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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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