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December 07, 2004

The Coming General Fund Crisis

Ogged shows much more comprehension of the government's long-term finance than any member of the executive branch has shown in public:

Unfogged:Sitting at my desk, waiting for a deal to die or get done. While I had the free time, I thought I'd write out something that's always bothered me. All thoughts and comments appreciated Consider a firm in the following situation. It is currently generating cash, though not spectacularly so. It has a defined benefit pension plan which is substantially underfunded, and which is only likely to become more so in the future. It could substantially increase its pension contributions, but that would effectively eliminate all of its cash flow. So it hits upon the following strategy. It deposits all of its free cash flow into its pension plan every year. However, it then borrows that same amount from the pension plan. The pension plan gets some kind of debt security in return. So, problem solved. The cash generated in the business remains in the business (and is available for whatever purposes its owners intend) and the pension plan has more assets and no longer needs to be considered underfunded.

Needless to say, any company that tried such a strategy would be violating about a hundred thousand different laws, and its executives would get, at a minimum, the death penalty. But what I don't understand is how this situation is any different than our current social security system. People will tell you that Social Security is not in dire straits at all - because even after payroll taxes cease to be sufficient to cover benefits, the Social Security trust fund has plenty of assets (in the form of US Treasury obligations) to cover the shortfall. Only when those assets run out (way in the future, when the baby boomers have finally been culled from the herd) is there going to be a problem, and its not nearly so serious a problem as portrayed by those advocating privatization.

As I see it, its all well and good to say the trust fund has assets to back up expected future obligations. But it has to turn those assets into cash. And since the assets are claims against the government, the only way to turn them into cash is to 1) have the government borrow (effectively refinancing the debt), 2) increase taxes, or 3) cut spending. 1) seems the most likely result, and the government already borrows too much as it is. So how it this system sustainbal? I.e., isn’t the social security crisis much closer than we think?

I have no brief to argue in the privatization debate - that seems to me to be a separate issue. And when I say that people will tell you there's no social security crisis coming, some of those people are a lot smarter than me. So what am I missing?

You're not missing anything. The Social Security Trust Fund may well not be in crisis--relatively minor changes will put it into 75-year expected balance, and there is good reason to think that the 'expectations' of the Social Security actuaries are pessimistic.

However, the General Fund--the non-Social Security part of the government--is in crisis. The General Fund is now in deficit to the tune of 5.5% of GDP. Within a generation General Fund taxes will have to go up (or spending will have to go down) by enough to (a) close this deficit, (b) cover cost growth in Medicare and Medicaid, (c) deal with other unexpected contingencies, and (d) produce a 2.5% of GDP surplus to pay back the Treasury Secretary's obligations to the Managing Trustee of the Social Security Trust Fund.

It's a crisis. It's a big crisis. It's just not a Social Security crisis per se...

Posted by DeLong at December 7, 2004 11:00 AM

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» The General Fund crisis from Mark A. R. Kleiman
We don't have a Social Security crisis. We have a General Fund crisis. Let's not fix the wrong problem. [Read More]

Tracked on December 8, 2004 07:43 PM

» Bush has got the wrong end o'the stick from Explananda
Brad DeLong puts is succinctly:The Social Security Trust Fund may well not be in crisis--relatively minor changes will put it into 75-year expected balance, and there is good reason to think that the 'expectations' of the Social Security actuaries are... [Read More]

Tracked on December 13, 2004 12:53 PM

» Bush has got the wrong end o'the stick from Explananda
Brad DeLong puts is succinctly:The Social Security Trust Fund may well not be in crisis--relatively minor changes will put it into 75-year expected balance, and there is good reason to think that the 'expectations' of the Social Security actuaries are... [Read More]

Tracked on December 13, 2004 01:24 PM

Comments

Thanks for the link, but generally-hidden co-blogger Unf is responsible for this one.

Posted by: ogged at December 7, 2004 11:16 AM


Exactly right, which is why I cannot figure out the logic of proposals to fix "social security" (which may or may not do so) by making the deficit in the general fund worse. And even if partial privatization does not make the general fund's deficit worse, it at least makes it much more visible.

And I might add, the deficit in the general fund is not just a problem for the social security trust fund, it is a problem for everyone who holds US treasuries. It is true that lots are of long-term treasuries are held by Social Security, but even more are held by foreign investors (including central banks -- if you roll over your short-term claims forever because you are stuck as a big holder you effectively hold a very low-yielding long-term claim) and private investors ...

Posted by: brad setser at December 7, 2004 11:19 AM


How are the bonds held by the SSA any different from the billions of dollars of bonds sold to domestic and foreign investors? The cost of repaying the debt sold to non-government holders is accepted as a long term budget cost, so why is there such a stink about paying back the bonds held in the trust fund? They both have an equal obligation to be paid to avoid default.

Posted by: SP at December 7, 2004 11:22 AM


The government is just doing what many of the conglomerates did in their heyday (LTV, where are you?), using the revenue from an unglamorous business unit (SSA / FICA) to cover up the losses in the more glamorous units (missile defense shields, etc.). See, Bush really is the CEO President.

Posted by: JerryN at December 7, 2004 11:29 AM


how does this compare to Krugman's column today? As far as I can tell, he does not mention the treasury obligations or this problem of turning them into cash.

Posted by: econStudent at December 7, 2004 11:36 AM


Exactly right, which is why I cannot figure out the logic of proposals to fix "social security" (which may or may not do so) by making the deficit in the general fund worse. And even if partial privatization does not make the general fund's deficit worse, it at least makes it much more visible.

And I might add, the deficit in the general fund is not just a problem for the social security trust fund, it is a problem for everyone who holds US treasuries. It is true that lots are of long-term treasuries are held by Social Security, but even more are held by foreign investors (including central banks -- if you roll over your short-term claims forever because you are stuck as a big holder you effectively hold a very low-yielding long-term claim) and private investors ...

Posted by: brad setser at December 7, 2004 11:36 AM


A former student from 1991 asks for your thoughts on comments made today by 2004 Nobel Laureate, Prescott. Prescott contends that current General Fund is "no problem" and to say otherwise is "ignorant".

See http://money.cnn.com/

Balance-sheet argument offered by Prescott seems to smack of Barro's Ricardian Equivalence Theory -which I never found convincing. Surely, we are not headed in that direction again... are we?

Posted by: Christian Guzzy at December 7, 2004 11:41 AM


Yes, yes, yes, at last it gets a clear airing. Cashing the bonds requires current income or borrowing, exactly, and the cashing begins very soon.

Some think that these people in the bush administration intend to create a massive deficit crisis in order to slash everything that isn't either defense spending or a payout to a campaign contributor. That would mean just about everything related to the general welfare, in current understanding of federal policies.

I'm not sure, myself. Some may want this-- certainly Grover Norquist does. Others, like Cheney, may simply believe that deficits just don't matter at all, that the US is too big and too important to the world to fail.

Whoever thinks of government as a redistribution machine that transfers money from suckers who can't avoid paying taxes to favored insiders-- and that's most of the business interest in the administration-- has to be in the second school. Is that any way to run a railroad? But then, Ken Lay would say yes, wouldn't he ...

Just how bidness is done in Texas, I guess.

Posted by: Altoid at December 7, 2004 11:41 AM


Fund is "no problem" and to say otherwise is "ignorant".

See http://money.cnn.com/

Balance-sheet argument offered by Prescott seems to smack of Barro's Ricardian Equivalence Theory -which I never found convincing. Surely, we are not headed in that direction again... are we?

Posted by: Christian Guzzy at December 7, 2004 11:43 AM


Social Security
All this talk about Social Security going bankrupt, etc. Nothing could be further from the truth.

I've already resigned myself to working, at least part time, for the rest of my life. Maybe we will go back to the hippie communes in our old age. They keep pushing up the qualification age for social security, so maybe a lot of us will be dead before we ever collect. Then there's the bad aftereffects of all those drugs we took that are just starting to show up.

And it's stupid to even THINK about asking our kids to pay higher Social Security taxes. We already spoiled them rotten, and we know that their answer is SURE to be no. HAHAHAHA. They might let us live in their garage apartments though, for all the work we put into them.

Sign me-- A Mother with six leftover prom dresses.

Posted by: cloquet at December 7, 2004 11:51 AM


Brad,

OR WHAT WILL HAPPEN! WILL THE GOVERNMENT WILL GO BANKRUPT?! NOT POSSIBLE! WHY NOT STATE THERE MAY BE A HUGE BOUT OF INFLATION THAT WILL MAKE EVERY DEBTOR DEBT FREE! MOST AMERICANS SHOULD WISH TO BE SO LUCKY!


...Within a generation General Fund taxes will have to go up (or spending will have to go down) by enough to (a) close this deficit, (b) cover cost growth in Medicare and Medicaid, (c) deal with other unexpected contingencies, and (d) produce a 2.5% of GDP surplus to pay back the Treasury Secretary's obligations to the Managing Trustee of the Social Security Trust Fund.

It's a crisis. It's a big crisis. It's just not a Social Security crisis per se...

BALONEY! ITS INFLATION!

Posted by: Winslow R. at December 7, 2004 12:06 PM


Glenn Hubbard floated the latest trial balloon yesterday on NPR. He claims that frivolous lawsuits are a 2% tax on GDP. Tort reform would save -- what a coincidence -- exactly enough money to offset Social Security privatization. A two-fer for Bush.

This whole Social Security reform is like watching a slow motion train wreck you can do nothing about. They own the executive, they own the legislative, the own the courts. Just like the war in Iraq, Karl Rove made perfectly clear a year ahead of time exactly what he was going to do and nobody believed it. Its going to happen again and its going to be a tragedy.

Posted by: JackM at December 7, 2004 12:13 PM


And Hubbard is thought to be a likely choice for head of the Federal Reserve. Well, my guess is they'll be entirely discredited by 2012. Then things are going to get harder. Bah!

Posted by: Randolph Fritz at December 7, 2004 12:47 PM


It's the demographics!

The private accounts will have the same problem as the social security trust.

The problem is the demographic bulge. A lot of people decided to have children at the end of World War II. Those children will be retiring soon. That's all there is to it.

Any mechanism for transferring value forward in time has the same problem with this bulge. It doesn't matter if it is a government or a private organization.

When the baby boom gets into retirement big time, the social security system will be stressed and the stock markets will go down as the number of sellers needing cash exceeds the number of buyers seeking future retirement security.

Any member of a large demographic cohort will do better with a public retirement pension than a private one. The reverse is true for those in smaller cohorts.

Waving a magic wand marked "private" at the problem will not fix anything. Knowing the baby boomers, they will eat their young.

Posted by: kaleberg at December 7, 2004 12:54 PM


Do we at least get to state what the real deficit is once we borrow the money to privatize SS and take it off-book?

Posted by: peBird at December 7, 2004 01:30 PM


I wonder how hyper-inflation would affect this obligation. As SS is supposedly indexed to inflation, that would suggest that the demand vrs current assest would be increased.
now that could lead to a social security disaster no?

Posted by: Ron Sturtevant-Stuart at December 7, 2004 01:42 PM


This whole Social Security thing is so stupid. Right now we have about 7.5 trillion dollars in public debt. Of that, 4.5 trillion is held by private investors, and 3 trillion is held by government entities, of which the Social Security trust fund is the biggest. Hint: BONDS CAN BE SOLD AT ANY TIME. There's this thing called a "bond market", y'know? The only thing that happens is that the bonds are now in private hands, rather than in the hands of the trust fund. Well, that, and the U.S. government might need to raise the interest it pays on its bonds in order to attract more money from the rest of the economy, which in turn will decrease the amount of money available for investment in the rest of the economy, but given the massive over-investment that has resulted in massive over-capacity in recent years, that's hardly an economic disaster.

THERE IS NO CRISIS HERE! None. Zero. Zilch!

- Badtux the Numerical Penguin

Posted by: BadTux at December 7, 2004 02:59 PM


Unfogged put this in the same business finance light that I just used to explain what was entirely wrong with what Edward Prescott allegedly said in Sweden - assuming CNN/Money reported it correctly (see Angrybear for details). And yes - the General Fund problem is much larger than the Social Security problem - as well noted by Krugman's oped today.

Posted by: pgl at December 7, 2004 03:08 PM


Kaleberg: "When the baby boom gets into retirement big time, the social security system will be stressed and the stock markets will go down as the number of sellers needing cash exceeds the number of buyers seeking future retirement securit"

And privatization is the solution: it automatically creates a whole group of "greater fools" to buy my stocks when I need to cash out to get money for food.

Posted by: masaccio at December 7, 2004 03:36 PM


Kaleberg
The boomers did not eat their young. They didn't have many young because they spent so much to buy their houses from their parents (the greediest generation) that they couldn't afford as many as the greeds did. The greeds didn't eat their young, they ate their grandchildren.

Posted by: wkwillis at December 7, 2004 06:01 PM


what is the arguments from the other side (i.e., the side that contends the bonds are not real assets of the SS trust fund)- that the government will selectively default on certain bonds? If that were the case, it would be economic chaos.

Posted by: Christian Guzzy at December 8, 2004 06:50 AM


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