What this sleeper movie may teach us about employer responsibility to the 401k plans they sponsor?
Happy New Year! Thanks for being one of over 4000 CFO's, HR Directors, CPA's and employers that read our monthly newsletter aimed at decision makers that supervise their retirement plan for the many participants and beneficiaries that rely upon them to make the right decisions on their retirement money. The movie of the year is obviously Star Wars. Even before the movie came out last week, it sold more pre sold tickets than the actual opening night of previous box office gazzilionaire, Jurassic Park. But, I have decided to give the runner up silver medal to the folks who made The Big Short (released on Wednesday, December 23.) I like to read and I loved the book way back in 2011 when the Big Short hit the book stores. The actors selected are hilarious and I could not think of a better cast that is attempting to make a rather complicated subject (mortgages and Wall Street) and break it down into terms even the average middle American can understand.
The Big Short starring Christian Bale, Steve Carell, Ryan Gosling and Brad Pitt may really surprise you. Like Star Wars I have not seen it yet but I am sure it's going to be a Christmas treat. Michael Lewis is the same author that wrote Money Ball and Blind Side. This book was absolutely a home run about the market meltdown of 2008 and how a boring old simple mortgage system and greedy banks with no fiduciary responsibility to anyone were the key story on how and why it happened.
According to Jeff Bakers of the Oregonian in his review; "The Big Short, " both the events it depicts and the book it is based on, is brilliant in its simplicity. The housing market was in a prolonged bubble as the 2000's rolled along: prices kept going up, more loans were being written, more houses were being built and sold. Everybody was getting rich. Nobody -- well, almost nobody -- looked below the surface to see all the bad loans being approved, then packaged and resold, creating a mountain of credit with no foundation. Once the economy turned and the default rate started going up, the whole thing collapsed. The brilliant, simple part is that a few people and institutions did do their homework and saw the rotten core. They made massive bets against the housing market through financial instruments called credit default swaps and collected hundreds of millions when the bubble burst.
Now if you get a chance to watch the movie, try to think of the word Fiduciary. I submit to you; did anyone in the whole mortgage process have a fiduciary obligation to the customers that were buying the mortgage? Did the appraiser, real estate agent, mortgage broker, banker and Wall Street have any fiduciary responsibility to anyone? Obviously not or I submit to you that the mortgage melt down of 2008 would have had a difficult time happening. According to the book, even the US Government was in on the deal with Congress to make mortgages available to just about anyone that had a pulse. Thru political persuasion, the Feds that were behind Fanny Mae and Freddie Mac were encouraged to loosen underwriting and credit standards. And, it worked.
Explaining the 2008 market meltdown in fun and easy to understand terms is the magic of Mr. Lewis and I am hoping that the movie captures the excitement in the book. Like the book Money Ball where Michael Lewis explains in fun detail the esoteric world of how a poor baseball team like the Oakland A's were able to compete against the Yankees and Boston Red Sox, The Big Short is a comedy of errors wrapped in an enigma and quickly unwrapped for all of us at Christmas time in a great big beautiful holiday morning present.
Sometimes you can equate an over-valued housing market to a game of musical chairs. As many American's were flipping homes from Vegas to Miami and all points in between, caught up were a lot of innocent average home owners. The flippers were all walking around the circle thinking that the lending cycle would never end or....never anticipating that the music would ever stop. Unfortunately, the average Joe who really needed a mortgage and was not looking to flip homes got caught up also in the music. The problem is, you just don't know when. To quit the game early negates the ability to win, while staying in too long can be very painful. Besides the average American getting hurt in the housing bubble, the American tax payer also took it in the shorts because they were behind Fanny Mae and Freddie Mac. The book even found Strippers on the Las Vegas Strip capable of owning a couple of Condo's and a home on a golf course were willing participants in on the mortgage train wreck just around the corner. It was a house of cards ready to collapse. The movie focused on a few key people who eventually took notice of all the mortgages being sold up stream to the banks and off the balance sheet of the local banks. Wall Street than gladly packaged these suspect mortgages as Collateralized Debt Obligations (CDO's). The buyers ranged from soverign country funds, defined benefit plans, mutual funds and assorted other investors. I believe someone once said in the finance industry that CDO's were "Weapons of Mass Financial Destruction (MMFD)." If you look to the right on the time line of 2002 to 2006, mortgage backed securities rose from $38 billion to $90 billion per year in purchases.
Many insurance agents and stockbrokers are wonderful hard working advisors who provide a lot of good to the average investor who wants to rollover an IRA or buy some life insurance. But, when it comes to the fiduciary standard, many commissioned brokers who sell 401k plans may be operating in a similar atmosphere to the "Big Short" where no one has a fiduciary responsibility to the investor. These brokers simply do not have any skin in the game. For example, if you are a bank representative, you may have an interest in selling only the banks fixed income choice in the menu of 401k funds instead of a better money market fund from another financial institution. If you are a fund company representative selling a 401k plan directly (no trained fiduciary advisor), you may want to sell your own proprietary Growth or Target Date fund instead of a better fund from another fund company. And, if you are an insurance agent, you may want to sell the company group annuity insurance 401k plan that rewards you with more commission yet has higher investment expenses to the participant. All of this process may be a confusing minefield to the employer buying a 401k plan between the suitability standard (commissioned brokers) and a fiduciary standard where the advisor cannot have a conflict of interest.
Lloyd Blankfein, CEO of Goldman Sachs had a difficult time explaining the difference between a broker and a fiduciary standard at his testimony before Congress on April 27, 2010. Youtube the testimony. Mr. Blankfein stated WASHINGTON DC - In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting. Source (McClatchy DC, Nov 1, 2009) that "we are not fiduciaries." Congress it seemed could not grasp the idea that Goldman Sachs could sell millions of dollars (no billions) of mortgage backed securities on one side of a sale and bet against the transaction on the other side (shorting the sale). The concept of betting against a customer who was buying from you was foreign to Congress and difficult to comprehend. And, today, the public has the same innocent point of view when a broker is selling a 401k plan under the suitability process rather than a fiduciary standard. The average 401k plan sponsor cannot fathom how a broker can sell products inside a 401k plan that may favor them and not be a conflict of interest. It is all perfectly legal!
The non-fiduciary community that sell 401k plans in America At Christmas time, Terry was suggesting The Big Short as a great stocking stuffer book. have been smart to understand that employers in America are catching on to the advantages of using a fiduciary advisor instead of a commissioned broker. Wall Street and broker/dealers that don't want their Registered Representatives to be fiduciaries have embraced a new fiduciary service that allows them to "off load" the fiduciary responsibility to another entity just like the "Big Short". At Ok401k I call it the "RIA in a Box "fiduciary offloading service. There are new vendors in the arena who gladly will take on being the fiduciary to your 401k plan. Morningstar, Iron Financial, Mesirow and Wilshire Associates are just a few of the fiduciary companies that employers can use for ongoing investment advice to the 401k plan. The problem is, the commissioned broker's fee is still on top of you and your employees 401k money.
So, when you watch "The Big Short" probably after you saw the latest Star Wars movie this holiday weekend ask yourself about who is a fiduciary to you and your employees on the 401k plan? Do you have a local onsite fiduciary advisor who has no conflict of interest or a commissioned broker operating under the suitability standard? Don't be "shorted". You need to know. Merry Christmas and Happy New Year!
This article came from the January 2016 Newsletter. Download the Newsletter Here