The
establishment of Social Security as a retirement program should have
been so simple that a caveman could have run it. Probably, but not our
political geniuses.
Once considered the government’s finest achievement, Social Security
now provides a nearly perfect microcosm for government incompetence,
arrogance and corruption. Formed in 1935, its original intent may have
been noble, but it soon became a vote-buying scheme, a slush fund and a
fraud.
The deterioration of Social Security demonstrates how politics
destroys well-intentioned programs. The perversion of the program
occurred solely for the benefit of the political class and included
political maneuvering, fraudulent promises, demagoguery and false
claims. The biggest broken promise of all is still to come – the
financial collapse of the fund.
Social Security as a Ponzi Scheme
The essence of any Ponzi scheme is that the underlying program does
not pay for itself and depends upon new money for its continuation.
Bernie Madoff’s scheme was no different than Social Security. In
Madoff’s case, he paid out returns to investors greatly in excess of
his ability to earn. He sustained his fraud until his ability to
attract new money fell below his level of payouts.
Social Security operates on the same model. It is likely that the
original conception of the program was honest, but according to the NY Times that was also likely Madoff’s initial intent:
… it seems likely that Mr. Madoff, an investment manager
since 1960, started out legitimate or semi-legitimate. People in that
position sometimes foolishly think they can hide a one-time loss with
new investors’ money, and make up for it with a big gamble later.
The mechanics of a Ponzi scheme and the skills of the swindler
determine how long the fraud can survive. Social Security mechanics
were favorable. Long periods of pay-in preceded retirement pay-outs.
Initially, demographics were favorable as the population was relatively
young. As late as the 1940s the SS had 40 workers supporting one
retiree. Today only three workers support each retiree. This chart
shows workers to retirees:
Swindler skills were unnecessary because the program operated under
the force of law. All workers (except certain government workers) were
required to “contribute.” Even as retirement “returns” declined over
time, there was no opting out of the system. Without coercion, workers
would have abandoned Social Security for better returns in private
retirement programs.
For years, Social Security was recognized as underfunded. In typical
political fashion, the insolvency of the program was ignored. So long
as payments were being made, there was no problem. Good politics always
overrules good finance. Now, the Trustee of the program estimates
underfunding at $17.5 TRILLION, the amount necessary to achieve actuarial soundness.
After decades of collecting more contributions for Social Security
than were required for current payouts, the liquidity crossover point
has arrived. As shown in the chart below, SS payouts are beginning to
exceed collections. The fund has now reached both insolvency and illiquidity.
The Politics of Social Security
To understand how the program reached this point, it is necessary to
understand the contemporary political mind. Politics is played to
produce “gain without pain.” It is a Santa Claus game of giving.
Political decisions follow the adage of Lord Keynes: “In the long run
we are all dead.” Maximize the short term. Let someone else clean up
the long-term consequences.
In President George W. Bush’s inaugural address he pledged to save
Social Security. He tackled the so-called “third rail” of politics,
proposing privatization as a solution. Older persons would remain in
the current program, while younger persons would enter into private
contracts. Because returns were higher in the private contracts, no one
would be worse off. It was a Pareto-optimal solution to a vexing
problem. How could it be opposed?
The program was a non-starter for most of the political
establishment. Numerous public objections were raised but never the
real ones — control and spending.
The control issue was primarily a Democrat concern. Social Security
was the centerpiece of the Roosevelt and Democrat legacy. Government
management of the program was critical to the philosophy of paternalism.
The spending issue concerned both parties. Social Security
represented a source of “free” funds that many were unwilling to forego.
Social Security as a Slush Fund
Debate over Social Security reform has always focused on recipients.
To truly understand the issue, however, it is necessary to take a
public- choice theory approach. For politicians, Social Security
represented a slush fund. Until recently, the fund generated enormous
excess cash that was taken and spent by Congress. This “free money”
didn’t need to be raised via income taxes.
This reprehensible use of SS funds was accompanied by equally
reprehensible propaganda convincing the public that contributions were
held in a trust fund.
The size of the slush fund was substantial. Over $5 Trillion was
removed and spent. To put this into perspective, this amount was enough
to cover total Federal spending for the first four years of the first Clinton Administration.
Bush’s privatization effort never had a chance. Its failure had
nothing to do with public reaction. Privatization would have killed the
slush fund, an act equivalent to budget cuts. Few politicians were
willing to accept lower spending on pet projects.
The tragedy of Social Security is that it became a major political
tool. Politicians invoked threats and lies during campaigns to gain
political advantage. The trust fund was a source of additional
government spending. Few cared about the soundness of the program.
After all, it was working well for them (politicians).
Had there been real concern for constituents, the Social Security
problem would have been solved long before Bush reached office. Patches
were made here and there, but no real reform. The Greenspan Commission
did nothing but extend the problem and build up the amount of funds to
be raided.
Bush’s privatization plan offered a reasonable way out of the Social
Security hole and a way of honoring SS commitments. It was DOA because
it would harm the political class. As in most political decisions, the
public’s well-being was never the objective.
The imbalances inherent in SS have now eliminated the slush fund.
The program now is a cash consumer, not a producer. As the drain
increases, the probability for political action increases because now
it restricts political spending. For this reason, political action is
apt to take place soon. It is now in the interest of the politicians to
stop the drag against their spending. Once again, the motivation is
political self interest rather than constituent interest.
Nine years after the privatization plan proposed by Bush, the
mathematics have changed dramatically. Solutions are harder although
more necessary. As pointed out by Allan Sloan of Fortune in his article “Next in Line for a Bailout:”
Social Security currently provides more than half the
income for a majority of retirees. Given the declines in stock prices
and home values that have whacked millions of people, the program seems
likely to become more important in the future as a source of retirement
income, rather than less important.
The required cash infusion to make the program actuarially sound is
about $23 Trillion ($17.5 trillion plus the $5+ trillion taken from the
fund).
The Federal Government itself is insolvent and cannot fill this
hole. Political gimmickry of some sort will undoubtedly be offered as a
solution. It will be interesting to see whether the solution includes
the establishment of another slush fund.