July/August 2012 The Hole in the Bucket

Americans obsessed over personal finance during the last forty years as never before. So how come so many of us wound up broke? Here's the little-known story.

By Phillip Longman

Never before in history has the great American middle class obsessed so much over financial planning as during the last forty years or so. In the 1970s, this obsession fueled the growth of hot new magazines like Money and TV shows like Louis Rukeyser’s Wall $street Week. By the 1980s, it had led to the creation of personal finance sections in almost every newspaper, and to myriad radio talk shows counseling Americans on what mutual funds to buy, how much they should put into new savings vehicles like Individual Retirement Accounts or Keoghs, and how to manage their new 401(k) plans.

In the 1990s, millions of Americans learned the accounting program Quicken, avidly followed the tips offered by Jim Cramer and the Motley Fool, and employed legions of tax and financial advisers and online tools to help them figure out whether they should convert to a Roth IRA and how they should take advantage of the new “529” college savings accounts. In the last decade, millions more have turned to outlets like HGTV to learn the ins and outs of flipping houses, consolidating credit card debt with a home equity loan, and combining a medical savings account with a high-deductible insurance plan.

Who in the 1950s ever worried so much about managing money?

And yet here we are today. According to a recent study by the Employee Benefits Research Institute, fully 44 percent of Baby Boomers and Gen-Xers lack the savings and pension coverage needed to meet basic retirement-age expenses, even assuming no future cuts in Social Security or Medicare, employer-provided benefits, or home prices. Most Americans approaching retirement age don’t have a 401(k) or other retirement account. Among the minority who do, the median balance in 2009 was just $69,127. Meanwhile, the college students who graduated in 2011 started off their adult lives encumbered by an average $25,000 in student loans.

What went wrong? We can all come up with scapegoats, of course. It’s common to hear, for example, that America became a nation of impulse shoppers and spendthrifts over the last generation. But like a lot of conventional wisdom, this consensus isn’t just wrong, it’s mean. The average American household actually spends significantly less on clothes, food, appliances, and household furnishings than did its counterpart of a generation ago. There is, however, a deeper story to tell—one that is still largely unacknowledged in our political debates.

As far back as the 1970s, many thoughtful observers could see the basic outlines of the middle-class insolvency crisis we are facing today. Some were even able to predict accurately, decades in advance, that it would all start coming to a head around the end of the 2000s. The big new trend they focused on was changing demography. By the end of the ’70s, birth rates were falling precipitously, meaning that the rapid population growth that had come with the arrival of the Baby Boom generation in the 1950s was over. At the same time, Americans were living longer and retiring earlier, and the poverty rate among children was starting to rise sharply.

This sea change had all sorts of implications. But one of the most obvious—to, among others, thoughtful liberals like Joseph Califano, a member of President Carter’s cabinet, and Senator Patrick Moynihan—was the long-term challenge the shift presented to the financing of Social Security and private pension plans. At the time, Social Security was paying out benefits to retirees that exceeded the value of their contributions by between $250,000 and $300,000 in today’s money, as Sylvester Schieber, former chairman of the Social Security Advisory Board, recounts in his recent book, The Predictable Surprise. Yet while these windfalls had set expectations among Americans of all ages about what constituted a minimally comfortable middle-class standard of living in retirement, they were clearly unsustainable.

By the end of the 1970s, the wages of most young people paying into the system were stagnating. By 1983—even with the arrival of the full Baby Boom generation into the work-force, including gigantic increases in the number of working women—Social Security simply ran out of money.

In perhaps the last major act of bipartisanship in Washington, President Ronald Reagan and House Speaker Tip O’Neill came together to “save” the system. But by steeply raising payroll taxes on workers and cutting their future benefits, they made Social Security a much less generous deal for generations going forward. Most would get little more back from the system than they paid in. Baby Boomers and their children would just have to learn how to live without the windfall benefits of the past.

At the same time, another major prop that had sustained the standard of living of the past generation was also clearly in trouble: private pensions. Like Social Security, these accounts were being threatened by the declining ratio of workers to retirees. Adding to the challenge, many of the highly unionized old line manufacturing companies, which typically offered these kinds of pension plans, were starting to be subject to creative destruction, union busting, or, because of the shift to automation, substantial reductions in the numbers of workers paying into their plans.

From the point of view of younger workers in the emerging workforce, these traditional benefit plans, even when well funded, were also an increasingly bad deal. Most did not offer any benefits until a worker had been with a company for at least five years, sometimes ten, and benefit formulas tended to be heavily back-loaded in favor of those who spent a whole career with one company—an increasing rarity. The old pension plan system was particularly hard on women trying to combine part-time work with family responsibilities. For more and more workers, traditional pensions going forward would offer little or nothing.

Thus, reasonable people called for the creation of new 401(k) and other so-called “defined contribution” plans. Under the new plans, workers did not lose benefits just because they changed jobs. To be sure, they lost any guarantee of fixed monthly benefits for life, but if their investments did even modestly well, they could earn far more than they would have under traditional plans.

Meanwhile, there was no way that the new plans would encumber individual companies or the next generation with pension debts; by design, beneficiaries received only whatever the market value of their investment turned out to be. In broad outline, transitioning to these plans, in the face of the demographic and workplace charges America was experiencing, was a reasonable and rare example of the government and the private sector collectively engaging in prudent, long-term planning.

Except, of course, for a few “minor” details that hadn’t been thought through. This massive change of strategy—arguably on a scale of the New Deal in its ultimate effects on American life, only on the downside—might have worked, for example, had all Americans been required to save for retirement. But mandating savings was off the table, because some said that would be “paternalistic”—and in the age of Reagan and spreading free market libertarianism, that was an argument stopper.

Phillip Longman is a senior editor at the Washington Monthly and a lecturer at Johns Hopkins University, where he teaches health care policy. He is also a senior fellow at the New America Foundation, where Atul Gawande is a board member.


  • Darsan54 on July 11, 2012 12:28 PM:

    I walk away with the feeling it's all hopeless.

  • DAFlinchum on July 11, 2012 1:50 PM:

    When 401(k)'s first came out I thought that they were a Trojan Horse that would lull workers into thinking that it would be an addition to their defined benefit pension plans and at the same time signal to employers/companies that 401(k)'s would be a fine substitute for defined benefit pension plans. As it happens I was correct.

    First a few companies, then more, and more still as the companies that tried to do best by their employees discovered that it was hard to compete with those companies that went defined contribution. The employees who had been happy to have their companies do a small amount of matching funds soon found that this would be their company's only contribution in the future. Long term employees saw their defined benefit pensions frozen; new employees got 401(k) only.

    I now predict that the same thing will happen with the ACA and company provided health care. First the employee portions of fees, copays, premiums, etc will start rising until the employees' costs are nearly as much as if they went to the exchanges. Next, companies start off-loading employees to the exchanges and paying the cheaper penalty. The employees see little difference as their costs have risen so much and the federal government will shoulder more and more costs as it subsidizes families on the exchanges. Where will this money come from? Higher taxes on 'the rich'? Don't bet the farm.

    It is going to prove to be a boon to the biz interests from insurance companies on down as companies shift the costs of doing business, which used to be health care benefits for employees, onto the government and community at large and pocket the extra profits.

    The ACA will not be so 'affordable' and will instead be the law of unintended consequences.

  • Daniel on July 11, 2012 9:55 PM:

    What starts with an F, ends with a K, and means get screwed?

  • BenefitJack on July 12, 2012 6:02 PM:

    The author states: "Most Americans approaching retirement age do not have a 401(k) or other retirement account. Among the minority who do, the median balance in 2009 was just $69,127."

    Two issues with how that is positioned in the article:

    First, he is absolutely correct that the LACK OF a retirement savings plan is one of the main reasons why workers will not be prepared for retirement. The four top reasons are:
    (1) Most individuals do not have access to a plan at work,
    (2) Most individuals who do have access to a plan at work fail to enroll when first eligible,
    (3) When individuals get around to enrolling to save for retirement, they typically don't contribute enough; many fail to contribute enough to get the entire company matching contribution, and finally,
    (4) The typical American changes employers 5, 6, 7 times in a working career, and too frequently, she takes a distribution of any such savings and uses them to pay accumulated debts (or to splurge).

    Second, the $69,127 number is misleading positioned as it is here too close to the statement "as they approach retirement age". One Employee Benefits Research Institute study of millions of participants confirms that the average account balance in 401(k) plans as of December 31, 2010 was ~$60,000, however, workers who had 30 years service with the same employer and are over age 60 had an average account balance of ~$202,000.

    The implicit suggestion that many workers or even a majority of workers once had access to a well-funded, non-contributory, final average pay, defined benefit pension plan, perhaps with an automatic post retirement COLA is just fantasy.

    In terms of a precursor for how employers will respond to health reform, look no further than what has happened to employer-sponsored coverage over the last ten years, or, what happened to retiree health care coverage over the past 30 years.

  • Rugosa on July 12, 2012 7:00 PM:

    woa - you got me at had all Americans been required to save for retirement Did you not read what you wrote a few paragraphs up: By the end of the 1970s, the wages of most young people paying into the system were stagnating.

    How can you require us to save for retirement when our incomes increasingly can't keep up with the cost of living?

  • Lex on July 13, 2012 9:47 AM:

    Interesting, though, isn't it, how just about all Fortune 500 CEOs have defined-benefit pension plans AS WELL AS other retirement savings. Not to mention golden parachutes: The guy who was pushed out as CEO of Duke Energy a few days ago after serving in the position all of about 20 minutes (literally) gets an exit package valued at north of $40 million, financed, in all likelihood, by stockholders, ratepayers or both. That's just farking nuts and ought to be illegal.

  • Bill Bush on July 13, 2012 3:58 PM:

    Submit to your Galtian Overlords! Die immediately after retirement, leaving your entire estate to pay off the federal deficit! Kill the wounded! Cull the hospitals with a cost analysis tool favoring soonest future profitability!

    Or abandon the dog-eat-dog mentality and the current vicious variant of capitalism. Try doing things humanely, responsibly and kindly. Unless you think the first paragraph sounds like fun.

  • leo from chicago on July 13, 2012 5:47 PM:

    "How can you require us to save for retirement when our incomes increasingly can't keep up with the cost of living?"

    Exactly. I love how they tell you you can save up to such and such a percentage (tax free!) in 401k accounts and IRA's -- when you're living paycheck-to-paycheck.

  • brian t. raven on July 15, 2012 4:05 PM:

    1. We could close the door to immigrants,
    2. We could impose high tariffs on imports.
    3. We could make it easier for workers to unionize.
    4. We could even raise the income tax rate on the top 1 percent to 100 percent.

    It's a very good and informative article except for the four recommendations above. From the perspective of basic economics these are fundamentally flawed. The Monthly needs to send these kinds of articles to a venerable economist before publishing. Even if the recommendations were merely musings they still should have been excised; because they diminish the argument by undermining author credibility.

  • skeptonomist on July 20, 2012 8:03 PM:

    Generally good piece explaining the role of the finance industry in shrinking the assets of the 99%. The housing bubble was directly responsible for most of the loss since 2002, and it probably would not have been possible without credit-default swaps, which gave a false sense of security to all the bad mortgage debt. There is little sign that the dangers of derivatives have been restrained.