Scrambled Nest Eggs: The Financial Crisis and Federal Retirement Policy

On July 7, 2009, Wilson Center on the Hill and the Division of United States Studies hosted a seminar on the effects of the present financial crisis on retirement incomes. Presenters included John Gist, a private consultant who was formerly a senior advisor in economic and fiscal affairs at the American Association of Retired Persons, and Heidi Hartmann, president of the Institute for Women's Policy Research. The moderator was Sonya Michel, director of the Division of United States Studies.

Michel provided a context for the discussion within the recent history of government retirement policy. Americans' retirement rests on the "three-legged stool" comprising Social Security, occupational or employment-based pensions, and personal savings and other assets. Since passage of the Employee Retirement Income Security Act in 1974, many employers have shifted from traditional pension programs with defined benefits, to defined-contribution plans, generally 401(k)s. Meanwhile, the value of personal savings and other assets has become more volatile due to increasing rates of stock ownership and a growing dependence upon rising home prices. Of the three components of retirement income, only Social Security remains tightly regulated.

John Gist presented sobering statistics about the magnitude of the crisis in home values. Between 1990 and 2005, roughly 35 percent of households refinanced their mortgage debt each year. The amount of equity extracted increased over time, until it reached an average (mean) of nearly $1 trillion annually from 2001 to 2005. On average, homeowners who refinanced first mortgages and took out cash withdrew $40,000 in home equity, according to the 2007 Federal Reserve Survey of Consumer Finances..

Increased consumption was only a small fraction of what they used these funds for, Gist said, and.nearly half of the equity extracted from home equity went toward home repairs and renovation, while debt consolidation accounted for an additional third.

The financial crisis has placed heavy pressure on householders who refinanced, particularly those who are at or nearing retirement and whose homes are their greatest financial asset. Homes have lost more than a quarter of their value between the third quarter of 2007 and first quarter of 2009, which amounted to 20 times the quantity of equity extracted. Older householders have been especially hard hit in that they borrowed substantially more than their home values appreciated and were more vulnerable as house values declined sharply after 2006.

Heidi Hartmann argued that the current financial crisis has revealed that America's present retirement system is broken. Retirees and near-retirees have been hit three ways. Along with the decline in home values, they have lost from 25 to 50 percent of the value of their investment portfolios, while increased unemployment has made it harder for them to replace lost income with wages.

Women are especially at risk of poverty, even though members of the present generation have worked twice as much as their mothers. Their wages are still 77 percent of men's, and they earn only 38 percent as much over their lifetimes because of their greater participation in childrearing and other types of caring work Furthermore, recent trends have eroded the support they could receive through marriage, traditionally an important source of retirement income for women. Higher divorce rates have left fewer women eligible for benefits through their husbands, and the laws governing newer forms of retirement savings, such as IRAs and 401(k)s, do not prevent husbands from denying benefits to their wives. That is because they do not fall under the Retirement Equity Act of 1984, which requires retirees to get waivers from spouses foregoing survivors' payouts. With passage of REA, the percentage of mostly male wage earners who provided pension benefits to surviving spouses doubled from approximately one-third to two-thirds of eligible employees. Although there is no comparable data with regard to IRAs and 401(k) plans, many experts are concerned that the lack of regulation leaves many wives without adequate protection.

Hartmann outlined three alternative policies that the federal government could implement. First, an automatic IRA would require employers to set aside a portion of their workers' pay in a retirement account. The second alternative is the "universal 401(k)" in which the government would match contributions to retirement accounts. Third, a guaranteed retirement program would require employers and employees to pay 2.5 percent of workers' incomes into a retirement program, with a federal tax credit offsetting the loss of take-home pay for the poor. To pay for such programs, both panelists agreed that the federal government could repeal the tax credits currently provided for 401(k)s, since such concessions usually go to high-income people who do not need additional incentives to save.

Drafted by Michael Easterly, DUSS
Edited by Sonya Michel, Director, DUSS
David Klaus, Consulting Director, Wilson Center on the Hill