lot of commodities. And that has quickly shifted inflation back down.

And it was a record drop in the consumer price index. In a normal environment, that would be a good thing, but it does highlight the potential risk of deflation here.

We already have asset price deflation. We’re seeing it in stocks; we’re seeing it in housing. What we need to try to avoid is sort of that spiral, that deflation spiral that characterized the 1930s.

JEFFREY BROWN: Well, explain that, though. Why is deflation such a bad thing, if prices drop?

LIZ ANN SONDERS: Because it basically defers purchases. Everybody sits back and waits. If you’re anticipating a decline, it makes it very difficult to stimulate demand for anything, demand for borrowing, demand for consumption, demand for spending, demand for investment.

It really causes kind of a grinding halt in economic activity, given that the expectation is for things to continue to decline, prices of everything.

A 'long list of uncertainties'

Liz Ann Sonders
Charles Schwab
We have not only erased all of the gains from the last bull market between 2002 and 2007; with today's move, we actually sold off down to below the levels that we had seen even earlier than that.

JEFFREY BROWN: All right. Another issue out there being much watched here in Washington is the stalemate over automakers and what to do for them, if anything. Is that a factor that people are watching? Is that affecting the markets?

LIZ ANN SONDERS: Oh, no question. I think that that is a big part of the uncertainty right now. We're in a lame-duck session for Congress. We're in between presidential administrations.

It looks like Treasury Secretary Paulson is saying, "Look, you know, I've done what I'm going to do at this point with the amount of money that has so far been used from the rescue plan into the banking system, into direct investments." And we don't seem to be able to get to a conclusion.

It looks like Congress is going to have to come back in December. And I think uncertainty regarding not only the autos, but any direct help for homeowners, which is the other piece of this that at least for now has taken a backseat to autos, only adds to what is a very long list of uncertainties right now.

JEFFREY BROWN: Now, you know, every time we have this discussion, we talk about the substantive things out there, and then the psychology, and I wonder about that psychological barrier of 8,000 that was crossed yesterday and then today quite another plunge. Do you -- when you're looking at things, do you look at psychological barriers like that, numbers with three zeros in them?

LIZ ANN SONDERS: No. I mean, I do look at some psychological barriers. They don't necessarily happen to be rounding numbers.

I think the bigger one that I think has impacted a lot of folks is we really have seen an upside down "W" in terms of the market action over the last 10 years.

We have not only erased all of the gains from the last bull market between 2002 and 2007; with today's move, we actually sold off down to below the levels that we had seen even earlier than that.

So we're really starting to break down below what some had viewed to be significant support for the market. So that goes beyond just the even rounding number of 8,000.

JEFFREY BROWN: And, briefly, I keep hearing people talk about looking for a bottom. I guess we're still looking, right?

LIZ ANN SONDERS: Well, you know, bottoms are processes over time. Even in -- you know, the recession in 2001 was fairly mild. We know the market took it on the chin, but even then we had an environment where we had the first initial move down in July of '02. Then we had October of '02, which was the ultimate low. We sold off again until March of 2003.

So even there, we saw three big waterfall declines over a nine-month period of time. So the idea that we're going to have this perfect "V" bottom in the market certainly isn't borne out by history and I think, you know, unlikely in this environment, as well.

JEFFREY BROWN: All right, Liz Ann Sonders, thanks again.

LIZ ANN SONDERS: Thanks, Jeff.

Risks to pension plans

Jeremy Siegel
University of Pennsylvania
So I'm not at all convinced that firm-financed plans are going to be any better than those where individuals accumulate on their own 401(k)s.

JEFFREY BROWN: Now, from a big drop today to longer-term questions raised by the huge hit to the retirement accounts of millions of Americans.

Joining us to explore those issues are Jacob Hacker, professor of political science at the University of California, Berkeley, and author of "The Great Risk Shift," and Jeremy Siegel, professor of finance at the Wharton School of Business at the University of Pennsylvania and author of "Stocks For the Long Run."

Well, Jacob Hacker, does the market turmoil now mean we need to somehow rethink our retirement system, particularly the 401(k)-type plans?

JACOB HACKER, University of California, Berkeley: I think it does mean that we need to start rethinking that system. Obviously, the declines that we've seen in the market are hard on all sorts of pension plans, not just 401(k) plans.

But what we're really seeing is that 401(k) plans put so much of that risk onto workers and their families. So over the last generation, we've seen a move away from traditional defined-benefit pension plans that basically promise people a fixed benefit in retirement to 401(k) retirement plans that push all the risk onto individuals. They're basically investment accounts sponsored by employers.

So we've moved away from a system in which we had private savings, a guaranteed private pension plan system, and then Social Security to a system in which basically everything but Social Security is private savings. And I think that system is a lot more wobbly right now, and people are concerned about it.

JEFFREY BROWN: Jeremy Siegel, you've looked at this for a long time. What do you see when you look now? Have we become too reliant on those kinds of plans with not enough people understanding the risks?

JEREMY SIEGEL, University of Pennsylvania: Well, I think we have to be realistic. There's no way firms now can offer a defined benefit plans.

Their existing plans are terribly underfunded with this drop in the market. They would not be able to offer anyone such plans. And one has to also remember, just because the firm offers a plan doesn't necessarily mean it is secure.

As I say, these plans are greatly underfunded. It's a question of whether those benefits will be paid in those cases.

So I'm not at all convinced that firm-financed plans are going to be any better than those where individuals accumulate on their own 401(k)s.

JEFFREY BROWN: But you're saying things may be bad with the 401(k)-type contribution plans, but things could be worse if we had the old pension plans?

JEREMY SIEGEL: I think all the firms would be in a worse case if they didn't move to that, because they could not pay out the promises that are made. We already see, again, even though they phased out defined benefit in so many cases, the few remaining they're having trouble on funding.

You know, when there's an asset price meltdown, it affects everyone. It affects the firms and the individuals. And I don't think there's any easy way out of that.

Alternatives to traditional plans

Jacob Hacker
University of California, Berkeley
So there's no question we're not going back to the old world. But that doesn't mean that we couldn't make 401(k)s work a lot better to deal with the market risks that we're seeing really very vividly today.

JEFFREY BROWN: Well, Jacob Hacker, do you have an alternative plan that is different from going back to the traditional pension plan?

JACOB HACKER: Yes, I agree completely with Professor Siegel that we're not going to go back. The risk that used to be borne by companies are not going to be reassumed by them.

But I think that we should be taking this opportunity to start thinking about how we might want to restructure 401(k) plans so that they can provide a more secure source of retirement income for workers.

I think that that would involve making sure that those plans were available more broadly, because, at the moment, it's still less than half of workers who are participating in a retirement plan at their workplace, that these plans also provided some of the risk protections that were once provided by traditional defined-benefit plans, such as providing people with a promise of a relatively guaranteed benefit, providing them with a benefit that is -- that would allow them to avoid the risk of outliving their assets in retirement, and also protecting them against gross kinds of errors, like over-investing in the stock of your company or in a very badly diversified portfolio.

So there's no question we're not going back to the old world. But that doesn't mean that we couldn't make 401(k)s work a lot better to deal with the market risks that we're seeing really very vividly today.

JEFFREY BROWN: Well, what do you think of that, Jeremy Siegel? It sounds -- go ahead.

JEREMY SIEGEL: I think there's a lot of truth in what Jacob is saying. You know, there are a lot of choices in 401(k)s. One of them is to put your money in a money fund, and certainly that looks good over the last few years. Over long periods of time, that hasn't been the best choice.

We should offer annuities, inflation-protected annuities, and give the choices to the individuals. I don't think the firms are in any position to assume them; we have to give more choice to the individuals.

But let me also say, from -- you know, once markets dropped 50 percent -- and that's certainly what we've seen -- you know, looking forward, even though through all the pain, investors have gotten pretty good returns going forward.

So I wouldn't give up at all on stocks. Despite the pain, I think there's going to be some good returns down the road.

JEFFREY BROWN: But if you're a retiree now or close to retiring and you've done what many people have told you about for several decades, and saved, and put into those diversified accounts, not put all your money into safe things like bonds, suddenly it doesn't look good at all, does it?

JEREMY SIEGEL: It doesn't, but one has to remember that, even at age 65, life expectancy is 20 more years. You don't have to have it all in cash right at age 65, and so that you do have time in order to recoup a lot of the losses.

And I'm confident that we will. It's just -- I agree with you -- terribly painful and upsetting in the short run to just undergo such a deflation of asset values.

The market

Jeremy Siegel
University of Pennsylvania
We're not going to be using our homes as ATM machines anymore, even house prices. You know, good, old-fashioned savings is going to come back.
JEFFREY BROWN: Well, Jacob Hacker, I'm wondering how you look at -- several generations now of workers have come into the workforce with these kinds of plans and is basically the only thing that a lot of us know and, for the most part, with benefit up until this point. So what happens now in terms of the psychology of investing? We all remember the stories of depression-era, when a generation no longer invested, stopped investing. Do you worry about a psychological backlash like that? JACOB HACKER: I certainly do. And I think that one of the things to remember is that, with 401(k) plans, the individual psychology of investing is much more important, because these plans are not handled by professional money managers as traditional defined-benefit plans were. But I want to raise one really important point, which is that, even though these plans have become much more widespread, we have seen a decline in the proportion of people who are ready for retirement, who have enough savings to adequately secure their retirement. So 401(k)s have not been doing a great job of encouraging people to save adequately for retirement. At the same time, we shouldn't forget that these plans are highly unequal. It's not as if traditional defined-benefit pension plans were really broadly distributed, but we have not moved to try to make sure that lower- and middle-income workers are receiving some of the same tax breaks and some of the same opportunities and incentives to save as higher-income workers. So 70 percent of the $135 billion that we spend to subsidize 401(k)s and IRAs is going to the richest 20 percent of Americans. We need to make that more broadly distributed as part of a larger package of reforms that will put our retirement security system on a more secure foundation for the future. JEFFREY BROWN: Well, Jeremy Siegel, let me give you a last word on that. We used to talk about that three-legged stool, right, of the Social Security, personal savings, and pensions or 401(k)s. Is that still viable? JEREMY SIEGEL: Well, we know even Social Security of the government is not adequately funded, certainly, the health care benefits going forward. But I also want to mention, along with Jacob, that one of the very good features that was added in the last few years was the default feature that you do contribute to 401(k)s to get Americans to start savings again. We're not going to be using our homes as ATM machines anymore, even house prices. You know, good, old-fashioned savings is going to come back. The government made a good move. We're going to start with you saving. You can opt out of it if you want, but that's the way you should start your plan for your retirement, and I think that's a very good position to take. JEFFREY BROWN: All right. Jeremy Siegel and Jacob Hacker, thank you both very much. JACOB HACKER: Thank you.