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.
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.
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