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Market Regulation: Boon or Bane to 401k Plan Sponsors & Investors?

August 02
00:33 2011

With the ever increasing vilification of Wall Street since 2008, it might help to remind those naysayers of the definition of Hasty Generalization. While it’s true some bad players got undue benefits, the vast majority of “Wall Street” 1112674_73344455_spring_stock_xchng_royalty_free_300participants – including publicly traded companies, everyday investors and the greater part of the public – suffered. With the public debate of “too-big-to-fail” Wall Street villains, to paint these victims with the same brush embodies the very meaning of the logical fallacy secundum quid, which, although literally translating to “according to what,” represents the Latin name for Hasty Generalization. And it’s a fallacy 401k plan sponsors and their employee investors might end up paying for if Wall Street regulation runs wild.

Let’s take a step back to the real wild days of Wall Street nearly 150 years ago. One of the economic lessons we learned from the Civil War was the agrarian economy had forever fallen to the new industrial economy. Unlike farms, however, factories required much more capital, and amassing that capital required the expansion of the capital markets, a.k.a., “Wall Street.”

Particularly in the North, where the planting season lasts less than six months, the prospects of a full twelve months of steady work proved too enticing to employees. The need for more factories – and for more railroads to connect those factories to the raw material sources in the Midwest and the consumer markets on the East coast – spawned a rollicking market for investor money.

Of course, in this pre-regulatory era, corrupt stock dealers often made off with the life savings of poor farmers simply by forcing their companies into bankruptcy. In the nearly three decades from 1873 to 1900, America – and much of Europe – suffered from the Long Depression (nee, “the Great Depression” until the 1930’s). We’ll skip Europe’s mess (which was probably due to various wars) and focus on America. Following the end of the Civil War, American economic policy can be summarized in two words: Gold and Trains. “Gold” because the country, in an attempt to return to the gold standard, began diverting cash for the purpose of purchasing gold and “Trains” because everyone on his brother wanted to get into the railway business.

The twin bubbles caused by overbuying gold and overbuilding rail lines led to The Panic of 1873. For the next 65 months, according to the National Bureau of Economics, America suffered through the longest period of contraction ever recorded. (The Great Depression of the 1930’s only experienced 45 consecutive months of a shrinking economy.) Although the depression of the 1870’s ending in 1879, 114 of the next 253 months saw economic decline. Things really didn’t clear up until the turn of the century in 1901.

Ironically, today we refer to this period as “The Gilded Age” as it’s the period that saw the greatest growth in American history. It produced such names as John D. Rockefeller, J.P. Morgan and Andrew Carnegie. It also produced a few of the more infamous true robber-barons like Jay Gould. While most wallowed in economic malaise, these men became very rich, despite the ups and downs of an economic beset by panics every few years. The most ardent populists painted them all with the same robber-baron brush.

Although populist legislation like the Sherman Anti-Trust Act and the Interstate Commerce Act became law in the late nineteenth century, enforcement did not begin in earnest until the dawn of the Progressive Era in the (Theodore) Roosevelt Presidency in 1901. Coincidentally, the century of regulation began with a market crash and several more recessions. The Progressive Era peaked with the Woodrow Wilson administration, who bequeathed us such enduring controversies the national income tax and the Federal Reserve.

Growth didn’t occur again until Warren G. Harding removed some of the war time taxes and called for a return to “normalcy” at the outset of the Roaring Twenties. But, while the Progressive Era targeted corporations, the capital markets remained as wild and free as they were in the 1870’s. With all the prosperity of the 1920’s, it was only a matter of time before good money began chasing bad. The bubble popped in 1929 and, perhaps with ominous hint to the doings of a future Republican president, the then current Republican president initiated a series of (now universally regarded as misguided) policies that worsened an already bad situation. A new era of regulation was born.

Ironically, although he didn’t start it, Franklin Roosevelt has become the poster boy for the period of government overextending itself. We’ll let the economists argue how his policies may have unnaturally extended the Great Depression. Instead, we’ll focus on the good he did for the capital markets. Prior to the Securities Exchange Acts of 1933 and 1934, there really wasn’t any accounting compatibility between publicly traded companies. With these acts, and the subsequent universal adoption of generally accepted accounting principles, the study of stocks, their valuation and the concept of managing a portfolio blossomed.

It turns out regulating the capital markets, oddly enough, helped spur economic growth by lighting a fire under the capital markets. This differed from previous (and later) attempts to regulate individual business and industries, which tended to discourage investment. The market regulations of the 1930’s didn’t really come to fruition until the end of World War II. If the post-Civil War period was the Gilded Age for the United States, than the post-World War II was the Golden Age. And, unlike the Gilded Age which gilded only a handful, the Golden Age spread the sparkling dust among every willing American. Only now, almost three generations after the close of that war, is the pre-eminence of the American economy being seriously challenged.

What does this short history lesson teach us about regulation and its impact on the account balances of 401k investors? First, not all regulation is bad. Regulation which levels the playing field, like the Securities Exchange Acts did, helped facilitate a more reliable accounting of publicly trading stocks, making them less risk and more attractive as investments. Since this applied to new issues as well as old issues, it spurred the creation of more capital, more businesses and more jobs than at any other time in American history. The growth of Wall Street meant the growth of Main Street.

On the other hand, the malicious targeting of businesses and their industries for regulatory retribution, or the shackling of burdensome social policy on the shoulders of private business, discourages that investment. Judging by the market reaction and government policy, we appear to have been in this environment since 2008. Further denigration of “Wall Street” can only exasperate an already tenuous situation. The one act designed to address the markets – the Dodd-Frank Act – not only failed to address the problems caused by derivatives in 2008, but appears to have actually baked “too-big-to-fail” into the cake. No wonder why these giant companies inspire such venom. But to lump these few (but enormous) rogues into the rest of our intertwined economy punishes those very victims of “too-big-to-fail.”

Sooner or later, we’ll come to the understanding that “Wall Street” and “Main Street” are the same thing. “Wall Street” is not the large financial companies that act as intermediaries. “Wall Street” is the mom-and-pop store down the street, the regular Joe working from 9 to 5 and the average investor whose retirement depends on the continued growth of the American economy. If legislators mold regulation to awaken growth and put the spring back into our economic engine, we all benefit. If, on the other hand, politicians focus on the stick rather than the carrot, we all suffer (except, apparently, for those very few robber-barons).

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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