October 25, 2007

Institutionalized speculation

One day, the "asset prices must always be pushed higher" approach toward preventing the U.S. economy from succumbing to the gravitational pull of deflation will run its course and the "rentier culture" will beat a hasty retreat back to wherever it is they came, but after the decision the other day by the Labor Department to require new employees to invest in stocks if they make no other choice during what is normally a very confusing first day at their new job, well, the hasty retreat has been pushed back a little bit.

As documented in this WSJ story($) and as heard elsewhere on business news channels the other day, the Labor Department has seen fit to require employers to make 401k participation the default choice for new employees (a good thing). In addition, a new rule will limit the default investment options to only three choices, all of which include stocks and none of which guarantee the return of principle (potentially a very bad thing).

The insurance industry is understandably disappointed after stable value funds were excluded from the list of default options that, according to the WSJ report, includes "balanced funds, which typically have a fixed blend of stocks and bonds; life-cycle funds, which have asset allocations that shift gradually over time, based on an investor's age; and a diversified portfolio of funds managed by an outside adviser."

Those companies that already have their own "default 401k enrollment" plan in place and had opted to put new employees' savings into safe and secure stable value funds will have a few months to direct new employees' money into equities. Apparently, making stable value funds the default investment choice in the past had been done in order to minimize the possibility of law suits resulting from these "default" investments losing money and angry ex-employees seeking redress.

Now that the Labor Department has "institutionalized speculation", lawyers will have to look elsewhere for clients.

Statistics show that about one-third of new employees had chosen not to participate in 401K plans at all, which makes the revised rules requiring some effort to "opt out" sensible, but, other than the obvious need to help ensure that asset prices are always pushed higher, why exclude stable value funds?

Stable value funds will generally earn four, five, or six percent and inflation is only two or three percent - at least that's how fast the Bureau of Labor Statistics says prices are rising.

Over a period of many years, this sort of real, compound earning can be a powerful thing.

A few years back, after the stock market bubble burst, short-term interest rates were slashed to freakishly low levels and money market accounts earned only one percent. At such times, stable value funds are like an oasis for 401k investors.

It seems like there should be some God-given right to earn five percent on your money in a safe and sane way regardless of what the central bankers do. Fostering, ignoring, and then cleaning up bursting asset bubbles with low interest rates, as was the pattern of former Fed chief Alan Greenspan, shouldn't result in risk averse savers being punished.

All 401k plan participants shouldn't have to invest in stocks, but soon they will - unless they opt out on that confusing first day or modify their selections later (which most employees never do).

We're probably headed back to one percent short-term interest rates again as a result of the most recent asset bubble bursting and who knows where equity markets will head in the years ahead - when the new 401k rules take effect next year, there will be few more dollars helping to push stocks higher.