Monday, September 19, 2011

Social Security v. the Republican Alternative

M.S. writing for The Economist notes:

Up until about 2007, the goal of such attacks was clear: conservatives wanted to replace it with a Chilean-style defined-contribution plan that would be invested in securities. Within its own assumptions, that programme did at least make sense; but since the financial crisis, and with average returns from Wall Street now sharply negative over an entire decade, both the logic and the political support for any such programme have evaporated.

This “goal” would represent two fundamental changes: (a) investing surplus funds in risky securities as opposed to government bonds; and (b) converting a defined benefits program to a defined contribution program. Part (a) was supposed to increase the expected return at the cost of bearing stock market risk – which as M.S. notes has witnessed average returns being well below expected returns of late. The Galveston Plan, however, implemented part (b) but kept surplus funds in a portfolio with lower risk and lower expected return. But not everyone was necessarily better off under this Galveston Plan.


Jack said...

"...the goal of such attacks was clear: conservatives wanted to repace it with a.." scheme that would greatly increase the amount of funds going into the profits of the investment banking community. The rationale for such a change makes no sense whatever unless one recognizes the fees to be earned by placing a nation-wide retirement system in the hands of the investment mangement industry. In exchange for greater risk, no assurance of better returns than offered by Social Security and the elimination of the disability and death benefit aspects of the SS system we have to pay annual fees so that our retirement system can be added to the fee generating casino operatin we refer to as Wall Street.

TheTrucker said...

"The only things certain are death and taxes". The connotations of that saying are normally negative. But when one actually thinks about it, this is not the case. In the frolicking world of balls to the wall capitalism there are winners and losers. And so long as the winners pay the taxes to provide for the safety nets then all is well. What has happened is that the taxes are much less certain than they have been. And at least a few in the the economics profession still seem to be avoiding and ignoring the beneficial effects of progressive taxation. For them it is always taxes = economic drag; as though government can do no good. The CBO released a report in April of this year that makes it very clear that those who participate in the Medicare system will save 19.5% on the cost of health care over the next 10 years. They make it plain the the savings arise from the lower overhead and from the market power of the Medicare system in setting prices. Yet we see no economists insisting on a Medicare Buy In choice. We see the health insurance companies continuing to take a huge bite out of the health care apple. Where the hell is Krugman when he is needed?

Suzan said...

Krugman has said this about a Medicare buy-in over and over.

Where were you?


Don Levit said...

Regarding health care, what we need are not-for-profit insurers such as a 501(C)(15) which is required to offer their insurance at cost.
Any "profits" must go to increase benefits or reduce contributions.
In about 2 weeks, I will be applying for a business methods patent which will provide, to my knowledge, the only health insurance product that can become paid-up.
Regarding Social Security, I believe we need to maintain the disability and death benefits.
In addition, if we have a defined contribution approach, I support the weighting of the balances toward the lower incomes.
What we must do, as soon as possible, is discontinue the Treasury being able to borrow from the Social Security trust fund.
A five year old knows that if you take money from his piggy bank A, and loan it to his friend's piggy bank B, that Piggy Bank A is empty until it is paid back.
And, unfortunately, the Social Security trust fund is paid back with new monies, pay-as-you-go monies, AS IF THE TRUST FUND DID NOT EXIST.
That is why we need investments which cannot be diverted to the Treasury to pay for current expenses.
One of the proposals when Social Security was being discussed, was to offer affordable annuities for our citizens.
I recently bought several annuities, which vary with the S&P index. If the index falls, I lose nothing. If the index increases, I capture a part of the gain.
These fixed indexed annuities, over the last 10 years, have way outperformed the S&P index itself!
Don Levit

Anonymous said...

«That is why we need investments which cannot be diverted to the Treasury to pay for current expenses.»

That to me sounds like a crazy idea, because the treasury can borrow whatever from whomever, and in any case OASDI is not an investment, it is an mutural assurance+insurance scheme, and it is its trust fund that is invested, and the investment is treasuries.

Suppose that one created an alternative scheme that resulted in a trust fund of something like N trillion dollars, your proposal would be forbid for any of it to be invested in treasuries («cannot be diverted to the Treasury to pay for current expenses»).

That to me sounds well crazy, as USA treasuries seem a pretty good investment for a long term very large trust fund (and many sovereign wealth funds have been buying them up like mad for years).

«I recently bought several annuities, which vary with the S&P index. If the index falls, I lose nothing. If the index increases, I capture a part of the gain.»

So you bought annuities with a call option on the S&P and no insurance element. As a rule those are very expensive in the long term, both because of the options and the lack of insurance.

«These fixed indexed annuities, over the last 10 years, have way outperformed the S&P index itself!»

10 years is as you wrote «recently» and old age etc. assurance+insurance products must be evaluated over several decades, and RISK ADJUSTED, where the risks are that the issuer will go bankrupt, returns will be lower than expected, volatility of returns will be higher than expected, the buyer will become poorer and be unable to buy an adequate number, and so on.

But there is a more fundamental problem that shills for private assurance products don't get or deliberately omit to mention: a financial product that is purchased by all workers in a country cannot have a risk adjusted net returns higher than GNP growth in that country (save for crazy situations). It just cannot happen arithmetically.

Because obviously if your annuities plus options minus insurance have above-average returns, someone else must pay for those with below average returns, and if everybody buys them, who is the someone else?

And again, if anybody can find a long term mass market investment that returns 3% (or more...) risk adjusted after inflation, they deserve to be praised as the saviours of humankind.

Until that happens, good luck.

Don Levit said...

I did not say that the private investments could not be invested in Treasuries. Indeed, I think that should be part of a diversified portfolio.
But taking your FICA surplus contributiions and investing them in Treasuries is different than the Social Security trust fund loaning the excess FICA contributions to the Treasury to pay for current expenses.
The example of Piggy Bank A and Piggy Bank B seems pretty clear, don't you think?
Don Levit

Anonymous said...

«I did not say that the private investments could not be invested in Treasuries.»

I could not care less about what you claim that you did not say, it is a clear fact that what you did write is «we need investments which cannot be diverted to the Treasury to pay for current expenses.» which excludes Treasuries as they are used to pay for current expenses in a massive way. Currently Treasuries sales probably pay for around 30% of current expenses.

As long as money is lent in whichever way by anybody to the Treasury it goes to pay current expenses (inasmuch part of the Treasury expenses are current).

Arguing otherwise seems entirely ridiculous if not entirely in bad faith to me, like several of your other arguments, which seem to me in general a farrago of poorly understood misconceptions about finance and how the state works.

Don Levit said...

Diverting investments to the Treasury could be stocks and bonds as well as Treasury securities.
It is the DIVERSION I am opposed to. What the trust fund, once its excess FICA principal is kept intact, invests in, is relatively immaterial, as long as it is conservative.
It can include Treasuries as part of its diversified portfolio.
Do you not understand the difference between Piggy Bank A and Piggy Bank B?
If not, our dialogue is simply two monologues.
Don Levit

Anonymous said...

The «Piggy Bank A and Piggy Bank B» story is one of those «poorly understood misconceptions about finance».

«A five year old knows that if you take money from his piggy bank A, and loan it to his friend's piggy bank B, that Piggy Bank A is empty until it is paid back.»

Well, even a five year old who is not totally dumb would know that if he takes 1 trillion dollars and loans them to his friend, he will get a 1 trillion dollars IOU in exchange, because it is not a donation, it is a loan. So even a five year old would know that «Piggy Bank A» is not empty after the loan; it contains instead of 1 trillion dollars, an IOU for 1 trillion dollars.

In particular in the case of the OAS+DI trust fund accounts, all that is happening is that some trillion Fed dollars are exchanged for the same amount in Treasuries dollars, and Treasuries are cash-equivalents, except that they pay interest.

Both the trillion dollars in "cash" fed notes and the trillion dollars in "cash equivalent" treasuries are actually represented as accounts at the Fed, even if perhaps for the sake of tradition there might be a drawer somewhere with the "birth certificates" of the treasuries, because there are obviously some birthers who need to see them.

I guess that it is difficult for some people to understand that it is nearly exactly the same whether a piggy bank contains N trillions dollars issued on behalf of the USA government by the Fed or N trillion dollars in Treasuries issued directly by the same USA government.

The only practical differences are interest and pretending that the USA government is borrowing its own currency.

But it is difficult to discuss with people who don't know that when you lend money to someone you get back an IOU for the money, and therefore your "piggy bank" contains exactly the same amount as before, just in a different form, and that Treasuries are anyhow cash-equivalents.

It is even more ridiculous to try and explain to the same people that there are no jackbooted commissars of the people that shoot on sight USA citizens who try to invest in other instruments than Treasuries if they think that they need to complement their voluntary purchase of an OASDI product. So there is no point for the OASDI product itself to be diversified, because purchasers of that product can purchase whatever else they want to complement it and reach whatever degree of diversification they choose. And given that just about everybody buys OASDI membership as a willing bargain between free agents, as argued before diversifying OASDI is pointless, because no instrument that is bought by nearly everybody can have above average returns.

Don Levit said...

You're right.
Piggy Bank A owner is due back the loan.
To put this in a Social Security context, about $40 billion of a cash shortfall occurred last year.
In order to make good on that deficit, $40 billion of interest was redeemed.
When you say Treasuries are cash-equivalents that pay interest, my reaction would be "Okay, so the interest is simply liquidated to its cash equivalent, with no new monies involved.
Unfortunately, that is not the case. These Treasuries are so special that they have to be redeemed (principal and interest) by new general revenues, AS IF THE TRUST FUND DID NOT EXIST!
Do you disagree? If so, how do you think the interest was redeemed.
How about providing some objective links and excerpts to support your statements?
Or, are you such a renown expert that third party material is not needed.
Don Levit
Don Levit

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