Don’t Believe the Hype
There's been much talk on the Street about President Bush's plan to do away with the institution of Social Security and the effect the plan will have on the financial services industry. Social Security's estimated $500 billion a year in employee payroll contributions would be one of the largest cash flows ever to be turned over to the securities sector as private accounts. And, many Americans speculate that financial services firms could earn hundreds of millions of dollars a year in fees and commissions if workers were allowed to invest part of their payroll taxes in the stock market, as the plan proposes.
The ongoing political debate has inspired a surge of headlines claiming that privatization would result in a bonanza for Wall Street. However, the Securities Industry Association calculates that the plan would generate, at most, $279 billion in fees over 75 years, or about 8.6 percent of the $3.3 trillion in the financial sector's total revenues over that period of time - more a blip than a boom for investment managers. A recent report by Needham, Mass.-based TowerGroup also asserts that the gains to the financial services sector would be less substantial than many are making them out to be.
According to Gavin Little-Gill, a senior analyst at TowerGroup and author of the report, the assumption that the privatization of Social Security will cause a boom in the investment industry is fundamentally flawed. "People are really talking about it in terms of asset management fees, and they're comparing mutual fund fees to the fees that would be associated with these accounts, but that's not the right way to look at it," he says. "The direct revenue associated with the privatization of accounts is insignificant to the securities and investments industry."
Behind the Ongoing Debate
The concrete details of how the proposed plan would be structured have yet to be made public, but information released by the White House in February outlines the President's Social Security reform strategy. The crux of the plan involves individually controlled, voluntary personal retirement accounts for workers born after 1950. Beginning in 2009, these workers would be permitted to set aside 4 percent of their payroll taxes into personal retirement accounts, with a $1,000 annual maximum, and could allocate their personal retirement account contributions among a small number of diversified index funds patterned after the current Federal Thrift Savings Plan (TSP).
The TSP is a defined contribution plan for government employees and members of the uniformed services. It's organized as a trust and, similar to 401(k) plans, TSP features include employee and employer contributions, pre-tax contributions and tax-deferred earnings, vesting schedules for non-matching employer contributions, and loan provisions. In addition, distribution requirements of TSPs are identical to those of 401(k) plans, with required minimum distributions and the ability to roll over assets to an IRA or other eligible employer plans.
Presuming the plan is approved, Little-Gill believes the real debate has to do with the actual servicing costs of these personal retirement accounts. At present, there are 3.4 million plan participants in the TSP, and the budget for servicing the TSP is just shy of $100 million. Comparatively, an estimated 100 million people, or 67 percent of the population, contribute to Social Security. "If you just use the TSP [as a model], which I think is a very well-run plan with very competitive administrative expenses ... you're talking about an environment where total servicing costs are going to rival $3 billion a year," Little-Gill says.
Moreover, much like the TSP, servicing for the private accounts most likely will be centralized. This means that, ultimately, only a handful of asset management firms will benefit from the plan. "If you look at the way they're talking about administrating Social Security accounts or privatization accounts, you have to move toward some form of centralized servicing," says Little-Gill. "Whether that's done on a governmental level or whether that's outsourced to a third-party provider, when you're talking about this kind of scale, believe me, the profit margins are going to be less than razor thin."
According to TowerGroup's report, the front-runners for potential Social Security reform servicing contracts are State Street Global Advisors and Fidelity Investments, both based in Boston. Although Barclays Global Investors currently provides investment services for four out of the five investment options under the TSP, according to the report, the fact that BGI is a non-U.S. owned entity puts it at a disadvantage.
Additionally, TowerGroup predicts extremely competitive bidding from the institutional broker-dealer community, which may significantly reduce management fees for the ability to control the asset flow. "There'll be a couple of [asset management firms] that will win some contracts if we move forward," says Little-Gill. "These guys are going to make money at some point, but not a whole lot of money."
Despite the less-than-colossal gains expected by the enactment of the proposed plan, most Wall Street firms are continuing to shy away from the debate. The numerous firms contacted by WS&T, including Morgan Stanley and Vanguard, declined to comment on whether or not they thought the plan would impact their businesses.
Still, Little-Gill does believe that Wall Street firms will reap some rewards. "I believe that this will still be good for the marketplace because it's going to drive assets from fixed income securities to equities," he says. "That is fundamentally the benefit to the industry, but it's much more complex than anybody has laid out in an argument today."