Interview ¦ June 20, 2000
Will Social Security Reform Float Wall Street's Boat?

By Brett D. Fromson, Chief Markets Writer

It's official. Speaking in Kentucky today, Vice President Al Gore, announced that, just like his Republican rival, Texas Gov. George W. Bush, he favors creating investment accounts to help American workers build retirement savings to supplement Social Security benefits. There are crucial differences between the two candidates' plans, but basically Al and W are all fired up to let Americans invest for retirement in the financial markets.

This is a campaign promise that Wall Street would love to see kept. The assumption -- especially by securities industry types who have lobbied for "privatization" -- is that federally-sanctioned retirement accounts will funnel a huge new wave of money into the market. That would not only enrich the fund managers tapped to handle the investments, but would be of sufficient magnitude to buoy all stocks.

If you listen to the candidates, it's a done deal. But, in fact, it's far too soon to bet that Social Security reform will emerge from post-election Washington and premature to even speculate what form it might take. So, trying to gauge its potential impact on Wall Street or on stock values is futile at this point.

That is the view of one of the shrewdest observers of Social Security reform around -- Vanguard Group's Joel Dickson, who helps the fund giant select investment mangers and happens to be a former Federal Reserve economist.

"There is a lot of work to be done," says Dickson. "Social Security reform will continue to be debated for the next several years. If the objective is to secure the long term financing of Social Security and add to the capital stock of the economy -- i.e., increase net savings -- then it's not clear what the best approach is. Until we have that debate, Congress is unlikely to pass any legislation. And until we have a final plan, it is very hard to make any real conclusions about how this will affect financial markets or people's investing habits in general."

Another Wall Street economist, ISIs Tom Gallagher, also plays down the financial market impacts of private investment accounts. In a report issued earlier this month, Gallagher wrote, "Any assessment of the political and financial implications of Social Security reform has to be a work in progress."

For stocks, Gallagher wrote, "the popular perception would be that private accounts would be a big boost ... but we wouldn't be quite that enthusiastic."

Trim head Charles Biderman estimates that if Social Security reform legislation ever gets signed into law, the money flows could reach $100 billion a year, about one-third of the total expected this year. Biderman estimates that flows of that magnitude could add 10% to 15% to the overall market value, all things being equal.

Not bad. But all things are not equal.

A senior economist at the Federal Reserve says: "Even if money does come into the market, where is it coming from? Is it money that individual investors would have invested on their own in other accounts? Is it money from sales of other assets? Is it net increased savings in the economy?"

In the short run, there could be some boost to the market, if and when there is an agreed-upon plan. "The short-term reaction [to the establishment of private accounts would very likely be that stocks would benefit," writes Gallagher.

But in the long run, the total return on capital invested in the U.S. depends on productivity growth. Not mere money flows.

"Statistical studies don"t support the idea that flows of funds to the stock market help explain changes in stock market valuations," according to Gallagher. "Studies of governments that move toward greater funding of retirement plans don"t find a meaningful impact on their stock markets; fundamentals affecting corporate profitability and interest rates will still drive market valuations; and in the increasingly [global] capital markets, greater savings by Americans could flow overseas if fundamentals in those markets are better."

If some version of the Bush or Gore plans ever emerges from Washington, the most obvious indirect beneficiaries may be Wall Street's insiders --the brokerages and mutual fund companies. Someone is going to have to manage and keep records of all those accounts. Perhaps the Social Security Administration could do the record keeping, but it seems as likely that Washington would turn to the private sector.

If the government does decide to rely on Wall Street -- perhaps even to the extent of subsidizing the handling of small accounts -- then the investment management and administrative fees coming to financial intermediaries could easily approach $100 billion to $150 billion over 13 years, according to New York actuary David Langer.

And that's why, as the campaign kicks into high gear, you'll see Wall Street lining up squarely behind both candidates.