How the Rich Get Richer
November 1, 2008
Bill Gates hasn't forced anyone to buy his products. We voluntarily
buy his software, making him a billionaire in the process. This
is the primary way the rich get richer – by creating value.
Investors like Warren Buffet create value by putting their money
where it is needed (where would Gates be if nobody invested in
his ideas?).
However, this honest way of business and investing is not
the ONLY way people become wealthy, nor the only way that they
maintain and increase their wealth. Once you have wealth you
have a lot of power, and that power can be used to make more
money in unethical ways as well. Many suspect that the rich get
richer at the expense of the poor and middle class – and
often it is true. Let's look at just one of the many ways they
do this:
Wealthy corporate officers raid the pension funds of employees
to enrich themselves further.
Here is how it works. Defined-benefit plans specify that after
so many years of hard work an employee will receive a certain
amount of retirement money monthly. This is a contractual promise
made by a company to the employee.
This means that in the years to come a corporation will need
to have a certain amount of money in the pension fund. With sophisticated
software their accountants figure out how much that is, and then
figure out how much they will need to put into the fund each
year to meet that obligation to their employees. But they figure
this based on an assumed rate of return. This is crucial to understanding
the scam.
For example, suppose a corporation knows it will need 50 billion
dollars in 30 years to fund it's retirement plan (this is greatly
simplified). If they assume a 6 percent return on investment
they'll need to put about 600 million dollars into the fund each
year. But if they assume a 10.3 percent rate of return, they
only need to put 270 million dollars in each year – a savings
of 330 million dollars.
Wait, though – it gets better. If the previous years
assumptions were lower, the amount of money in the fund may already
be enough, based on the new assumption. The corporation can claim
that the retirement plan is overfunded and so contribute nothing
that year – a savings of 600 million dollars!
That 600 million is added to profits, naturally boosting the
price of the company stock. Thanks to this great “profit
performance,” executives hand out tens of millions in bonuses
to themselves. They also exercise their stock options and sell
their stock while the price is high.
Of course making more than a 10 percent return on invested
funds is fraudulently unrealistic. Fortunately, most are not
this bad. In 2008, the average assumption for Standard &
Poor’s 500 members which have a pension plan is 8 percent.
But that is still too high according to many who study these
things. Their average plan also allocates close to 30 percent
to bonds and cash, which typically earn less than 5 percent.
Warren Buffet notes that the Dow Jones industrials compounded
at just 5.3 percent annually during the last century. 2 percent
added for dividends brings the return up to 7.2 percent. But
considering the mix of stocks, bonds and cash in most plans,
Buffett calculates that the stock part of the portfolios would
have to earn 9.2 percent to meet the 8 percent target. (This
is from his annual letter to shareholders of Berkshire Hathaway.)
The pension plan for his own employees assumes a more modest
6.9%, despite the possible benefit of his legendary investing
skills.
Are corporate officers purposefully ripping off employee pension
funds? Intent is a difficult thing to prove, and laws can't legislate
common sense. If a friendly accountant is stupid enough to think
the plan will make an 8 percent or 10 percent return, the corporate
officers are happy to keep him around. Are you starting to see
how this works?
You can imagine how this may eventually bankrupt pension funds.
Treasury officials estimate that pension plans in this country
are underfund by hundreds of billions of dollars. At some point
failures will overwhelm the government’s Pension Benefit
Guarantee Corporation. Some wealthy managers will have essentially
stolen the retirement money of their employees.
Of course to the extent that the government can bail out these
pension funds, they’ll tax you and I while the billions
stay in the hands of the crooked corporate bosses. This is one
way money is redistributed from the poor and middle class to
the wealthy.
You might think that at least small investors will benefit
from the higher stock prices. According to an article in the
September 8, 2003 issue of Business Week, this scam allowed corporations
to raise reported earnings by 10% to 15% during the 1990s. The
problem is, they did it not by earning that much more, but by
moving money from pension funds to the bottom line. If and when
they’re forced to properly fund the retirement plans, lower
earnings will be reported, bringing down the price of the stock.
So except for those who jump in and out at the right times, there
is no benefit to shareholders.
Wait – it gets worse. Because of hundreds of millions
of extra pay (bonuses and stock options) taken out undeservedly
by corporate officers who “faked” their performance,
companies are reduced in value. The end result is that money
is transferred unethically to these wealthy few at the expense
of shareholders, employees or both. Finally, the cost of this
unearned pay is also passed on in higher costs for the products
the company produces, which may hurt the poor more than anyone
else.
Although this is legal in one sense, if not for a gutless
government many of these crooks could be prosecuted. It’s
true that you can’t “prove” intent conclusively,
but what if the rate of return assumed was higher than any company
has ever actually achieved? I’ll bet that is true in some
cases.
Think about it. To assume a rate of return higher than anyone
gets or has ever achieved isn’t honest. It seems “beyond
a reasonable doubt” that this is done to purposefully defraud
the employees of their promised pension money, and to deceive
shareholders so officers can collect higher pay for a “faked”
performance. And if this doesn’t hold up in criminal court,
a civil court, with its standard of a “preponderance of
the evidence,” can at least take back some of the money
that has been stolen.
If even this route fails, we can at least have reasonable
regulation of retirement fund practices. Unfortunately the Bush
Administration has for years pushed to allow companies to use
more liberal accounting assumptions about rates of return (as
reported in the September 8, 2003 issue of Business Week).
That is just one of the many ways some of the rich get richer
at the expense of the rest of us. It isn’t that there is
anything wrong with wealth. And no dishonesty is required to
get rich. Notice that even though Warren Buffet could play the
same game, he assumes an honest rate of return for employees
of Berkshire Hathaway, so they don’t get shorted on their
retirement.
But others play dirty, and if we don’t correct the corruption,
people may lose faith in what they see as “capitalism”
(it’s nothing of the sort). Noticing correctly that many
wealthy people are taking advantage of the rest of us, but not
knowing where else to turn, they’ll probably demand more
socialist policies. That will make us all poorer.
Note: This is part of a series. You can find all of
the pages listed and linked to here:
The Redistribution
of Wealth to the Wealthy
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