Chapter 1: Long-Term Financial Security
Roger W. Ferguson, Jr.
In order to determine the way forward for business and society in the twenty-first century, we must first know where we stand.1 Today, the relationship between businesses and individuals—consumers, borrowers, investors, and employees—is strained. In the wake of the global economic crisis, the American public holds a cynical view of business and Wall Street.
As a nation, we are contemplating regulatory reform because our existing oversight system has not evolved with the financial services industry. We are rethinking health care; in Congress and across the nation, people are grappling with what could be the most significant overhaul of the health care system in forty years.
These are fundamental issues with the potential to shift our society. As New York Times columnist David Brooks wrote in a recent op-ed, we are in the midst of “a debate about what kind of country we want America to be.”2 What role will business play as society tries to right itself? How can we as Americans achieve a more balanced state to ensure long-term financial security for our society?
In proposing answers to these questions, I will focus on:
- Our opportunity to revisit the social contract;
- Measures we can implement to help businesses adopt a more prudent, long-term view; and
- Steps we can take to help individuals enjoy sound financial health over the long run.
THE SOCIAL CONTRACT
Over the past few decades, employees have assumed greater responsibility for their careers, professional development, advancement, and retirement. The workforce has become more mobile as it has adapted to the global economy.3 In an age of “employment at will,” corporate loyalty has waned.4 We know that lifetime employment is no longer an option. But lifetime income should be our objective as we rethink and renew the social contract.
New research from McKinsey & Company finds that the average American family will face a savings gap of $250,000 at the time of retirement.5 Even with payments from Social Security and pensions, as well as from personal savings in 401(k) and other retirement plans, the average family will have only about two-thirds of the income it will need. Moreover, according to the McKinsey study, for every five years we wait to address the issue of retirement security, we will see a 10 percent decline in the typical retiree’s standard of living.
That is one reason why TIAA-CREF and others are calling for a holistic system that ensures Americans will have the retirement income they will need. A holistic system would:
- First, ensure full participation and sufficient funding by enrolling employees automatically on their first day of work and offering incentives for employers and employees that encourage total contributions between 10 percent and 14 percent of pay—roughly double the average contribution today. Automatic IRAs, which President Obama has proposed, could provide a tax-favored saving opportunity to those without a workplace retirement plan—currently, about half the American workforce.
- Second, help employees manage risk by offering a menu of fifteen to twenty investment options. This menu would provide sufficient diversification without presenting an overwhelming number of choices.
- Third, give workers financial education and objective, noncommissioned advice to help them build a portfolio that reflects their goals and risk tolerances.
- Fourth, provide opportunities and incentives for employees to save for retirement medical expenses.
- Fifth, provide lifetime income through an affordable fixed annuity option.
I believe we have an obligation to help our colleagues, neighbors, and fellow citizens move safely to and through retirement. With the holistic system I have outlined, we can help all Americans enjoy greater financial security. But in order to accomplish that goal, we need to encourage businesses and individuals to adopt a more balanced, long-term, risk-managed approach.
PROMOTING FINANCIAL SECURITY IN BUSINESS
As we look to recover from the worst recession in seventy years, we must be mindful of the far-reaching structural changes that have altered the macro-economy, including the globalization of capital, labor, and production and the evolving role of national governments in driving growth and expanding regulatory oversight. These forces may have a moderating effect on inflation, particularly given the rise of unemployment and the strongest productivity growth rate we have seen over a six-month period since 1961.6
But these structural changes may also create favorable conditions for asset bubbles by encouraging sudden price increases in discrete sectors of the market. Commercial real estate in the late 1980s, the dot-com equity market of the late 1990s, and the housing market in the present decade are a few examples of financial bubbles that ultimately burst.7 In such an environment, businesses must resist the temptations of a short-term outlook and focus instead on sustainability.
A group of financial and academic leaders convened by the Aspen Institute has posited that “a healthy society requires healthy and responsible companies that effectively pursue long-term goals.”8 Citing the insidious nature of the problem, the group noted that “many college savings, 401(k), and related retirement funds engage in behavior that is inconsistent with their investors’ goals, as they trade securities, pay their managers, and engage in (or support) activism in pursuit of short-term financial objectives at the expense of long-term performance and careful analysis of fundamental risk.”
Regulatory reform can help to reemphasize long-term thinking. Indeed, Congress is considering comprehensive financial regulatory reform. Led by the House Financial Services Committee and the Senate Banking Committee, both congressional chambers have been working actively on this issue.
Well-conceived reforms can ensure that financial services firms are able to innovate, develop new businesses, and take reasonable risks within an appropriate supervisory framework that promotes overall long-term stability and protects market participants. In fact, at a New York University (NYU) conference on regulatory reform in September 2009, I participated in a panel discussion with Eric Dinallo, former New York superintendent of industry and visiting professor at NYU’s Stern School of Business, in which we discussed the creation of an Optional Federal Charter (OFC) for the insurance industry. This measure, which TIAA-CREF supports, would provide life insurers with the choice to be regulated by a single federal entity or to continue to operate under the current state-by-state regulatory structure. An OFC could increase the efficiency of the life insurance industry, maintain product safety and soundness, and make U.S. life insurers more competitive on a global scale.
Proper reform will take time. But there are steps businesses can take immediately to operate more prudently, such as strengthening their risk management programs and ensuring—through good corporate governance—that their strategies and compensation are aligned with the long-term interests of shareholders. These long-term-planning strategies can drive corporate performance and help strengthen the market overall.
Furthermore, shareholders in the United States should be given greater rights, including access to the proxy to nominate directors, majority voting in director elections, and a shareholder vote on executive compensation. Shareholders and companies have a common goal of long-term wealth creation and must work toward that goal together.
Encouraging businesses to adopt a more rational, long-term approach will enhance the health and financial security of the country’s economic system. Individuals need similar help and guidance to achieve personal financial security.
HELPING INDIVIDUALS ACHIEVE FINANCIAL SECURITY
Since the mid-1980s, the ratio of household debt to disposable income has more than doubled, increasing from 65 percent to an unsustainable, all-time high of 133 percent in 2007.9 Americans have been living beyond their means. Two-thirds of the U.S. GDP was driven by consumer spending, and easy credit helped fuel its growth.
That scenario is changing out of necessity. The personal savings rate, which was around 10 percent of income in the 1970s and fell to zero in 2005, has risen to roughly 5 percent. Households are focused on paying down their debts. This deleveraging will have a dampening effect on consumer spending in the short term, but it bodes well for long-term economic stability in the United States and globally. Moreover, encouraging individuals to save more money will help restore their personal balance sheets. One way to assist individuals to achieve this end is with financial education.
In a recent study, Americans over the age of fifty were asked three questions involving interest rates, the effects of inflation, and the concept of risk diversification10:
- Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After five years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?
- Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After one year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
- Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
Only half of the respondents were able to correctly answer the first two questions; only one-third of the respondents were able to correctly answer all three. These are Americans over age fifty—individuals who are either close to retirement or in retirement. As it turns out, the ability to solve a few basic math problems can significantly influence an individual’s financial security.
Researchers have established a correlation between financial literacy and retirement planning, which in turn is a powerful predictor of wealth accumulation. People who plan for retirement have more than double the wealth of people who do not plan. Conversely, individuals with a lower degree of financial literacy tend to borrow more money, accumulate less wealth, and select mutual funds with higher fees; they are less likely to invest in stocks, more likely to experience difficulty with debt, and less likely to know the terms of their mortgages and other loans.
If we are to strengthen the long-term financial security of our society, we must do more to improve financial literacy; financial services firms can (and should) lead the way.
To promote long-term financial security, we need to strengthen the relationship between businesses and individuals. We must align the interests of employers and employees, sellers and consumers, issuers and investors. We need to wean ourselves off of unchecked consumerism and focus on exports and investments to drive growth. We need to save more and consume less. We need to think about what kind of country we want America to be.
A new social contract should include a holistic system to help ensure that all Americans can enjoy a more secure retirement; eschew short-termism in favor of long-term performance, sustainable value creation, and prudent risk management; and advocate a balanced approach to saving and investing by raising the level of financial literacy. By seizing these opportunities, we will strengthen our economy and create a more vibrant, financially sound society.11
ENDNOTES
2. David Brooks, “The Values Question,” The New York Times, November 23, 2009.