Funds Wary of Overhaul of Social Security System

When Treasury Secretary Paul O’Neill went to New York on Monday to discuss a potential $90-billion annual investment of Social Security taxes in financial markets, the largest U.S. mutual fund companies stood him up.

Executives from Vanguard Group Inc., Fidelity Investments, Putnam Investments Inc. and Janus Capital Corp. turned down an invitation to hear O’Neill push President Bush’s plan to let taxpayers invest a portion of their Social Security money.

Although the plan looks like a boon to some on Wall Street, mutual fund companies see a potentially losing proposition: that the government will cap management fees at a level too low to cover administrative costs.

“We’re not licking our chops,” said Joel Dickson, a Vanguard principal. “It’s unclear what reform would look like.”

The Investment Company Institute, the mutual fund industry’s chief trade group, said one solution is for the federal government to administer the accounts. The government is in the best position to do that, the group said, because it already keeps records on Social Security contributions and can guarantee all taxpayers get the same service regardless of the size of their accounts.

The problem with that solution is it would cost the government billions and run into congressional opposition to a federal role in market investments.

Finding a compromise that will satisfy fund companies, the administration and Capitol Hill will be difficult, supporters say.

“The administration has a tough sell job ahead because Wall Street is skittish, Republicans on the Hill don’t seem too optimistic about it and the Democrats are going to be tough,” said Matt Moore, an analyst for the National Center for Public Policy Research, which favors personal retirement accounts.

“But I think we can construct the system so that administrative costs aren’t necessarily a concern,” Moore said. One way may be to pool small accounts into larger blocks, he said.

The O’Neill luncheon was sponsored by the Coalition for American Financial Security, a group formed by companies such as Frank Russell Co. and State Street Corp. to raise hundreds of thousands of dollars to promote the Bush plan, which is now before the president’s newly formed Social Security Commission.

“If I know the government, they will regulate this area very, very heavily,” said Lawrence Borsanyi, a senior vice president at Arnhold and S. Bleichroeder Inc., a closely held investment advisory group and brokerage that is considering joining the coalition. “It will probably put pressure on fees” companies can charge to manage personal accounts, Borsanyi said.

The average stock mutual fund investor with an account balance of $2,000 pays an average of $27 a year in fees, according to Investment Company Institute. On an account of $400, the amount a worker earning $20,000 a year could put aside annually under Bush’s proposal, such fees could wipe out returns. That’s why Congress will be under pressure to cap fees at a lower rate.

“Any plan, in the end, has to have very strong measures to keep the administrative overhead low,” said John Rother, legislative director for the AARP, the largest lobby group for retirees.

Fund companies say fee limits may wipe out any profit for them if they have to shoulder the cost of services, such as record-keeping, sending regular statements and providing telephone operators to answer questions, as well as the cost of running the fund itself.

Vanguard’s Dickson said his company would collect revenue of just $1.20 a year for accounts of $400 under its current fee schedule, which is based on an account’s balance. Personal retirement accounts also may siphon business away from individual retirement accounts and other retirement products that fund companies offer.

In the long run, though, fund companies stand to profit as workers’ accounts grow. Total assets in such accounts may grow to about $1.22 trillion over 10 years, according to estimates by the National Bureau of Economic Research, a nonprofit group. That may take longer than most want to wait, said Don Ezra, chairman of the financial services coalition and a Frank Russell executive.

“You’ve already got mutual fund companies who’ve said, ‘Until these amounts get higher, I’m not sure I’m terribly interested,’ ” he said.

Robert Pozen, vice chairman at Fidelity and one of the members on Bush’s Social Security Commission, referred to the issue of administrative costs for the personal accounts during the 14-member commission’s first meeting last week.

“It’s important that we look at how they are designed,” Pozen said. The AFL-CIO labor federation and other critics say the commission is biased toward personal accounts as a way to fix Social Security.

Sylvester Schieber, who sat on former President Clinton’s Social Security Commission, said the Bush panel isn’t a “slam-dunk advocacy group” for personal accounts.

“I’ve seen Bob Pozen in meetings where he looked to me to be skeptical,” Schieber said.

Fidelity, which hasn’t taken a position on accounts, declined interview requests. “Nobody’s going to talk to you,” Pozen told a reporter after last week’s meeting.

Tanner said fund companies are nervous about publicly airing their concerns. “There’s this almost visceral fear that someone on the Hill is going to get mad at them,” he said.