In Era of Mass Investment, Wall St. Would Be Wise to Embrace Reform

When the stock market crashed in 1929, fewer than one in 80 Americans owned stocks. Today at least half--and probably as many as two-thirds--of American households own stock. More Americans have more at stake in the rise and fall of the stock markets than ever before.

That broad social change is providing the fuel for the political firestorm over Enron Corp., WorldCom and the other scandals in corporate America. It’s difficult to imagine that accounting regulation and balance sheet fraud would be attracting nearly so much attention from the president, Congress and the media if only a relatively narrow elite still owned equities. And this may be just the start. It’s a fair bet that the trend toward mass investment will raise issues well beyond the arguments over securities regulation now consuming Washington.

The migration of Americans into the markets has already changed the balance of power on those regulatory issues. For years, the securities and accounting industries fought off tougher government oversight--often enlisting legislators from both parties to beat back federal regulators they considered too zealous. The handful of institutional investor advocates on the other side of those battles--like the effort by the Clinton-era Securities and Exchange Commission to bar accountants from consulting for the companies they audit--were overmatched.

That was partly because average investors remained almost entirely uninterested in reform while the markets were levitating in the 1990s. Indeed, in recent years many conservative theorists predicted that the growing investor class would ally with corporate management for small-government, low-tax, less-regulation policies. Instead, against the backdrop of scandal and the drooping Dow, investors have become a force for more government regulation of the markets.

As a matter of broad philosophy, polls show that investors--who are, not surprisingly, more affluent than the public overall--are generally skeptical of big government. But polls also suggest the wave of corporate scandals has caused investors to see themselves as consumers who expect government protection from manipulation and fraud.

That’s created a much broader constituency for securities and accounting reform. Last week’s resounding Senate votes for new oversight were driven partly by the intense media focus on the scandals, but also by legislators’ fear of appearing to side with management against small investors. “These are voters now” getting hurt, says Ann Yerger, research director at the Council of Institutional Investors, an alliance of big pension funds that has long fought these fights. “It is a little more impersonal when it is an institutional investor suffering the losses.”

In the months and years ahead, the cloud over Wall Street may also change the dynamic on other issues that are more tangible to average families than accounting or corporate governance reform--like Social Security and pensions.

The bull market of the 1990s muted debate over a profound change in the American retirement system: the increased reliance on the stock market to fund private pensions. Traditionally, Americans who received work pensions were guaranteed a fixed monthly payment when they retired. But since the early 1990s, more workers have been guaranteed only a regular contribution from their employer to an investment account that they manage.

That increased dependence on 401(k) plans looked like a good deal when stocks were soaring. But falling stock prices, and rising allegations of scandal, may generate demands for pension security and portability that go well beyond the limited measures (focused on discouraging workers from relying too heavily on their employers’ stock) the Senate will debate in a bill this year.

Likewise, the mess on Wall Street may recast the debate over Social Security. Through the 1990s, rising stock prices and broadening ownership were wind in the sails of Republican proposals to partially privatize Social Security by diverting part of the payroll tax into accounts that workers could invest in the stock market.

Workers who received quarterly statements showing their 401(k) plans defying gravity understandably itched to also take a plunge with their Social Security taxes. But betting on Wall Street to fund Social Security may appear less attractive now that stock prices are sinking and the markets are looking like a casino rigged for the house.

Even small investors have grown accustomed enough to market fluctuation that most experts don’t expect the Dow’s downward slide, or even the wave of scandals, to reverse the long-term trend toward broader stock ownership. That’s a good thing: The willingness of average Americans to invest helped provide the capital that fueled the growth of the 1990s. It wasn’t long ago that experts considered the ability of American entrepreneurs to raise capital and start a business a critical U.S. advantage over Japan and Europe. The boom wasn’t all bubble: It also funded technological breakthroughs that helped propel the broadest advance in living standards in years.

But the scandals and sliding stock prices are usefully highlighting the value of providing ordinary families with financial assets secure from the turbulence of the markets. With average Americans already so reliant on the markets for their well-being--largely through the rise of 401(k) plans--the chaos on Wall Street ought to raise a yellow flag for those who would make them more reliant yet by partially privatizing Social Security. The system has always worked best not as a lottery ticket, but as a storm shelter.

In the meantime, the best way to guarantee that average Americans remain willing to invest is to ensure them the markets aren’t a fool’s game. Wall Street has profited enormously by attracting Main Street into the exchanges. But the price may be to end the club-like arrangements that allowed the securities industry to largely set its own rules. With so many people now invested in the markets, those cozy arrangements have become unsustainable. The new rules descending on Wall Street may be the first reforms driven by the era of mass investment. But they are unlikely to be the last.

Ronald Brownstein’s column appears every Monday. See current and past Brownstein columns on The Times’ Web site: www.latimes.com/brownstein.