GuidePost

The GRABot BAG
by Sherrie E. Grabot, CEO

January 2010
Side Effects of the Great Recession

The immediate effects of the Great Recession have been painfully obvious. Some of the side-effects, however, are much less so. Those of us who know a lot of young people may have noticed one such result in the emergence of a “recession generation:” teens and twenty-somethings who have been touched by financial distress at formative times in their lives.

This generation may experience lifelong effects, such as lowered expectations and a more pessimistic attitude than their predecessors. On the other hand, there’s evidence that they are also less materialistic, more civic-minded, more self-aware, and armed with a longer-term perspective on the world. Compared to many of their elders these days (see below), this attitude is welcome indeed.

Murphy’s Law Revisited
A more subtle side-effect of the Great Recession might be described as a corollary of Murphy’s better-known Law: If it’s possible to see doom or danger in a given piece of news, we are almost certain to do so.

Anyone who follows financial news can see this principle in action. Below is a survey of some recent samples, ranging from global trends to much more specific retirement-plan issues. And because rules are made to be broken, look for a counter-example of unexpected optimism at the end.

The Next Worst Thing
The financial meltdown is behind us. But its unpredictability and severity has left people shaken. Looking around at the wreckage that is our economy, and looking ahead to a slow recovery, we wonder, “how can we make sure that never happens again?”

Ask a dozen experts and you’ll get a dozen answers. In Washington the administration is pressing ahead with another set of proposals for top-down financial reforms. If the details are still unclear, the prospects are even less so: The plan may be either a step in the right direction, or guarantee of a future disaster.

And that’s just in this country. Policymakers across the pond advocate yet another strategy for preventing future banking implosions without either sabotaging firms’ ability to make money or encouraging reckless behavior. Since money knows no boundaries these days, international consensus is essential, but it seems to be as elusive as ever.

Blowing Bubbles
Back in the U.S. the very fact of a recovery is another cause of worry. Strong gains in equities, especially among financial firms recovering from near-death experiences, would ordinarily be reassuring. But because the markets have been so volatile, and the underlying economy so sluggish, some commentators are putting the word “rally” in quotation marks and waiting for the next correction.

They’re not talking about another asset bubble – but rather, four of them. Stocks are the worst; depending on whom you ask, the market may be overvalued by as much as 50%. Whether this rise is due to a tidal wave of cheap money provided by government stimulus programs and near-zero interest rates, to irrational optimism, or to the fact that money has to go somewhere and other assets look worse, the situation does not inspire confidence.

Fee Frenzy
There are more signs of uncertainty closer to home in the world of 401(k). We recently reported on the settlement of a class-action suit against Caterpillar regarding excessive fees (and kickbacks as well) in its retirement plan. Days later, Wal-Mart lost a key ruling in a very similar case.

According to plaintiffs’ attorneys, the company breached its fiduciary responsibility by assembling a limited selection of funds for its plan and offering most of them at retail prices. Considering the plan’s massive buying power (1.2 million participants and $10 billion in assets) and the company’s reputation for hard bargaining and rock-bottom pricing, Wal-Mart’s actions seem confusing at best, troubling at worst. Their failure to disclose revenue-sharing provisions with Merrill Lynch, which the plaintiffs argue cost participants $140 million since 2007, certainly seems out of step with today’s retirement plan world.

This case may be egregious, but similar situations are actually not all that uncommon. Sure, investment providers have to get paid somehow. But as long as fees continue to eat away at participants’ savings in a significant way, issues of fairness and disclosure will continue to trouble the industry.

Conversion Experience
Another retirement-plan headache is the possibility that savers will move their money out of 401(k) entirely. Converting traditional tax-advantaged investments to Roth IRAs is a real possibility, especially for participants with larger balances, as we reported in the last issue. If they do so in large enough numbers, their flight could make retirement plans more costly for those who remain – and have a negative impact on the reputation of 401(k) more generally.

To head off any potential stampede, a coalition of industry groups advocates changing the rules to allow comparable conversions from traditional plans to a Roth equivalent. This would allow people to take advantage of a Roth tax structure, but retain the protection of ERISA and keep other plan benefits such as professional management. To date, the proposals are on the House Ways and Means Committee’s radar screen, but not yet on the table.

Nerves of Steel
Not everyone is fearful, however. A recent piece on the Bessemer Trust describes how an organization that serves some deeply conservative clients is investing aggressively, boosting its weighting in risky assets such as mortgage-backed securities and global small-cap equities. As their management puts it, “Leaning into the prevailing wisdom is something we very much try to do.”

This is not your average investment firm. The trust was founded by Andrew Carnegie’s business partner in 1907 to manage his family’s assets. Today they handle other clients as well, but you need a cool $10 million just to get started, and you need to be in for the long haul.

With clients like these and $55 billion in assets, the trust has some extraordinary advantages. They “buy” top-flight external fund managers for their riskier assets the way the rest of us purchase fund shares, and their due diligence process involves face-to-face meetings and a thorough vetting of all operations, down to the firm’s lawyers and accountants.

If you think about it, there is still one key similarity between Bessemer’s clients and the average 401(k) investor: time. Whether because of great wealth or 401(k) regulations, they’re in no hurry to sell. The healthy appetite for risk that comes with a long-term perspective should serve as a reminder – that even in a year like this one, the future still offers a lot of upside.

~~ Sherrie