The Comming Retirement Crisis.

Industry and government budget specialist Thornton Parker argues that coverging trends could jeopardize the retirement of countless baby boomers - especially those with piles of stocks in their retirement plans.

three major trends are on a collision course -- poised to crash when American baby boomers try to retire. And, as pension plans and other retirement portfolios switch from buying stocks to selling them, stock prices will decline for years, trillions of dollars of phantom wealth will vanish, and a depression could result.

The three trends are:

* Aging Populations: Populations of industrialized countries are aging, and more people expect to retire in relation to the number of workers who must support them.

* Phantom Wealth: The economies of these countries are increasingly being driven by phantom wealth that is based on unrealistic stock prices.

* Percentage of Stocks for Retirement: In the U.S., half of all stocks are held to pay for retirements, and the percentage is increasing.

The reasons are simple. Since most stocks pay small dividends (if any at all), retirement portfolios buy them for gains. On retirement, retirees need cash, so stocks have to be sold to convert any gains to cash. Nobody has yet shown how there can be enough buying power to produce gains.

Currently, about two-thirds (or 66 percent) of the national income goes to workers as compensation, giving workers control of most of the domestic stock buying power. Recent Census Bureau projections show that about 27 percent of the country's adults -- including all the boomers -- will be age 65 or over by 2030. If they all retire, there will be only about 2.7 people of working age to support each of the retirees. In practice, many older people will continue to work and many younger people will be in school, starting families, or not working for other reasons.

The Social Security problem: although eligibility for full benefits is being increased to age 67 by 2030, there are expected to be only 2.1 workers to support each beneficiary.

Stocks-For-Retirement Problems

The stocks-for-retirement problem is nearly twice as bad. The Committee on the Investment of Employee Benefit Assets (CIEBA) sponsored the 1999 report Implications of Investing Social Security Funds in Financial Markets. The section written by the investment management firm Invesco Inc., says that people who buy stocks typically buy most of them during their peak earning years, ages 40 through 59. The Census Bureau projects that by 2030, 79 million people will be in their peak earning years and 69 million will be age 65 and over. If stock buying patterns continue about as they are now, there will be fewer than 1.2 workers in their peak buying years for each potential retiree. That ratio shows the flaw in proposals that promise to "save" Social Security with stocks.

At a fundamental level, retirement means continuing to consume without producing. Each year, workers produce a national pie of goods and services. Most of what retirees consume comes from that pie, while retirement programs just help retirees buy a larger slice. The hard fact is that the more retirees consume, the less there is left for workers. Except for the few retirees who can live on interest and dividends, most retirees' investment income come from asset sales. Because most of the buyers must be workers, millions of boomers can't enjoy many years of retirement without relying on those who are still producing.

Unfortunately, the problem is larger. For years, retirement savings have flowed into pension and mutual funds in search of gains. Managers of these funds passed the pressure for gains on to companies. In order to inflate their stock prices, companies responded in a variety of ways: by cutting costs, downsizing, specializing, merging, laying off workers, abandoning communities, reducing dividends and avoiding internal investments that didn't promise rapid paybacks. These practices added to anxiety, discontent, meanness, political friction and even racial tensions. In fact, it is no coincidence that objections to affirmative action escalated along with the drive to inflate stock prices.

Stock gains have distorted traditional investment patterns. In the environment of the 1990s, anybody could double money in four years or less with an indexed mutual fund, so that became the standard for evaluating companies' internal investment opportunities. The concepts of Economic Value Added (EVA) and Market Value Added (MVA) are schemes devised to build future stock gains into companies' internal hurdle rates. As a result, many productive investments that the country needs to produce long-term real wealth are not being made because they simply can't grow as fast as stocks that create what is known as "phantom wealth."

Phantom Wealth "Defect"

Phantom wealth is created by treating all shares of a company's stock as being worth the last trade price. For example, if a company has 100 million shares, and a few trade for $1 more than the previous trade price, most portfolios -- including all retirement accounts -- act as if $100 million in wealth has just been created. But if a subsequent trade is for $1 less, the $100 million vanishes. It was a phantom.

Much of the New Economy feeds on phantom wealth, created at no cost to companies by printing more stock certificates. This is much like counterfeiting, and it is beyond the reach of the Federal Reserve System that is supposed to control the money supply. There is a symbiotic relationship between investors' demands for quick returns and the short product cycles of technology companies. But when retirement sales destroy the prospects for rapid gains, many of those companies will melt like ice in boiling water.

Americans who wait too long to face some unavoidable facts of their own retirement will watch trillions of dollars of phantom wealth just vanish. The country will have distorted its economy by trying to do the impossible -- that is, to let millions of boomers retire without putting the burden on workers.

With so much wealth managed now by large institutional investors who are measured on their performance, another fundamental fact is being overlooked. Stocks can produce two completely different kinds of returns: endogenous and exogenous. Endogenous returns come from within a company, usually as dividends; they are rewards for what it has accomplished.

Exogenous returns come from outside a company and are based on what traders think about the future performance of the company, its industry, interest rates, the stock market, the economy, political conditions and countless other factors. When stocks are sold to convert exogenous returns into cash, the cash comes from the buyers, not the company.

In today's environment exogenous returns can be made more quickly, so public companies are concentrating on them. But if boomers' retirements are going to deflate stocks, big changes are coming. Much of what companies do to create phantom wealth will be seen as wrong. The demand will then be for endogenous returns that come from creating real world value.

Reversing the Trends

To reverse the three trends described above and prevent a financial catastrophe, the following three things should be done rapidly:

1. Inform, study and deal with the issues before making decisions: U.S. Senators and Representatives should be informed of the situation and advised not to divert Social Security funds to stocks until there is a realistic explanation of how stocks can help. If the program will not have to sell the stocks, the reason for buying them should be explained. If it must sell, future supply and demand conditions must be projected realistically. Explanations that draw on the history of stocks are useless and misleading because nothing similar has ever happened before.

2. Understand the Social Security and stocks-for-retirement issues; make projections based on realities: We know about the Social Security problem because of its annual 75-year projections. There are no comparable projections for the national stocks-for-retirement cycle. Today, only the front, or build-up half, of the cycle is being considered. The back, or selling half, is being ignored. Without realistic prospects of adequate buying power to sustain prices when boomers' retirement plans sell, the cycle must be treated like any other large system that lacks a critical component. It is fatally flawed.

Organizations like FBI should undertake their own due diligence analyses of the cycle and exchange their findings. If the findings show how the cycle can work, that would be great news. If not, retirement portfolios should be valued like other inventories of things held for resale -- at cost or market, whichever is lower. Gains should not be recorded until stocks are sold because so many stocks are in retirement portfolios, valuing them conservatively will reduce the drive to inflate them many times faster than the economy grows. With clear thinking, skill, and plenty of luck, it may it may be possible to deflate today's bubble without causing a depression.

3. Create real organizational value: As the drive to inflate stocks fades, corporations will need new reasons for being. The true measures of organizational worth may turn out to be their contributions to the lives of present and future Americans. For example, salaries, wages and benefits -- particularly for older people -- along with contributions to communities and dividends, may become outputs to be maximized rather than costs to be reduced. If that happens, investment theory and ideas of corporate governance will change drastically.

The future can be determined and driven by those willing to take the lead. If the stocks-for-retirement cycle can't work, the big question for managers is whether they will lead the changes or be driven by them.

Thornton Parker is author of the book What if Boomers Can't Retire? How to Build Real Security, Not Phantom Wealth, published by Barrett-Koehler, based on his research and 45 years in industry and government.