America, Welcome to the Poorhouse Read online

  America, Welcome to the Poorhouse

  (Intro & Chapter 1)

  Jane White

  © 2010 by Jane White

  Publishing as FT Press

  Upper Saddle River, New Jersey 07458

  Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

  All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

  Introduction

  Are You Better Off Than You Were as a Kid?

  The nationally broadcast debate in 1980 between President Jimmy Carter and would-be President Ronald Reagan was summed up in 10 short words: “Are you better off than you were four years ago?”

  For Carter, the situation was dire. Iranian radicals had held 52 American hostages for nearly a year. The economy had nose-dived while inflation skyrocketed. Nothing Carter said could counter Reagan’s rhetorical question. It was Reagan’s debate and a week later it was Reagan’s election.

  Today if you ask yourself, “Am I better off than I was growing up?” the answer may very well be no. This time it’s not a war or hyperinflation that’s threatening America (although we’re still paying through the nose for gasoline prices), but financial stress.

  Despite the fact that many Americans may appear to be wealthy, too many have been “living on leverage”—over their heads in debt—unless they’ve got “chief” and “officer” in their job titles because most of what they own is paid for with borrowed money—whether it’s credit card debt or home equity loans—not with rising wages. While in 1980 the average CEO wage was 42 times that of the average worker, in 2008 it was 208 times, averaging $7.7 million. At the same time, the average weekly earnings for Americans has actually decreased in the past 30 years, from more than $325 in the early 1970s to about $280 in 2005 (in 1982 dollars).

  In March of 2009 a poll by CNN Opinion Research Corp. showed that only 39% of respondents thought they’d be able to keep up their quality of life—down from 45% the previous year. Only 50% of homeowners said they were very confident they could keep making mortgage payments, down from 58% a year earlier. Only 24% of parents said they were very confident they’d be able to afford to send their children to college. And only 22% of working people thought they’d be able to save enough for retirement.

  The Four Biggest Sources of Financial Stress: Empty Nest Eggs, Unaffordable Homes, Overpriced Colleges, Credit Card Debt

  What’s tragic is that outside of CNN’s reference to pension stress, the biggest financial crisis that the media isn’t covering is that most of us will be pensionless or pension-poor when we stop working—if we can afford to. From 1974 to 2004, the percentage of Americans covered by a defined benefit plan shrank from 44% of the workforce to 17%, according to the Employee Benefit Research Institute. At the same time, more than 80% of the private-sector workforce is employed by a company that only offers a 401(k) plan, in which you pretty much have to bankroll your own pension—because the U.S. employer contribution rate is the second lowest in the world. Bottom line: With few exceptions, nobody can retire if they have only a 401(k) plan. The you-know-what will hit the fan in 2011 when the first wave of Baby Boomers is scheduled to retire and can’t afford to.

  I first observed the 401(k) crisis in 1993 shortly after landing a job as associate editor of a newsletter distributed to half a million 401(k) participants with their quarterly statements. While as a financial writer I had covered topics such as mortgages and the stock market, I wasn’t very familiar with 401(k) plans—and at that point, there wasn’t much media coverage of them—it wasn’t until the Enron collapse that the term “401(k)” was coin of the realm. Although most Americans participate in these plans, the plans’ names will vary with the employer.

  Once I started digging, I was alarmed to find out that, unlike a traditional pension, in which the employer traditionally invests enough money that employees can replace 70% of their salaries until they die—assuming that they have worked for the company long enough to be “vested” in the plan—401(k) accounts have no such promises.

  While there was some panic about 401(k) plans being risky in late 2008, the focus on the stock market slump was off-base. The problem with 401(k) plans isn’t that their investments are too risky, it’s that the cost of funding employee accounts is left largely up to the employees. Not only do many employers get away with not contributing a dime to their employees’ accounts, but when they do at best it’s typically only a matching contribution of 50 cents for every dollar you put in, or equivalent to 3% of your pay. This contribution rate is the second lowest in the world—even Mexico’s is higher, at 6% of pay.

  The second source of financial stress for 50% or more of Americans is overpriced housing. When it comes to housing, we have two problems: an overpriced market whose bubble has burst and irresponsible lending practices that have yet to be reined in. Although the median home price was a little more than three times the median wage in 1976, a mere five years later it was more than four times the median wage and it’s currently six times the median wage.

  In 2008, as the housing bubble was bursting, not since the Depression had a larger share of Americans owed more on their homes than they were worth—often referred to as being “under water.” Nearly 8.8 million homeowners, or more than 10% of the total, were under water in 2008, more than double the number in 2007. Although the housing slumps of the mid-1970s and late 1980s were confined to the coasts, the recent bust has cut a far wider path and has come at a time when home debt was at its highest level since World War II.

  Why do we care about overpriced homes? Because a house isn’t just a roof over your head, it’s the fourth leg of the “four-legged chair” that makes up your retirement equity—along with pensions (if you’re lucky enough to have one), Social Security, and 401(k) savings. One reason the “Greatest Generation” could retire comfortably is that many of them had pensions and most of them stayed in their homes for most of their careers—in other words, they had a “buy-and-hold” home investment strategy as opposed to trading up to homes that they couldn’t afford, as is the case with many people today.

  Many would-be homeowners who are living in areas where homes are overpriced and unaffordable may have to face the initially daunting prospect of moving to regions where homes are affordable and jobs are plentiful. What’s more, those of you who are living in depressed areas in Michigan and Ohio may need to consider the same thing, for precisely the opposite reason: It’s not affordability that’s the issue but the risk that your home will be worth less than what you paid for it when you retire because your local economy has tanked.

  The third source of financial stress is that college costs have skyrocketed at a time when the majority of Americans need a college education to succeed in a globalized world. With so many service and factory jobs being outsourced to India and China, we’ve got to aim for the majority of the next generation to get a college degree. The good news is that this crucial need is on President Barack Obama’s radar screen: In an address to a Joint Session of Congress in late February of 2009, he said, “I ask every American to commit to at least one year or more of higher education or career training. This can be community college or a four-year school; vocational training or an apprenticeship. But whatever the training may be, every American will need to get more than a high-school diploma.”

  Finally, credit card debt and home equity loans have enabled us to live beyond our means—at the same time forcing us to pay many times the sticker price of an item because of the corrosive influence of compound interest in reverse—at a point when we need all the extra money we can get to save
for retirement and pay for our kids’ college education.

  This book is organized in order of “financial stress levels”: Retirement comes first because at least 80% of the population can’t afford to retire, mortgages are second because half of the population is under mortgage stress, college costs come third because most people need a college degree to succeed in a world where we’re competing against low-wage labor abroad, and credit card debt is fourth because 35 million people pay only the minimum balance on their bills, increasing the cost of the debt.

  In each section, I’ll look at the cause of the financial stress, propose legislative reforms to solve the problems, offer advice on how you can manage your finances until we get reform, and suggest an action plan to get reform. In a nutshell, reform means tripling the employer 401(k) contribution rate to equal 9% of pay as is the case in Australia, outlawing adjustable rate mortgages, lowering the cost of college, and cutting down on credit card debt and home equity loans.

  Why do we need reform when we’ve got a reform-minded President in the White House? Because there’s only so much President Obama can do when too many members of Congress and the Senate are compromised by campaign contributions from the business lobby.

  The first reason we need to shut down K Street, the location in Washington where most lobbyists have their offices, is because of the influence that the business lobby has on politics. There are now 15,000 lobbyists in Washington—27 for every member of Congress. The second reason is that there’s no law against a politician becoming a lobbyist—there’s only a “cooling-off period” between the time the politician works for taxpayers and the time he or she works for lobbyists—which means these politicians are often likely to draft or change language to make legislation more business-friendly, versus taxpayer-friendly. According to Public Citizen, a consumer advocacy organization, between 1998 and 2004, some 42% of former House members and 50% of former senators who were available to do so became registered lobbyists.

  The good news is that the internet has unleashed a revolution in fundraising, campaigning, and communicating. In the same fashion that small contributions from millions of voters—along with leverage from king-makers like Oprah Winfrey—catapulted Barack Obama from a long shot to a front-runner, the virtual grass-roots movement can ensure that Congress and President Obama continue to work for the electorate.

  The better news is that we’ve got a new administration in the White House. President Obama has set up a Middle Class Task Force that promises to reach out to Americans and address the causes of their financial stress, from healthcare coverage to pension security. I’m hoping that my readers can convince him to aim for boosting Americans’ wealth so that more of them stay or move into the upper middle class.

  It’s time for a second American Revolution.

  Chapter 1

  Why You Can’t Retire from a 401(k) Plan: You Won’t Have Ten Times Your Salary in Your Account at Age 65

  Mention the word Australia and the images that come to mind are “shrimps on the barbie,” koala bears, and kangaroos. I’d like to add another image: people who can actually afford to retire.

  A report issued in January 2008 by AMP Financial Services, a firm that manages Australian retirement funds and also reports on retirement readiness, revealed that Australians between the ages of 30 and 34 are projected to have assets of more than $540,000 in today’s dollars in their accounts by the time they are ready to retire; those between 20 and 24 will have nearly $700,000.

  How do those six-digit projected nest eggs for the typical Australian compare with the nest egg of a typical American approaching retirement? Unlike its Australian counterpart, the Investment Company Institute (ICI), the U.S. trade group for mutual funds, doesn’t measure whether 401(k) participants are on track, only whether assets have grown. In 2007, the ICI issued a news release reporting that Americans held $2.75 trillion in 401(k) plans. While ICI President Paul Schott Stevens was quoted as saying, “Ensuring that working Americans are preparing for retirement is a public policy of vital concern,” nowhere in its report is it stated whether this amount divided by 52.2 million 401(k) participants equals an adequate nest egg.

  Here’s the bad news: According to Fidelity Investments’ 2007 report on its clients, the median balance for workers on the cusp of retirement, age 60 to 65, was a measly $43,000—not enough to last most people a year or so—and that would apply only to people earning $43,000 in that age group. The formula that’s often used by pension actuaries to calculate a benefit is ten times “final pay”—or the salary you’re earning right before retirement. If most 65-year-olds have only around $43,000, they won’t be able to afford to retire for another decade or more—higher earners are in an even worse predicament.

  Australian Employers Must Contribute the Equivalent of 9% of Pay and Can’t “Suspend” Contributions to Employee Accounts

  The reason Australians’ nest eggs are fuller than those of their American counterparts? Very simply, Australian employers are required to contribute to workers’ superannuation (Australia’s word for pension) accounts—the current contribution rate is the equivalent of 9% of salary—three times the typical U.S. employer contribution rate—up to a salary ceiling of $137,880 up to age 75. In addition, the contribution is made regardless of whether the employee contributes—it’s not simply a “matching contribution.” One in four Americans doesn’t contribute to a 401(k) account and therefore ends up with nothing.

  What’s more, Australian employers aren’t allowed to stop or “suspend” making contributions when the economy sags, as is the case in the U.S. More than 60 major U.S. employers announced that they were lowering or suspending contributions in the U.S. as of early 2009, including Reader’s Digest, Sprint Nextel, U.S. Steel, Unisys, FedEx, and Eastman Kodak.

  Australians Can Sell Homes to Boost Their Retirement Accounts

  While contribution limits for American workers over age 50 are capped at $22,000 in 2009 (indexed to inflation), Baby Boomer Australians can sell a home or another asset and add the proceeds to their accounts. Under changes introduced in the 2006 budget, workers over age 60 can make after-tax superannuation contributions of $150,000 a year, or $450,000 over three years. Unlike their American counterparts, the Australian government realizes that Boomers need this brute-force opportunity to jump-start their savings because the 9% guarantee was only instituted in 2002—with the result that Boomer Australians will benefit from fewer years of super contributions than their Gen X or Gen Y counterparts.

  The result of this stewardship? Australians actually contributed more to their accounts than their employers did in the second quarter of 2007; according to the Australian Prudential Regulation Authority, employees contributed $22.4 billion, compared to $18.9 billion by employers on their behalf.

  Other Countries Are Pension-Richer

  Australia’s pension system isn’t the only one that’s putting ours to shame. According to a report by the Organization for Economic Cooperation and Development, the United States ranks near the bottom of the 30 member countries in pension generosity. Only six of the member countries had lower pension wealth than the U.S.

  Australia is one of eight countries that has a mandatory 401(k) style system and six of them are more generous than ours; the average employer contribution rate is equal to 7.25% of pay. Denmark’s is equal to 11.8%, Hungary’s is 8%, Mexico’s is 6.5%, Poland’s is 7.3%, the Slovak Republic’s is 9%, and Sweden’s is 4.5%.

  CEO Pay Is 208 Times the Average Joe’s, Whose Wages Are Shrinking

  Not only do much of the rest of the world’s pension systems put ours to shame, but pension poverty for the middle class is occurring at a point when the “CEO class” is taking home sky-high paychecks. In 1980, the average CEO wage was 42 times that of the ordinary worker. As of 2008 it was 208 times—averaging $7.7 million. At the same time, the average weekly earnings for Americans has actually decreased in the past three decades, from more than $325 in the early 1970s to about $280 in 2005
(in 1982 dollars).

  If the median wage had increased at the same rate as that of the top brass since 1980, it would be $79,000 instead of the current median wage of about $37,000. With that kind of salary, many more middle-class Americans would be able to afford a bigger chunk of their kids’ college bills rather than needing loans to pay for most of them. More of them could afford to put 20% down on a home purchase and therefore avoid taking out risky adjustable-rate mortgages. They could even afford to contribute more to their 401(k) accounts, perhaps closer to the 12.6% of pay contributed by Australians versus about 5% for Americans.

  If anything, it’s the increasing productivity of the average American worker that is boosting America’s bottom line. According to Mercer Human Resource Consulting, while corporate profits rose 15% a year from 2002 to 2005 and CEO compensation rose by an average of 7.2% per year, wages of exempt employees rose by an average of 1.1% per year—which instead of a raise is actually a “lower” if you factor in yearly inflation rates of about 3%.

  How Good Times, Bad Times, and “Pension Reform” Took a Wrecking Ball to Our Pension System

  Before we look at how you can make the most of your 401(k) plan and offer strategies for getting Congress to pass my proposed 401(k) Security Act, which would mandate 9% employer contributions, it’s worth it to learn how our pension system went astray.

  If you grew up in the 1950s through the early 1970s, there was a good chance that your dad was covered by a regular pension, also known as a defined benefit plan, because the economy was booming, unions had more clout, and employers needed to offer perks to lure employees. (I’m saying dad and not mom because in those days it was rare for moms to work outside the home.) However, starting in the 1970s, companies started cutting back on pensions, as “stagflation” and increased competition from Japanese manufacturers threw our economy into a tailspin.