The Derivative Project

Did Professor Shiller’s Speech to NAPFA Forget the Footnotes?

Did Professor Shiller’s Speech to NAPFA Forget the Footnotes?

Did Professor Shiller’s Speech to NAPFA Forget the Footnotes?

Nobel Prize winning economist Robert Shiller of Yale University delivered a speech* on December 4, 2013 hosted by the National Association of Personal Financial Planners (NAPFA) and Forbes.
Did the financial planning industry quickly capture remarks to solely advance their Agenda: “Robert Shiller gives his take on the future of advice; urges government help in paying for it.”  “Nobel Laureate: Everyone should have a financial advisor”, from Investment News, December 5, 2013.  No surprise here on the headline, where the Agenda includes Michael Kitces of Pinnacle Advisory Group, Inc. whose firm charges some clients in excess of 3.30% annual fees.
                           Financial Planning Association
Read Pinnacle Advisory Group Inc’s SEC ADV here.   Add the sub-advised fee for Transamerica Financial Advisors and Pinnacles’s fees, in addition to mutual fund costs, yet before portfolio turnover costs, and the poor retirement investor would be paying out for advice below the  benchmarks over 3.30%.
Perhaps Professor Shiller wants to conduct a cost/benefit analysis on fees paid to select an investment manager and the value add of these financial intermediaries.
*The Derivative Project Footnotes:
(1)  Professor Shiller qualifies capitalism:  “It only works if we have proper regulation.”
(2)  “There are aggressive, greedy, selfish people.  They tend to go into finance.”
“The lack of good financial advice was one of the causes of the financial crisis.”  Where is the researched, academic rationale for that sweeping statement?
What does Professor Shiller mean by financial advice?  Coaching people to save more?  Helping people understand how much debt they can take on?  Investment selection?  Understanding OTC and exchange traded derivatives and positioning portfolios and selecting mutual funds when markets are behaving irrationally and having the tools and training to understand these aberrations and act appropriately for clients?

The role of financial intermediaries in our society following the 2008 financial crisis is one of the most critical issues to every American.  This issue far exceeds the economic impact to society overall of healthcare.  Yet, unlike healthcare, it is an issue that remains cloaked in poorly articulated rationale, lacks bona fide academic rigor and flourishes through conflicted self-serving white papers. The situation is directly comparable to Senator Warren’s critique last week, referenced in this Wall Street Journal Blog, Elizabeth Warren Eye’s Wall Street’s Think Tank Ties.”

The financial intermediary issue lacks transparency and public awareness due to obfuscation and guerrilla marketing by an industry that has captured not only the media, but Congress, the Judiciary, and the Executive Branch.
The Derivative Project and Not On My Nickel have joined forces.  The role of financial intermediaries and their role in the current retirement crisis will be front and center in the 2016 Congressional and Presidential elections.  Why?
Unfortunately, the post-mortem analysis on the role of financial intermediaries is being driven by Wall Street, captive academics and captive media, such as the New York Times, that are all actively promoting  “Financial Planning for the Masses” without sound economic studies and analysis of this business model that present findings on how and if this new industry adds substantive value.  This “industry” is but 40 years old, its inception deriving from the advent of defined contribution plans, 401k’s in the early 1980′s.  How should it be structured to add societal value given the dependence of the the bulk of retirement investors on this new retirement savings model?
The first step is to break out a financial intermediary role for “coaching” and for “investment selection.”  They are two distinct services, each requiring significantly different training and expertise. Regulation must conform to this inherent difference.

While not footnoted in this Investment News article, Professor Shiller also spoke on August 22, 2013 to the Commonwealth Club of California about “Reclaiming Finance for the Common Good”, based on his new book, Finance and the Good Society. His talk is linked to above.
Investment News’ article forgot to highlight the two most critical statements Professor Shiller made in his speech to the Commonwealth Club, last August:
(1)  On capitalism:  “It only works if we have proper regulation.”
(2)  “There are aggressive, greedy selfish people.  They tend to go into finance.”
Thus, given Professor Shiller’s two critical statements above, there is the most compelling argument to avoid financial intermediaries today for investment selection. Today’s landscape for retirement investors has never been in such a crisis:   Proper government regulation of financial intermediaries for investment selection is nonexistent. The fourth estate is absent. Individuals have no understanding of the fees they are paying these intermediaries or the value these intermediaries are delivering.  Their economic “value” is all based on hearsay.  There has never been a rigorous economic study on the value of financial intermediaries for investment selection, regulatory capture and the costs of such to our society overall.
Professor Shiller spoke to the Washington Post on October 15, 2013 about how retirement investors use to have professionals managing their money in a defined benefit plan.  Those same professionals are still available to every retirement investor.  It is the financial intermediaries that have created the mismatch, the disconnect and are preventing 401k investors from accessing these top portfolio managers, registered investment companies, directly and without a redundant intermediary fee.  Professor Shiller stated to the WP, 401k investors are not interested in selecting and investing in their 401k’s.  That is fact.  Why?  The financial services industry has created this lack of interest, through a paternalism and ineffective education in the workplace, that creates an unhealthy dependency on the financial services industry, which in-turn, benefits the industry.
The fact that “financial advisors” were not trained in exchange traded or OTC derivatives and the impact of this lack of training to the severity of the financial crisis has yet to be examined by any leading University.  However, post financial crisis the CFA is increasing their training in derivatives and FINRA is just now saying “advisors” should understand the products they are selling.  The CFA organization is stating, “We had a good run.  Now it is time for fiduciary capitalism,”  as explained in this presentation here. They know they blew it leading up to t
he 2008 financial crisis.  The simple fact their industry is now moving into “fiduciary capitalism’ means they admit, despite their mandate, they were not fiduciaries before.
What is the basis of Professor Shiller’s statement to NAFPA, “Lack of good financial advice was one of the problems that led to the financial crisis.”
  • Where were the financial advisors, the CFA’s, warning about the build-up in losses from OTC credit default swaps on AIG’s balance sheet and the risks that might pose to your nest egg?  Why were the Charles Schwab CFAs still rating AIG a strong buy in Fall 2007 despite their every increasing billion losses in their credit default swap portfolio?
  • To the contrary, why did a Charles Schwab’s Branch Manager mock a client in March 2008, in his Branch Manager’s client notes for raising concerns about a potential collapse of equity markets due to excessive leverage in speculative trades in credit default swaps?   Why did Charles Schwab refuse to protect 65 year old retirement investors and adjust their equity allocations despite a client’s warning that they should do so in November 2007?
  • These Schwab financial advisor notes were made discoverable in a FINRA arbitration about the breach of fiduciary duty by Charles Schwab’s Private Client group in March 2008 for failure to take action following a client warning about AIG and its excessive risk to the financial markets. These statements are fact and in writing, not hearsay. Why won’t the media cover this story and the issues it presents?  The SEC will not take action, since FINRA ruled on this fiduciary breach. Why have academics failed to highlight the conflicts of interest that pushed Charles Schwab, for example, to abandon their fiduciary duty to their investors in their retirement years and place their profits over the safety of the retiree’s investment nest egg in 2008 and 2009?
  • A major cause of the severity of the financial crisis was the failure of financial intermediaries to alert authorities, to alert investors, to alert the media, to the dangers of large scale speculative trades without adequate capital backing, even when they knew of the dangers. They knew of the dangers and the significant risks. This was not complex or rocket science. Every farmer understands why they must post margin on their hedges for their crops at the futures exchange and the systemic risk that would be created if every farmer were allowed to speculate to any amount they wanted without margin.  Basic financial concepts.
The Derivative Project’s White Paper:  “The Cost of Financial Intermediaries to Retirement Investors’s Financial Asset Growth and the Role of Regulatory Capture in U.S. Sustainable Economic Development in light of Mandatory Retirement Proposals” is available upon email request to  Place “The cost of financial intermediaries” in subject line.
An excerpt from this study below provides this simple analysis of the reality of most retirement savers today:  their employers are failing them and financial intermediaries are failing them.  This chart demonstrates in Professor Shiller’s words: “the role of aggressive, greedy people who enter finance when there is not proper regulation”:
One may ask the simple questions from this chart, if, as a 401(k) investor, one could choose between:
Option A - the State Farm Target Date Fund – HLHAX, sanctioned by the Department of Labor, with a payroll deducted “Opt-Out” fee to financial advisor to Charles Schwab/Guided Choice) or
Option B – A Not On My Nickel researched fund, PRWCX, chosen oneself with proper tools, price discovery, with the training to understand why, with clarity on what one would be investing in and ability to earn almost $20,000 more in five years
which Option would the investor choose?  Investors do not have this free choice today.
This is the scenario that is happening to retirement investors day in and day out.  The retirement investor is forced to take Option A, there is no transparency, non-conflicted financial education and they believe their employer has selected investment options that are in their best interest.  The New York Times tells them everyone needs an advisor, that charges an assets under management fee as does a recent Nobel Laureate, without highlighting the underlying issue – capitalism only works if there is proper regulation. Their paycheck is debited, along with their 401k contribution for an “advice fee” they did not approve in advance.
In this most serious crisis, as the above chart shows, there is not proper regulation. How does one know—one thinks an attorney calls this “prima facie evidence”- here is the evidence:
  • Based on supply and demand forces, why does this Target Date mutual fund have over 1.57 billion dollars invested in it?  What are the economic forces permitting the poorest to rise to the top, contrary to conventional economic thought?
  • Which employer(s) are using this Target Date Fund as a Department of Labor approved qualified default investment option(QDIA) and why would they when there are better alternatives readily available, as the Balanced Fund, PRWCX, also a “QDIA” represents.
  • Has there been any economic justification that presents the rationale for Charles Schwab and Guided Choice from charging an employee directly for their “advice” without prior approval of the employee – (the opt-out model used by employers and financial services firms in the workplace today.)?  What is the economic value these “advice” services are bringing to the defined contribution plan participant, based on automatically taking an annual assets under management fee?
What Should Retirement Investors Do When “Proper Regulation” is Absent?
The answer is straightforward.  Avoid the problem. Avoid the intermediaries. After five years of meeting with Congress, FINRA, the SEC and the Department of Labor, following the 2008 financial crisis, the evidence is compelling.  There does not currently exist proper regulation to protect retirement investors and financial intermediaries must be avoided as they are currently regulated.
We founded The Derivative Project in 2008 to usher in a new era of economic sustainable development that is dependent on a workforce that understands their personal responsibility in managing their life savings. With the right carrot, they will take action and do it. It is human nature.
Despite Professor Shiller’s statements to the Commonwealth Club last August, the financial crisis was caused by a “systemic vulnerability we did not understand” lacks any factual evidence.  We purport that statement is very misleading.  The “systemic vulnerability” is but Finance 101.
The financial crisis was caused by lack of proper regulation to control the “aggressive, greedy, selfish people, they tend to go into finance.”  OTC derivative speculation, without adequate capital to back up the speculative trades, if a market moves against them, is a straight-forward concept in finance, not a “systemic vulnerability we did not understand.”
401k – 2.0 is the New Paradigm as “Fiduciary Capitalism” Cannot Exist Without Proper Regulation as Professor Shiller Acknowledges
Not On My Nickel introduces th
e new era of investing 401K-2.0.  Capitalism requires innovation, risk and incentive, a game, as Professor Schiller stated to the California Commonwealth Club.  Not On My Nickel represents the next generation defined contribution model —one that engages the investor and ends a paternalistic dependency on a conflicted industry that is limiting innovative capital formation due to the lack of educated and informed free choice by every plan participant in their defined contribution plans.
The old DC model has allowed ongoing proliferation of poorly performing mutual funds.  The new paradigm, 401K -2.0, Not On My Nickel, allows the top performing active or passive funds to rise to the top of the pack.  Every portfolio manager will strive to be in this pack.  It may take them 5 to ten years, but that is free market capitalism.  These new portfolio managers will have to “pull themselves” up by their boot straps and wait until them can make the creme de la creme list. Fund companies and poorly performing Funds will no longer get a free pass, supported by the hard earned retirement savings of every American.
No longer will retirement savers be forced to sacrifice their futures to poorly performing, high fee mutual funds who solely stay in existence through conflicted consultants, “financial intermediaries” that promote them.  Supply and demand are the forces that rule, with individual investors making informed choice to select the best that fits their needs.
The Asset Management industry has grown from $82.8 billion in 1997 to over $341.9 billion in 2007.  This industry has grown from .99% of GDP in 1997 to 2.43% of GDP in 2007.*
The industry will continue to grow, with the rise in retirement savings accumulations in defined contribution plans. Mandatory retirement savings may further push these numbers significantly greater.  However, the growth rate of the asset management industry will decline on an revenue basis, due to the loss of income generated by financial intermediaries, for investment selection, both by conflicted plan consultants and individual “financial advisors” that add no value in the investment selection process.
Absent the financial intermediary income, the retirement investor will have more assets at retirement providing more disposable income for basic cost of living needs, for discretionary spending, for housing, or investing in education for their grandchildren.  The simple elimination of these financial intermediary investment selection fees, that add no value, combined with the ability for every retirement investor to access the top performing portfolio managers, directly, will contribute to narrowing the income gap between the wealthiest and the middle class.
The financial planning industry will be redefined to provide the role for those that need a helping hand as Professor Shiller describes –to spend within their means and to be given the counsel to save for their future. Behavior is tough to change and psychology degrees for those that want to help those that need the extra push would be valuable to society overall, as Professor Shiller states.  However, investment selection will no longer be a responsibility for those that are not specialists in that market, as Not On My Nickel described here in this Blog post.
The Lack of a Price Discovery Mechanism in Defined Contribution Plans Today
Robin Greenwood and David Scharfstein, both of Harvard University, wrote recently in the “Journal of Economic Perspectives” Spring 2013 in “The Growth of Finance”:
“Surveying the current economic literature on these issues, it is certain that we do not very well understand the price-discovery and trading mechanism, nor the economic forces that allowed high-fee active management to survive so long.”
It is common sense that dictates why high-fee active management and poorly performing funds exist:  There is no transparent price discovery for retirement investors.  Retirement investors believe their employers are placing them in the best investments, while they are not.  The Department of Labor has no parameters on assessing the value of financial intermediaries and to date the only financial education in the workplace has been provided by the financial services firms.  One could claim that fact in itself is a breach of ERISA fiduciary duty.  A true fiduciary, such as an employer retirement plan, should provide financial education that is independent, not tied to the sale of any service or product.
Not On My Nickel is the first independent retirement plan financial education service that has been designed to offer every employee access to bona price discovery through the tools, research and straight-forward education to do so.
Regulatory capture has allowed the failure of today’s financial intermediaries to foster true innovation and sustainable capital formation, as the 2008 financial crisis demonstrated.
To the detriment of our economy and our society overall, academics who have great respect and a very public microphone, have failed to highlight the barriers to free market capitalism and to work to shift the balance back to normal supply and demand, where poorly performing funds, such as the one in the graph above, will no longer exist.

Innovation in financial services is alive and well.  Not On My Nickel is the first defined contribution plan service to provide “price discovery” tools to participants.

Capitalism and innovation flourish, as Professor Shiller stated in his talk to the California Commonwealth Club, when there is risk and a game.  Not On My Nickel, Retirement Investing in the Workplace 2.0, delivers that game and that carrot to defined contribution participants and eliminates the stick.
*”Journal of Economic Perspectives” Spring 2013