Rethinking Social Security’s Future
We’ve all heard it: Social Security is broke. Worse, it’s a grand Ponzi scheme, according to one politician. The great fear for many Americans is that Social Security will run out of money to pay benefits to millions of retirees, leaving a generation of elderly Americans destitute. The recent mini crisis over raising the debt ceiling only fueled concerns that benefit checks might not go out as scheduled if the debt ceiling had not been raised.
At the same time, Social Security is not generating much growth. Its funds are invested automatically in special Treasury bonds that aren't able to be traded and that in 2010 carried an average interest rate of 2.76 percent. “There is no human decision involved,” says Sandra Salstrom, a spokeswoman for the Treasury Dept., which administers the fund. Under the current system, the fund is expected to run out in 2036.
Some people say that Social Security's future could be better. Extending its life could be as simple as investing the funds in a smart, professional manner similar to other public and private pension funds.
The California Public Employees’ Retirement System (CalPERS), for example, has $239 billion under management and earned an average net return of 12.5 percent in the 2010 calendar year and an average annual return of 8.6 percent from 1988 to 2010, according to Wayne Davis, a CalPERS spokesman. It generated high returns because 65 percent of the fund’s assets are invested in international blue chips and domestic and developing world stocks.
Brian Bruce, an adjunct professor of finance at Baylor University in Waco, Tex., says an 8 percent “blended return” across all of a pension fund’s investments is a reasonable expectation over the next five to 10 years. Bruce, who is also chief executive officer of fund management firm Hillcrest Asset Management in Dallas, believes the Social Security trust fund needs to include a diversified basket of alternatives to fixed income, like real estate investment trusts, master limited partnerships, and global equities. The AT&T pension fund, for example, is heavily invested in timber resources, he notes.
Robert D. Reischauer, president of the Urban Institute in Washington, D.C., and a current trustee of the Social Security trust fund, published a book in 1998 called Countdown to Reform: the Social Security Debate, in which he proposed investing about 20 percent of the trust fund in an equity index such as the S&P 500. “This would be meat-and-potatoes investing,” Reischauer says.
According to Reischauer, such a move would increase the trust fund's income about 1.5 percent over the rate it is currently receiving, an amount equal to about $37 billion more a year. By his calculations, that would close around half the gap in the underfunding that's projected to cause the trust fund to run out of cash in 2036.
Such a strategy, however, faces challenges. Olivia S. Mitchell, director of the Pension Research Council at the Wharton School at the University of Pennsylvania, says the government has already spent the money in the trust fund to pay for budget deficits. That is, while the government’s obligation to pay out billions of dollars to retirees is on the record, the hard cost to back up that promise has been lent out to the Treasury. Before the money could be invested, the special bonds would have to be redeemed by an act of Congress.
The fund would also come under tremendous political pressure to invest in certain areas and not in others -- a problem faced by President Bill Clinton when he considered investing the trust fund in higher-yielding stocks. Clinton also faced pressure from activist Jesse Jackson, who demanded that the money not be invested outside the U.S., because that would take jobs away from Americans.
Another consideration: Who would assume the risk of loss in case the stocks went down in value? In private pension plans, the company assumes that risk. With public pension plans, it is ultimately the taxpayer who would have to make up any shortfall, or the benefit recipients, who would be asked to accept less than they were promised.
“Very few asset managers look at the liabilities, and that is a fundamental misunderstanding in pension land,” says Mitchell.
No Silver Bullet
The insurance industry, however, does keep a close eye on liabilities. Through asset-liability matching, it is already known how much needs to be paid out in 10 years. The asset manager would buy low-risk corporate bonds and government securities to match that liability. Money earmarked for more distant payouts -- 20 or 30 years off, say -- could be invested in higher-return securities, such as stocks.
There have been several efforts over the years to use the stock market to bolster Social Security. President Clinton’s plan to use 60 percent of a projected $4.4 trillion surplus over 15 years never made it to serious consideration, largely because the projected budget surplus evaporated. President Bush's plan to set up individual retirement accounts as a replacement for Social Security was opposed by leading Republicans as well as Democrats because of the implied risk of individuals investing on their own.
Given the resistance, even the Urban Institute's Reischauer, a proponent of investing the trust in equities, admits that more work will need to be done to extend Social Security. It seems clear that investing in the stock market will not be a silver bullet to solve Social Security’s problems. "Investing in equities isn't a silver bullet to solve all the problems," he says. "It's a modest component of the solution."
(Charles P. Wallace is a freelance writer in New York.)
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