Must-Read: Felix Salmon: Annals of Dubious Research, 401(k) Loan-Default Edition
Must-Read: I have a huge amount of respect for the analytical abilities of Bob Litan and Felix Salmon–and for Elizabeth Warren, Jane Dokko, and Gary Burtless:
(2012): Annals of Dubious Research, 401(k) Loan-Default Edition: “Remember that this is a paper written by the CFO of Custodia Financial…
…someone who clearly has a dog in this…. Smart’s interest [is] to make the loan-default total look as big as possible, since the bigger the problem, the more likely it is that Congress will agree to implement Custodia’s preferred solution. But when Litan and Singer looked at Smart’s paper, they weren’t happy going with his $6 billion figure. Indeed, as we’ve seen, their paper comes up with a number six times larger. So if even the CFO of Custodia only managed to estimate defaults at $6 billion, how on earth do Litan and Singer get to $37 billion?… They double the total amount of 401(k) loans outstanding, from $52 billion to $104 billion. Then, they massively hike the default rate on those loans, from 9.6% to 17.9%. And finally, they add in another $12 billion or so to account for the taxes and penalties that borrowers have to pay when they default on their loans. It’s possible to quibble with each of those changes–and I’ll do just that…. But it’s impossible to see Litan and Singer compounding all of them, in this manner, without coming to the conclusion that they were systematically trying to come up with the biggest and scariest number they could possibly find. It’s true that whenever they mention their $37 billion figure, it’s generally qualified with a “could be as high as” or similar. But they knew what they were doing, and they did it very well.
When the Chicago Tribune and the LA Times say in their headlines that 401(k) loan defaults have reached $37 billion a year, they’re printing exactly what Custodia and Litan and Singer wanted them to print. The Litan-Singer paper doesn’t exactly say that defaults have reached that figure. But if you put out a press release saying that “the leakage of funds in 401(k) plans due to involuntary loan defaults may be as high as $37 billion per year”, and you don’t explain anywhere in the press release that “leakage of funds” means something significantly different to–and significantly higher than–the total amount defaulted on, then it’s entirely predictable that journalists will misunderstand what you’re saying and apply the $37 billion number to total defaults, even though they shouldn’t.
But let’s backtrack a bit here. First of all, how on earth did Litan and Singer decide that the total amount of 401(k) loans outstanding was $104 billion, when the Department of Labor’s own statistics show the total to be just half that figure?…
Robert Litan and Hal Singer: Good Intentions Gone Wrong: The Yet‐To‐Be‐ Recognized Costs of the Department Of Labor’s Proposed Fiduciary Rule: “The Department of Labor (DOL) fiduciary rule has been justified based on economic analyses by the DOL and the Council of Economic Advisers (CEA) that are flawed…
…and filled with internal contradictions. These flaws come mostly from “cherry picking” and misreading the relevant economic literature, and from ignoring significant costs to millions of small savers that the rule would impose…. The DOL’s Regulatory Impact Analysis (RIA) thus concludes erroneously that the net benefit of the rule would be roughly $4 billion per year (the CEA, making related errors, pegs the benefit at $17 billion). A conservative assessment of the rule’s actual economic impact–taking into account the categories of harm noted above that are ignored by DOL and CEA–finds that the cost of depriving clients of human advice during a future market correction (just one of the costs not considered by DOL) could be as much as $80 billion, or twice the claimed ten‐year benefits that DOL claims for the rule….
Depriving clients of human advice during a future market correction could be as much as $80 billion…. The decision to stay invested (or not) during times of market stress swamps the impact of all other investment factors affecting long‐term retirement savings, including modest differences in advisory fees or investment strategies. “Robo‐advice”… cannot effectively perform this critical role. (An email or text message in the fall of 2008, for example, would not have sufficed to keep millions of panicked savers from selling, with devastating consequences for their nest eggs)….
The DOL… wagers the welfare of millions of Americans on the mistaken notion that ending commission‐based compensation is better for small savers than assuring them continued access to human financial advice through an affordable and time‐tested model…. A less costly alternative that would meet the DOL’s objectives would be to require enhanced but simple disclosures relating to brokers’ compensation from companies sponsoring investment products they sell…
Elizabeth Warren: Letter to Strobe Talbott: ”I am concerned about financial conflicts of interest…
…in a recent study authored by one of your nonresident Senior Fellows, Dr. Robert L. Litan…. Other Brookings-affiliated researchers raised concerns… that appeared to be directed at Dr. Litan’s work…. Dr. Litan’s study… contained a broad but vague disclosure, stating that “funding for this study was provided by the Capital Group”…. I asked Dr. Litan additional questions for the record…. The Capital Group commissioned… the study… paid $85,000… no other entity provided financial support…. Lita asserted that “the conclusions are our own”. However, he also noted that “The Capital Group provided us with feedback and some editorial comments”…. This statement appears to be inconsistent with Dr. Litan’s testimony before the Senate that “Dr. Singer and I are solely responsible for the analysis”….
These disclosures are highly problematic…. They raise significant questions about the impartiality of the study and its conclusions, and about why a Brookings-affiliated expert is allowed to use that affiliation to lend credibility to work that is both highly financially compensated and editorially compromised by an industry player seeking a specific conclusion, and has been implicitly criticized by the Institution’s own in-house scholars as bought and paid for research lacking in merit…
: Caveat emptor: Watch where research on the fiduciary rule comes from | Brookings Institution: “To no surprise, those benefiting from current practices…
…have paid for research to try to discredit the proposed rule. Such research claims that people don’t lose as much money from biased advice as careful, independent research has shown. Research not funded by special interest groups concludes that when they are paid to recommend certain financial products over others, advisors tilt their recommendations so that they receive higher pay. In other words, advisors respond to financial incentives just like the rest of us. Such biased advice hurts savers by lowering returns and by increasing fees. Independent research must generally undergo an anonymous review process before publication. Studies funded by special interests need not face such scrutiny. When it is to their advantage, they may use analytic techniques that would not be accepted in academic research, draw inaccurate inferences, use inappropriate data, or selectively report the results. In addition to denying the harm of biased advice, critics of the regulation pivot and allege that the Department of Labor has not crafted the right solution to a problem whose existence they initially denied…
: Financial Advice for Retirement Savers: Paying for Advice without a Conflict of Interest: “The proposed DOL rule would change the legal standard that applies to most financial advisors….
…Presently, most advisors are subject to a ‘suitability’ standard in giving advice to their clients. This requires advisors to understand their clients’ financial situation and to recommend investments that are suitable for that situation. The DOL proposes to subject advisors to a tougher ‘fiduciary standard’… [which] requires advisors to put their clients’ financial interests first…. As noted by the Council of Economic Advisors in a report describing the effects of advisers’ conflicts of interest, there is abundant evidence that some conflicted advisors recommend investments that are remunerative to the advisor but that reduce the expected return obtained by clients. The research showing the adverse effects of conflicts of interest on advisors’ recommendations and retirement savers’ decisions is extensive and persuasive.
A counter-argument to imposing a fiduciary standard on all advisors is that the commission system, which creates adverse incentives for advisors, is necessary in order to pay for financial advice to retirement savers… [that] even conflicted advice is better than no advice at all. This claim does not seem terribly compelling. There are alternative ways to compensate financial advisors that do not create an obvious conflict…. For a large percentage of the workers who have accumulated little savings, the best financial advice is often the simplest: Save as much as you can afford, and invest the bulk of your retirement savings in a low-cost target-date retirement fund that is appropriate given your age and tolerance for risk. It should not require a hefty commission to offer this advice.