Wait… Nearly 14 Million from a Blind Trust!?

A lot has been made about Mitt Romney’s recently released 2011 tax returns.  Most of his income comes from investments made in a ‘blind trust’.  Some take issue with whether or not the trust is truly ‘blind’.  Others have taken issue with his effective tax rate(it’s lower than what many wage earners pay).  I want to discuss, what I see as a much larger problem.  Let us assume for a moment that Mitt Romney’s blind trust really is ‘blind’.  How is it that a man makes nearly 14 million dollars by doing absolutely no work?

A blind trust is supposed to be where a wealthy politician puts all his financial assets and then has no say in how it is managed.  The people who manage it for him earn a small(maybe a large) fee for managing it on Romney’s behalf.  By putting money into a blind trust one doesn’t have to do anything with it.  They aren’t consulted, bothered, cajoled, nothing.  Just a big ol’ check at the end.  This means Mitt Romney contributed absolutely zero work to the economy, but still managed to pull nearly 14 million dollars out of the economy for himself.  If this Forbes article on Mitt Romney’s Wealth is to be believed, that comes out to a 6% or 7% return on investment.

Let’s review the idealized role that investors play in a capitalist society.  Investors serve a very useful function in society.  They choose how and where to invest new resources.  If they choose wisely, society in general gets richer, and the investor makes money – possibly a lot of money.  A win-win.  The risk of course is that they choose poorly and lose some or all their money.  The money made by an investor is the reward for doing their homework and investing wisely in new enterprises.  Losing their money is the punishment for speculating or just investing foolishly.

The problem is, Mitt Romney did none of those things.  Did he really do anything worthwhile to earn a 6% return?  Six percent is pretty high considering that the average savings account is below half a percent.  The only decision he had to make as an “investor” was who to put in charge of his blind trust.  Is that one decision really worth 14 million dollars and a six percent return?  Maybe it is, but I think it would certainly warrant a review of the current rules of the system.

I am not suggesting as a solution anything radical like a 100% tax on financial income, or a ban on private investment.  What I am suggesting is to look at the ways this money is made.  The eco-system of laws and institutions behind it.  What government rules or agencies may be perpetuating it?  Does someone have to be a 200+ millionaire to earn a 6% return by doing nothing?  If so, why?  And is there a good reason why it is so?

Why is it that a person can state that they made nearly 14 million dollars last year without lifting a finger, and no one in the corporate so much as raises an eyebrow?

The 401k is a Government Subsidy for Wall Street

Wall Street apologists often try to defend Wall Street by pretending that it is somehow the last bastion of laissez-faire capitalism.  Even more comical, some wall street traders have even taken to call themselves defenders of free enterprise.  The truth is, the big bank bailouts in 2008 was the continuation of a long history of government sending our money to Wall Street.  There are several ways that the government subtly helps Wall Street fund it’s addiction to speculation and stock market gambling.  One of the ways it does that is through the 401k tax provision.

It shouldn’t surprise us that the 401K, marketed to us as a retirement plan, is just a cash cow for Wall Street. After all, the 401k started as a tax loophole for executive pay. So why do i call the retirement “plan” of millions a “Wall Street subsidy”? Well, let’s see how it works.

A 401k retirement “account” allows one to make money on financial income without being taxed on it until later. For instance, if, one year, you put 100$ in your 401k, the income tax you would’ve paid on it is suspended.  Not until after you’ve retired and pull out that money will you pay income taxes on it – long after you’ve made interest, dividends, and other money with your untaxed money.

On top of that, your employer will get certain tax deductions and credits for setting up and directly contributing to an employee 401k plan.  When an employer sets up a 401k, a wall street firm will charge them a certain fee.  But lo and behold, the government gives the employer a tax credit to cover some or part of the fee.  This is essentially the federal government subsidizing 401k Management firms.  Funny how we hear the financial elite complain about healthcare subsidies, but not complain about this subsidy.

The worse part is the tax-free income of the 401k.  All money made in a 401k can get reinvested and doesn’t get taxed until you want to spend it.  That might make sense for business taxes that pay only on profits, but not for personal taxes.  Personal income taxes, you pay on all income.  I don’t get an exemption for investing in a car that can get me to my job faster, why do I get an exemption for buying Dow Chemical stock?

A 401k locks you into handing your money to Wall Street firms by specifying what you can’t do with a 401k.  You can’t use your 401k savings to invest in your friend’s small business(You can take out a loan against your 401k, but still have to pay it back to wall street – with Interest!).  Unless that small business is listed on the New York stock exchange or some other stock exchange(that isn’t a cheap(pdf) or easy task) and there is a mutual fund that invests in it(very unlikely).  Once Wall Street has your money via your 401k, they have it until you retire (unless you’re willing to pay a huge fee, of course).

Some might think the answer is to boycott funding our 401ks.  Something akin to the Move Your Money campaign.  That campaign was trying to defund Wall Street by moving our money from the large commercial banks to local banks or credit unions.  But that won’t work as well.  Moving to a local bank or credit union didn’t involve losing much money.  In fact, it often means gaining money because credit unions often have better interest rates.  With a 401k, boycotting it means “leaving money on the table”.

Because the government incentives employers to have as many employees to participate as possible, they offer matching funds(which are tax-deductible) that employees wouldn’t get if they don’t participate in the 401k.  If an individual employee doesn’t participate he is losing money because of the government subsidies.

So what does this all amount to?  The federal government pays employers to setup 401k “retirement” funds that can only invest in financial assets that Wall Street firms control, pays employers to get as many people to participate as possible, and then gives employees tax breaks to go along with it.  The “defenders of free enterprise” are suspiciously quiet on this racket.

You might think I’m exaggerating the importance of the 401k in directing money to Wall Street.  So let’s look at the numbers.  The 401k law went into effect in 1980.  In that year, the percentage of people who owned stock was 13%.  A slight dip from 15% in 1970.  By 1989, the number was 32% – More than double 9 years earlier.  By 1998 over half of the country owned stock(source for numbers here).  There is significant financial wealth to be had with 401ks.  Nearly 3 trillion dollars worth.  That is a lot of money to be sloshing around in Wall Street’s computer banks.  As you can imagine that 3 trillion dollars means a lot fees for managing all that wealth.

I have no problem with people entering the wall street casino willingly.  But now we incentivise people to enter it.  Requiring people to enter it to make sure they get all the tax breaks they wouldn’t receive otherwise.  This requirement means that people who are not qualified to manage their own investments are forced into it.  The power elite know this.

I used to ask the CEO, CFO of my major clients, … often in a conference room [after] some young employee would bring in coffee, and as they would be leaving, I would ask the CEO, “Would you allow that employee to direct the investment of your account in the 401(k) plan?” They always thought I was some kind of idiot: “Of course not. I wouldn’t let them touch my account with a 10-foot pole.” And I said, “But you force them to manage their own!” And they are running their money into the ground.

The irony here is dripping.  First, we are assumed to be too stupid to properly save for our retirement, so we have to have tax breaks that incentivize us to give money to Wall Street to save for retirement.  But once we make the decision to hand our money over, then suddenly we are magically smart enough to manage our own stock portfolio.  As you can imagine, most aren’t educated nor have enough time to make informed decisions.  This disparity reflects poorly on those who most need a retirement plan.  Only the highest educated and most familiar regularly beat the system and maximize their gains.

I think what should happen is that this 401k tax loop-hole should be closed and in exchange we all get a general income tax cut(starting at the bottom bracket).  If we are all taxed less on our work and labor, we will have more money to save.  Then we can all decide on how best to save for retirement beyond Social Security.  Some might still enter the wall street casino that are knowledgeable enough, others might choose other routes like paying off mortgages early, or others still might try to build a small business.

The point is, we shouldn’t let Wall Street use the tax code to force us all into the same option.  That would be a real “free market” principle.  You would think all those big bankers would be all for that.  Unfortunately, they rarely speak up when a free market principle would actually take away one of their cash cows.  People like Peter Schiff will go in front of congress and demand eliminating the minimum wage, unemployment benefits, and anti-discrimination laws, but not once has he ever suggested eliminating the 401k or any of the other canards that direct money to investment firms like the one he owns.  So much for our “defenders of free enterprise”.

Revisiting the Confidence of our Sophisticated Financial Wizards

I ran across this “old” testimony from a spokesperson for the “American Securitization Forum”(ASF) to congress in 2003(pdf).  The ASF is made up of mostly large financial firms involved in the securities market including the now infamous mortgage backed securities(MBS).  Much of the testimony included is a matter-of-fact history of the development of the secondary market for mortgages.  What made me laugh was reading their conclusion and message for congress.  Their message was basically, we are awesome.  We’ve ‘innovated’ this awesome new market to provide credit to everybody.  Anything you do to regulate predatory lending will ruin this awesome thing we created.

Securitization reflects innovation in the financial markets at its best. Pooling assets and using the cash flows to back securities allows originators to unlock the value of illiquid assets and provide consumers lower borrowing costs at the same time. MBS and ABS securities offer investors with an array of high quality fixed-income products with attractive yields. The popularity of this market among issuers and investors has grown dramatically since its inception 30 years ago to $6.6 trillion in outstanding MBS/ABS today.
The success of the securitization industry has helped many individuals with subprime credit histories obtain credit. Securitization allows more subprime loans to be made because it provides lenders an efficient way to manage credit risk. Efforts to curb “predatory” lending that inhibit the legitimate use of securitization by assigning liability to the purchaser of a loan or some other means, threaten the success of the beneficial subprime market. Secondary market purchasers of loans, traders of securitized bonds and investors are not in a position to control origination practices loan-by-loan. Regulation that seeks to place disproportionate responsibilities on the secondary market will only succeed in driving away the capital loan purchasers provide in the subprime market.
I urge Congress to move with great care as it addresses the problem of predatory lending. The secondary markets are a tremendous success story that has helped democratize credit in this country. Well intended, but overly restrictive, regulation in this area could easily do more harm than good. This is particularly the case when state and local governments craft disparate anti-predatory lending statutes that place different compliance burdens on the secondary market. For this reason, the ASF urges this committee to consider legislation to pre-empt the authority of state and local governments in the area of predatory lending and to construct a safe harbor from assignee liability for secondary market participants.

These guys were so high on their own awesomeness that not only did they want congress to leave them alone, they wanted congress to MAKE the states leave them alone too.  The lobbying firm had some success with this.

Then, of course, 2008 rolls around and those financial wizards found out they were full of crap.  The punchline to all of this is that the ASF then lobbied for TARP to bail them out(pdf).

SIFMA and ASF support the use of a Guarantee Program to cover assets with high illiquidity premiums relative to their expected losses. In such instances, the assets are unable to be sold at prices that are reasonable based on the quality of the asset. SIFMA and ASF believe that the Guarantee Program should be considered for use with a full spectrum of financial assets, including both securities and whole loans. Treasury may consider whether identifying frequently referenced assets (such as RMBS referenced in multiple CDO transactions) may present an opportunity to magnify the benefits of any purchase or guarantee program

So the same group that 5 years earlier was telling everyone to leave them alone because if we try to make them stop selling deceptive loans, we’d ruin all their awesomeness, then they get congress to bail them out when their “innovations” blow up in their face.  Then they wonder why everyone is so upset with them.