Interview ¦ January 7, 1997
A Safety Net Whets Wall St. Appetites; Social Security Proposals Could Mean Billions in Fees

By Brett D. Fromson

The announcement yesterday that a presidential advisory council supports investment of Social Security payroll taxes in stocks could be the best news Wall Street gets all year.

Privatization could be the honey-pot of all time for Wall Street, according to Wall Street executives and analysts.

How big?
Under the proposal preferred by Wall Street, investment management and administrative fees could total $ 240 billion from 1998 to 2010, according to actuary David Langer.

Langer calculates that under a second, less-radical option to emerge from the council, the fees would total $ 75 billion in the same period.

"The numbers are mind-boggling," Langer said. "Now you know why our big financial institutions are the major proponents of this. They have tried to remain in the political background because of the size of money we are talking about."

There is a third proposal that would generate minimal fees, in the range of a few billion dollars. The vast majority of Wall Street executives and lobbyists oppose it.

Wall Street executives, who declined to be identified, concurred with Langer that they and their firms do not want to be seen leading the charge for privatization because of their obvious self-interest. "This could be huge for us," said an executive at State Street Bank, a Boston-based company that provides both administrative services and investment advice.

One of the 13 members of the presidential panel said the mutual fund industry impressed on him the potential rewards for Wall Street firms under the more aggressive privatization options.

Thomas W. Jones, vice chairman and chief operating officer of TIAA-CREF, the nation's largest private pension system, said he was approached a year ago by representatives of the Investment Company Institute, the mutual fund lobbying and trade group. "They said they were disappointed I didn't support Option 3, the proposal that generates the most revenue for the industry," Jones said. "They made the point that Option 3 offered my company -- TIAA-CREF -- the greatest potential for new business.

"My response was that I was appointed as a public member of the advisory council, not as a representative of a company or an industry," Jones said.

"I also told them that if the amount of overcharging and underperformance that is common in the mutual fund business was any measure, I was not optimistic about the free market taking care of things," he said.

A number of recent studies have found that most stock mutual funds fail to beat the broad market and many mutual fund companies charge excessive fees.

ICI Senior Vice President Julie Domenick said in response to Jones, "I know we met with people on the advisory council to hear what their concerns were. We've come to the view that whatever the option chosen, the government will look at fees. No one is interested in creating a high-cost option. I would disagree that this is fee-driven. Our view is that there are serious issues to be explored, one of them is individual investment accounts."

Jones is a supporter of the most limited of the three privatization options to emerge from the council, Option 1. Under this proposal, the money would remain in one pool invested in stock index funds managed by a dozen or so investment advisers. The advisers would be overseen by an investment board nominated by the president and confirmed by the Senate.

He prefers this approach for a number of reasons, primarily that it would cost far less than the two alternatives.

"There is no money for Wall Street in Option 1," he said. Jones estimates that in the first year, the investment management and administrative fees would be in the range of $ 10 million.

He said he made that estimate based on TIAA-CREF's experience as a pension provider and on the experience of the Federal Thrift Savings Plan, a government entity that oversees $ 18 billion in a stock index fund managed by an outside investment adviser.

In contrast, Option 2 would cost $ 500 million, and Option 3 would cost $ 2 billion in the first year, according to actuary Langer.

The huge differences can be largely explained, Jones said, by the fact that it costs far less to invest and administer one giant pool of money than 100 million or more individual accounts as the other options envision.

One mutual fund executive involved in the ICI's lobbying efforts said that while Wall Street prefers Option 3, it may rally around Option 2.

Option 3 is "politically unrealistic," the executive said.

"Privatization requires that Clinton and Gore get behind the idea," the executive said. "Legislation will be proposed this session of Congress, but nothing will be passed. We could be looking at a bill passed four years from now in a Gore administration. Option 2 would be a good starting point for legislation."

The three proposals for changing the Social Security system all allow for the investment of some funds in the stock market. Here is a brief look at how each plan would invest and what such investments would mean to Wall Street.

• Invest about 40 percent of the Social Security trust fund in a pooled account that would invest in stock funds linked to indexes such as the Standard & Poor's 500-stock index or the Wilshire 5000.
• Would increase total real return on the trust fund from 2.3 percent to 4.2 percent.
• Investment choices would be overseen by a presidentially appointed investment policy board.

• Create individual accounts funded with a mandatory 1.6 percent payroll tax.
• Workers would have limited investment choices, ranging from bond index funds to stock index funds.
• The government would hold the accounts.

• Create individual accounts funded with money generated by a 5 percentage point share of the current payroll tax.
• Workers would have greater investment choices than under the Individual accounts plan.
• The funds would be neither held nor managed by the government.

By 2010, more than $4 trillion a year could be pumped into the stock market from Social Security account plans, generating as much as $44 billion in annual fees for Wall Street under the personal security accounts plan.

SOURCE: David Langer Company