Tag Archives: social security

Connecting the Dots

Ever since Cyprus, Jeremiah is skittish about his bank account.  Here is a Harvard professor reminding us that bank deposits do not compensate for even a slight risk of default.

If the chance that Bank of America will not return my money is, say, a mere 1 percent, then the expected cost to me is 1 percent of my [savings]. That far exceeds the interest I receive, which, I hardly need remind depositors, is a cool $0.

We covered this calculation during the Cyprus event.  Banks pay a risk premium to big investors – you are just a hind-tit unsecured creditor.  Before switching to money market funds, be aware that the Fed’s proposed minimum balance at risk rules may bite you there, too.

It seems like your money is a problem that the government wants to solve.  In Europe, they’re drawing up plans for forced investment in small business, infrastructure, and “other projects.”

The savings of the European Union’s 500 million citizens could be used to fund long-term investments to boost the economy

If these are such swell investments, why isn’t Warren Buffett already in them?  The definition of a good investment is one that you’re willing to make without the government forcing you.

Jeremiah is suspicious of any government “help” with retirement, including this new myRA plan.  We already have Social Security, which takes from your paycheck today, in exchange for a hazy promise in the future.  This sounds like the same deal, only dressed up like a Roth IRA.

One concern with myRA is that while the principal is guaranteed, the interest rate is not, and the rate of G Fund bonds could fall below the rate of inflation.

It sounds like myRA is less about your retirement, and more about making a market for U.S. bonds.  We’d be believers if the plan let us invest in, say, inflation protected bonds – or Apple.

See also:  Bonds and Discipline

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The Andean Solution

Below is a recent letter to The Economist.  Jeremiah has often said that Social Security is a Ponzi scheme.  What’s interesting is that we – even The Economist – blindly assume other countries have the same problems.

It is incorrect to say that Chile’s workers are “increasingly unable to afford their parents’ pensions”. The pension system is based on defined contributions. Parents’ pensions are funded by the contributions they have put in over their working lives, not by younger workers.

Pensions funded!  Compound interest!  We were so shocked that we dug up this old article from Jose Pinera, the inventor of this amazing system.

The whole working population of Chile has a vested interest in sound economic policies and a pro-market, pro-private-enterprise environment.

It just goes to show you that sometimes we can learn from other countries.  American leaders could simply copy the Chilean system.  It is so obviously superior, you have to wonder why we never hear about it.  Maybe it’s that “free market” stuff.

See also:  Herman Cain’s Social Security Model

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Generational Conflict

The letter from Clara we published last week sets out the markers in a generational conflict that dominates our debate about class and wealth.  Political pundit Stephen Colbert says much the same thing here, and here is a blogger who writes that Social Security promises are null and void in the new economy.

promises made when the economy was growing by 4% a year and the next generation was roughly double the size of the generation entering retirement cannot be fulfilled

On the flip side, people retiring today have been paying into this failed system all their working lives.  Is it fair that Mr. Colbert’s generation should be the one holding the bag?  As Sami Karam observes in his own Clara piece, demographic challenges can be foreseen far in advance.

the number of people aged 40 in the United States twenty years from now is roughly the same number of people aged 20 today

Jeremiah does not blame greedy oldsters for wanting “their” Social Security payments.  He blames the political class for not reforming the program.  The housing bubble may have been a surprise, but this crisis has been brewing for twenty years.  To reform Social Security, it pays to understand where the program went wrong.

  • Passthrough funding seemed like a clever idea when the dependency ratio was low.  It allowed the program to show immediate benefits.  The adverse trend in this ratio was predictable, though, and funding should have been shifted to an investment model.  This would mean positive returns to the program, and it would also fund economic growth.
  • Social security holds its deposits in a special class of Treasury debt, which means free funding for the government.  It should be in an age-weighted portfolio, like any private pension fund.  The administrators should have a stake in obtaining positive returns on investment, and against the Fed’s policy of financial repression.
  • It is irresponsible to go on making promises about benefits, while not investing and not planning for population trends.  The program ought to work more like a defined contribution fund, regularly publishing changes to benefits and the retirement age, depending on the health of the fund.  This would give the public an interest in how well the program manages its money.
  • One goal of the program is redistribution.  People with good jobs would prefer to fund their own IRA, but they face an individual mandate to join Social Security.  We should allow them to opt out, fractionally, in exchange for lower benefits.  This would cost the program some funding, but it would add diversity and reduce total size.

Finally, the administration of Social Security needs to be reformed.  Its three main operations are funds collection, investment, and disbursement.  The latter two could easily be outsourced, taking care to end the Treasury’s conflict as a borrower from the fund.  Jeremiah would also like to see collections handled by a different agency than the IRS, because the IRS is unspeakably evil.

See also:  Age Shall Weary Them

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Promises They Can’t Keep

What do General Motors, Greece, and California all have in common?  Yes, they’re all broke.  More specifically, they all went broke because of unfunded pension obligations.  This is a pernicious moral hazard, especially in government.  It allows politicians to make big promises that come due years later.  Huge promises – about $500 billion, in California.

New Jersey’s $30.7 billion unfunded pension liability makes it the seventh-worst funded system in the country, while the unfunded liability for retiree health benefits is $56.8 billion, according to Moody’s Investors’ Service.

A “defined benefit” pension is nothing more than a promise that the money will be there when you retire.  If you recently retired from General Motors, it wasn’t.  A prudent company will keep track of its pension obligations, and put money aside.  They are required to track how much this money will cover.  Pension funding of 80% is considered good.  That’s for companies.  Governments have lower standards.

If your employer offers a “defined contribution” plan, or puts money into a 401(k), then that money is really there.  Otherwise, you should be very concerned about your funding ratio.  Instead of honest negotiations over wages, management can promise a fat pension and then never fund it.  This moral hazard is even worse in government, because – the workers are also voters!  The politicians will be long gone when the bill comes due.

The solution is to fully fund all pension obligations and charge them against current income, just like wages.  No big promises, no moral hazard.  Now, who do you suppose has the world’s biggest unfunded pension liability?

See also:  Privatize Social Security

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Come Back, America!

Now, here’s a guy who can make you wake up screaming.  David M. Walker, former Comptroller General of the United States, was on the radio yesterday.  He laid out exactly how broke America is, and what the consequences are likely to be.  Stephen King has nothing on Mr. Walker.  He is also a former head of Jeremiah’s favorite former government agency, the GAO.  You can see a video of him here.  Oops, no you can’t!  The 404 errors have started already.

In the interview, Walker scares the hell out of Terry Gross.  Naturally, she blames it all on president Bush.  Walker’s senate testimony, however, states that the crisis will not be solved by ending the war, ending earmarks, cutting defense, lapsing the Bush tax cuts or ending “waste & fraud.”  He is after the big nut, the structural deficit, which means Social Security.

Surprisingly, Walker does not want to privatize social security.  He just wants Congress to stop stealing from it.  He casually mentions “Social Security cash surpluses, which have been used to help finance other government activities.”  What?  Our contributions aren’t sitting in a bond fund?

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Privatize Social Security

The Economist wonders “whether it makes sense to let people retire at 65.”  Jeremiah wonders why the government is telling him when he can retire.  They only have this authority because they have taken thousands from Jeremiah throughout his working life – which he could have invested profitably – and now they will choose whether and when to give his money back.

Instead of investing this money, the government uses it to pay current expenses.  This is the very same fraud for which Bernie Madoff was recently convicted.

Far from earning interest, Jeremiah’s money, and yours, is paying salaries for 62,000 employees at the Social Security Administration.  That’s right – your tax money is more likely to pay for a government employee’s retirement than your own.

The way to “save” Social Security is to abolish it, or at least phase it out.  It would be nice if those who had paid in could get their money back at face value.  After that, the system could operate as a “public option” for those without the sense to open an IRA.

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