The Float

Employment Analysis Roundup

We don't have time this morning to offer a full (or even much of an abbreviated) analysis of today's employment situation release from the Bureau of Labor Statistics. An aside: People may call it the "September" job report, but let's be honest...the current-month numbers are so wildly unreliable that the most interesting tidbits in each new report tend to be the prior-month revisions, which give a better, though still flawed, sense of medium- and long-term trends.

Here are a few insightful assessments of today's numbers from around the web...

• Calculated Risk on how today's revisions fit into the long-term employment picture.
• Barry Ritholtz on the oddball swings in public-sector (primarily local education) employment that drove the August numbers down and the September numbers back up...all of which adds up to anemic, but not recessionary, private-sector job growth.
• MarketBeat's David Gaffen on the implications of today's release for the October Fed meeting.
• Felix Salmon acknowledges that monthly employment numbers generate some sound and fury, but argues that they signify increasingly little.

"25 Years of Mediocrity"

Over the last few months we've written extensively on the terrible shortcomings--and great potential--of defined-contribution retirement plans. Every now and then we run across an item that captures an important part of our argument, and this short opinion piece from Jim Wiandt of IndexUniverse is superb example.

Wiandt wrote this back in January, but it's still plenty timely as we consider the near-term trajectory of regulation and legislation in the 401(k) world. Wiandt opens with this appropriately furious salvo:

I recently came across a rather glib press release trumpeting the 25th anniversary of the 401(k) plan. It noted that 47 million Americans now actively participate in 401(k) plans, compared with 21 million who participate in traditional defined benefit plans. Essentially, we are well on our way to a wholesale shift of risk from large entities to the individual...the magical ownership society...where *presto poof* we kill (or maim) three birds with one stone: 1) nettlesome pension deficits disappear; 2) 1,000 points of ownership light blink on; and, 3) financial middlemen enjoy an unprecedented boon.

Call me a skeptic, but I've met a lot of individual investors and financial advisers, and the level of knowledge, even among those who are paying any attention, is...well...appalling. In the 401(k) business, you end up with a potent cocktail of investor cluelessness and (generally) a horror-show lineup of investment options. It adds up to an old joke I remember from when I was growing up in rural Ohio: "He may be small, but he sure is slow."

The 401(k) plan, or something like it, could actually work. But what we have right now is a bloated and inefficient system that forces investors to pay more than they should for investment options that aren't what they ought to be. The way that mutual fund companies cling to 401(k) plans as massive distribution machines locks investors into a limited choice of generally high-expense-ratio, high-fee plans, putting many investors in a situation where they might do better in a taxable account.

Hear, hear. And Wiandt's concluding riff--that "all we're doing is building on 25 years of mediocrity"--is perfectly apt. The defined contribution system needs serious work, and with stakes as high as these--intergenerational equity, government solvency, economic competitiveness, &c.--that work should begin yesterday.

Friday Reading

It's employment day on the Street, where good news is good news, bad news is good news, and mediocre news is good news...

• Third-quarter writedowns continue for the biggest names in financial services. Today's pre-announcers: Washington Mutual and Merrill Lynch, while Bank of America and JPMorgan may soon offer up more of the same.
• Bloomberg's Michael Sesit suggests that "safe haven" gold bugs might want to get a clue.
• At FT's Alphaville, Gwen Robinson relates a big (and very good) John Authers think piece on the current and future states of U.S. equity markets.
• Bloomberg's Mark Gilbert channels Walter Bagehot to explain and understand recent/ongoing credit market conditions.
• Yesterday we mentioned Representative George Miller's 401(k) fee disclosure legislation. His Education and Labor Committee has now posted the testimony delivered at yesterday's hearing on the topic. We haven't worked our way through that testimony yet, but we expect to have a comment or two after we get a chance to do so over the weekend.

401(k) Fee Disclosure: Legislation and Regulation

This morning, the House Committee on Education and Labor will hold a hearing on committee chair George Miller's proposed legislation (H.R. 3185) requiring substantial changes in the way defined contribution plans disclose fees and expenses to their sponsors and participants. (Click here for testimony from the Committee's March 6th hearing on hidden fees in retirement plans.)

Though Miller's bill is not the only legislative effort underway on the fee-disclosure front--and though it's very unlikely to become law in its present form--it's getting a lot of attention as the first to reach the committee hearing stage. Here's a tidy summary of H.R. 3185 from Hewitt Associates.

In addition to a wave of potential legislation, the Department of Labor is now finalizing proposed rules on fee disclosure in defined contribution plans. Back in July, we joined more than 100 other individuals and organizations in responding to the Department's Request for Information on its proposed rules. Here's our comment and the full list.

The spirit of our response to the DOL was that improved fee disclosure was and is an imperative part of a broader campaign to raise the likelihood of long-term investment success for plan participants. We expect that lower, more transparent expenses will encourage greater competition in the financial services industry, improve sponsor awareness, and elevate employee confidence and participation.*

We strongly support the trend toward greater transparency (though we aren't sold on every detail of Miller's legislation and we agree with the Profit Sharing/401k Council of America that legislators should defer to the Department of Labor until it finalizes its rules). But even lower, more transparent fees won't solve two much bigger problems with defined-contribution plans: (1) Non-fiduciary, product-driven sales practices that saddle plan participants with underperforming mutual funds and (2) the impaired investment performance that follows naturally from forcing participants to act as their own money managers.

What the retirement plan marketplace needs (desperately!) is the best of the old and new worlds, a combination of the inexpensive, high-quality investment discipline of the old pension world and the flexibility and portability of the new defined-contribution world.

Regulators and legislators should push service providers and sponsors in that general direction while trusting the market to develop new, more participant-friendly retirement plan solutions.

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*A note on sponsor awareness: Just as it's unfair and unrealistic to expect rank-and-file employees to be sophisticated choosers from menus of mutual funds, it's similarly unfair and unrealistic to expect them to be sophisticated consumers of fee-related information. The role of plan sponsors here can hardly be overstated. They're fiduciaries by definition, and the full disclosure rightly required of the financial services industry should be directed primarily toward sponsors, to help them make informed decisions on behalf of their participants. The point here isn't that participants should be kept in the dark about what they're paying and what they're paying for. Not at all. But sponsors have an absolutely indispensable function here, and regulators/legislators should expect sponsors to be sophisticated, prudent, fiduciary consumers of fee-related information. If sponsors make good, informed decisions, participants will reap the benefits of the high-quality investment options they need and deserve.

Sources

Murray Coleman, "Retiring 401(k) rules," MarketWatch, October 3, 2007

Thursday Morning Miscellany

Yesterday we linked to Susan Antilla's Bloomberg column on declining regulatory actions in the securities industry, which, it turns out, might have been a pretty decent contrary indicator. This morning, Bloomberg features this headline: "SEC Enforcement Cases Rise for First Time Since 2003."

Also from Bloomie: An interesting piece on the rise and fall of Warren Spector at Bear Stearns. It's not always easy to muster a lot of empathy for the Street's Masters of the Universe, but as pure anthropology this story is worth a few minutes.

A "mortgage czar"? First, no. Second, can we please retire the unbelievably tired "czar" bit?

You'll get a little smarter if you read these two items from Barry Ritholtz: "Are Markets Always a Discounting Mechanism?" and "Inflation: CPI, Core Rate, Inflation ex-Inflation."

Dark Pools

Prompted by MarketBeat, we worked our way through David Bogoslaw's BusinessWeek piece on "dark pools" and other alternative trading systems that combine impressive technology with some good old-fashioned privileges for some of the Street's heaviest hitters. Here are a couple highlights:

It's not easy being a big player in the stock market. Trading huge quantities of stock on traditional exchanges has become ever more challenging, costly, and potentially disruptive. And if other players see your moves, they can disrupt your trades. That's led to the emergence in recent years of alternative trading systems known as dark pools. And their growth could have significant implications for big stock exchanges—and individual investors.

...

Driving investors' quest for greater anonymity and lower market impact costs are their well-founded fears that information was leaking whenever they placed orders with sell-side brokers, which prevented them from getting the best execution on their trades.

...

The proliferation of dark pools could have ripple effects beyond just block trading, says [Sang] Lee at Aite Group. As long as they remain a niche market, they're probably of little consequence. But if the equities market becomes increasingly dark as more trading shifts to these platforms, while retail investors continue to see only the public portion of equity trading, it calls into question the actual meaning of public price quotes, Lee says.

So to counter the perception--and, of course, the reality--of the competitive disadvantages of trading huge positions on public exchanges, the Street's power players are collectively saving themselves from...themselves. This trend toward semi-private trading is understandable, and we'd like to dig a little deeper before we get too exercised about it, but at first blush it raises interesting questions of bifurcated markets, one set for the little people, another for the big ones.

Source

David Bogoslaw, "Big Traders Dive Into Dark Pools," BusinessWeek, October 3, 2007

Wednesday Reading

A few midweek items worth checking out...

• Bloomberg's Susan Antilla notes that regulatory actions in the securities industry have fallen off a bit.
• Tax-inefficiency is one of several reasons we don't like (or use) mutual funds, but Chuck Jaffe helps investors understand funds' periodic (mostly annual) distributions of dividends, interest payments, and capital gains.
• At CNNMoney.com, Alexandra Twin notes the markets' return to the bullish bias implicit in the recent framework of "good-news-is-good-news" (because it signals a resilient economy) and "bad-news-is-good-news" (because it's likely to prompt the Fed to continue cutting the fed funds rate).
• In yesterday's "Investing in Funds" section of the Wall Street Journal, Ian Salisbury notes the increasing bifurcation in the exchange-traded fund marketplace between low and falling prices for super-competitive, fully commoditized basic index vehicles and high and rising prices for newer, narrower entrants into the ETF space. (subscription required)
• Tim Price gets his humor on with "The Twelve Days of Crisis." The whole thing's great, but the last (non-song) paragraph is the highlight.

A New Real Estate Dilemma

This morning, like most mornings, brings more grim news from the residential real estate market. Today's version: Pending sales of existing homes falling 6.5 percent in August from July levels, which in turn were 11 percent lower than June levels. The year-over-year change in August numbers? Down 22 percent. Here's a good summary of the price-and-inventory situation:

"There is still no bottom in sight,'' said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm. "Sales will continue to fall until there is a greater price capitulation by sellers. It still appears that we have not reached market-clearing prices to reduce the inventories of unsold existing homes.''

But here's the thing: selling at market-clearing (i..e, lower) prices can be exceptionally expensive for the most leveraged occupants of single-family homes (who, as many observers have noted, are not homeowners in any meaningful sense). In yesterday's Chicago Tribune (via Minyanville's Kevin DePew), Mary Umberger introduced a new dilemma for sellers: closing costs and realtor commissions that exceed sellers' minuscule (or, in some cases, negative) equity. Here's Umberger:

Closing day approaches, and our leveraged homeowner apparently has forgotten how many folks have their hands out at the table -- and without appreciable appreciation he can't satisfy them all.

As an example, my real estate agent acquaintance grabs a settlement sheet from a recent transaction on a home that cost just under $600,000.

Reeling off a few of the line items, she notes that the seller had to cover $1,800 in title insurance, a $75 water-certification fee, nearly $900 in tax stamps to Chicago and Illinois; a $550 attorney's fee; a $40 "overnight processing" fee. Those and numerous other charges drove the closing costs to about $3,400.

And that didn't include the pro-rated property taxes for which the seller was liable and which weren't covered by the escrow account. In this case, the seller had to set aside $6,000 from the sale of the house to cover the taxes.

Then, ahem, there's the commission.

"If you're listing a house for $410,000 and the mortgage is $390,000, you've got a problem," she said, in a bit of an understatement.

Based on the 5 percent rate she says prevails among city real estate agents, a seller in her $410,000 example would pay a $20,500 commission.

"People get a call from their attorney the week before closing, and they're expecting to hear, 'This is what you're going to get at the closing;' instead, it's 'Here's how much you have to bring,'" she said.

This is just another reminder of what's different about the market for residential real estate: long lags, emotional hangups, relative illiquidity, complex transactions, &c. All of which makes for a very extended market-clearing process that appears poised to continue for many months.

Sources

Bob Willis, "U.S. Economy: Pending Home Sales Slide to Record," Bloomberg, October 2, 2007

Mary Umberger, "Here's a New One: Being Too Broke to Sell," Chicago Tribune, September 30, 2007

Caveat Emptor

Interesting (if not fully conclusive) piece from BusinessWeek's Ben Steverman on the very mixed record of GorillaTrades, the absurdly advertised stock-picking service. The whole story is worth reading--as are reader comments available at BusinessWeek.com, several of which cite personal experience in defending GorillaTrades. Here's the key passage from early in the piece:

Readily available data from GorillaTrades make it difficult to evaluate its true, long-term record, but a BusinessWeek analysis suggests subscribers would do far better parking their money in low-cost, tax-efficient index funds, as many mainstream financial advisers recommend. While the broader stock market has racked up big gains in the past three years, a portfolio of GorillaTrades picks falls well behind the inflation rate. GorillaTrades picks even lost money in 2006, when the broad Standard & Poor's 500-stock index was up 12.8%.

As we read this piece, we're prompted to think not in terms of GorillaTrades per se, but of the broader issues raised by this story: the utility of stock-picking, the inevitable disconnect between a "system" and far-flung individuals' implementation thereof, and the plausibility of advertising claims in the system-selling business.

Having attended a system-selling seminar several months ago--as pure industry reconnaissance, we can assure you--we sensed a great deal of gullibility in the room, which was packed with an astonishing 300+ people on a weekday morning here in Madison. Actually, gullibility might not be exactly right. It was more like an affirmative desire to believe that it really was possible, that beating broad market averages was relatively straightforward, even easy...and if you just paid several thousand dollars to finish the "investor education" on offer that day, the kingdom could be yours.

These courses, tools, and systems aren't all worthless. Some offer more useful and transferable insights than others. But we do object to the implicit and explicit claims that it's just this easy. It isn't. Investors would do well to interpret any such claims with extreme prejudice.

Source

Ben Steverman, "GorillaTrades Unmasked," BusinessWeek, October 1, 2007

Simplify, Simplify

Last week we posted an item calling for dramatically simpler choices in defined-contribution retirement plans. At about the same time, Investment Advisor published Savita Iyer's "Less is More," which describes the emerging trend of sponsors (i.e., employers) trimming their plans' investment options.

We think radical simplification--reducing investment options to a few inexpensive, fully diversified, balanced portfolios--makes the most sense. For every participant who thinks he (and the gendered pronoun, though technically imprecise, is very intentional) can do better on his own, a much larger number of participants could literally have their retirement incomes saved by this kind of simplification, which would minimize the potential for emotional decision-making (e.g., indifference, greed-driven performance-chasing, fear-driven capitulation, &c.) to create truly disastrous long-term results.

Radical simplification would deliver massive improvements over the typical menu-of-mutual-funds, participant-directed plan. But we see lots of evidence that marginal simplification is viewed as good enough. For example, Iyer's piece cites one advisory firm that cut a plan's menu in half--from 70 mutual funds to (roughly) 35! That's surely an improvement, but we think it sort of misses the point. After all, it leaves all the problems we cited last week essentially undisturbed.

We think the financial services industry should help plan sponsors take Henry David Thoreau's advice seriously: Simplify, simplify. The great transcendentalist wouldn't be proud of us just yet, but we're getting there.

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Also of interest to the retirement-plan-minded: Another recent piece from Savita Iyer, this one on the effects of auto-escalation policies that increase contributions with the length of employees' participation. The biggest beneficiaries of auto-escalators: Low-income workers.

Sources

Savita Iyer, "Less is More," Investment Advisor, September 25, 2007

Savita Iyer, "Auto Escalation a Sure Boost," Investment Advisor, September 25, 2007