Brad DeLong's Semi-Daily Journal: A Weblog

Answer to the basic question:makes no difference,whether it is "pay as you go" or investments in bonds and/or stocks,future benefits are a claim on future income to be paid for by future workers...

"Mr. Goss acknowledged that many experts believe investment returns should be adjusted for risk and that the common proxy for a risk-free return is the real yield earned on Treasury bonds...."

"Many experts" do indeed believe that. How many don't?

Brad, I thought you were receptive to the idea that Social Security might realistically make use of the equity premium. Have you changed your mind?

What we learn from this, among other things, is that David Brooks is not reading the newspaper he writes for, since he was citing precisely these unadjusted returns statistics in his most recent column.

Liars, indeed.

If there's any doubt about the true motives, check this from today's LA Times:

"Said Grover Norquist, president of the conservative advocacy group Americans for Tax Reform: "Social Security should be reformed not because the system is going broke but because it's a lousy program."

Such a lousy program, that actually creates a safety net for low-income retirees. Can't have that! After all, the Wal-Marts of the future surely will need greeters hungry enough to work there for close to minimum wage....

In all this discussion I've seen no one talk about the effect a massive inflow of cash would have on the market as a whole; is that a "who knows?" question, or can it be addressed?

Brad, even assuming one could get a higher rate of return by investing in stocks versus Treasury Bills, and it is probably true if one wanted to accept the increased risk, individualized accounts are still not the right way to go. There are a myriad of reasons why this is true; borrowing money to play the market being the most obvious, but another primary concern, which you point out, is that risk becomes an element in the system and, more disturbingly, the risk is shifted solely onto the individual account owner. I can accept the risk but not the shift to the individual account owner.

It is easy to envision a one day drop in the market and there goes a chunk of someone's account, and if he/she is near the end of their earning years their benefits if this occurs are reduced with no time left to recoup the losses unless, of course, they seek further risk and the cycle of destruction begins.

I would be amenable to diversifying the Trust's portfolio. Having all of its assets in Treasury Bills violates the first rule of Finance, i.e. diversification. Admittedly there would be greater risk, however over the next forty five years, which is the time frame we are concerned about (now until 2052), the risk would be better managed if we simply diversified the Trust's assets rather than individualize the risk. The risk would be spread out among more of us and there would be sufficient time to recoup any short term losses in the market.

Contrary to Mr. Brooks, I am a bleeding heart left wing liberal who trust markets to the extent that in the long run they generally work. As part of my trust in markets, I recognize that they go up and down and I accept that this is part of the nature of markets; I don't think Mr. Brooks understands this part. He seems unwilling to acknowledge that markets go up and down and people live in the short run. If Bush revamps social security he needs to tailor a plan that recognizes the volatility of markets and the fact that people live in the short run. The current Social Security system understands this privatized accounts does not.

if the Bush administration is so concerned about return, and the better perfromance of the stock market, why doesn't it just invest all SS dollars into index funds? maybe because they need the SS money to 'hide' their own budget and spending irresponsibity.

"Should a rational person believe that Social Security's very real financial shortfall can be reduced just by shifting from bonds into stocks?"

Social Security's "very real" shortfall is only real if you accept that US productivity growth in the out years falls to the 1.6% rate used in the Intermediate Cost alternative. And no I do not believe that the "gap" can be met by switching from bonds to stocks in that environment.

I am still waiting for a plausible stock based privatization plan that does not call for better numbers than the Low Cost alternative that shows a fully funded Social Security system without any changes whatsover.

Economic Assumptions under the Three Alternatives
http://www.ssa.gov/OACT/TR/TR04/V_economic.html#wp159107

Dimson, Arsh and Staunton say “only when we look back at intervals of forty years or longer can we say that the risk premium has always been positive” the authors add “Our estimates of the future annualized equity premium, relative to government bonds, are not far from 3 percent. With 3 percent annual cost and performance drag, an equity mutual fund might give a final value that is no greater than the direct ownership of government bills or bonds. Nearly all the gains in wealth from equity investment would have been transferred from the investor (who still bears the investment risk) to become a resource for the investment manager, professional adviser and tax collecting authority. What would happen if investors were to become convinced that the annualized equity premium might be indeed little more than 3 percent ?”

sorry, it's Marsh, of course. Princeton UP 2002

Here's a letter I sent to Andrews this morning.

----------------------------

Dear Mr. Andrews:

Thank you for penning "Social Security Reform, With One Big Catch" (NYT, 2004-12-12).

In addition to your useful point about risk/return tradeoffs, there are two other points to consider regarding the investment of social security taxes in equities.

First, the projections for future equity returns are inconsistent with the economic assumptions used in the projections of the future health of the Social Security system. Equity returns are limited by future economic growth, and the rate of growth posited in the SS projections is far lower than the historic rate of growth which is the foundation underlying the historic rate of return on domestic equities. (Dean Baker has made this point repeatedly; his work can be reviewed at http://www.cepr.net.)

Second, the overall national rate of investment returns cannot be improved by altering the mix of stocks and bonds held. Quoting William Bernstein of Efficient Frontier: "In short, __the aggregate national investment return will be approximately the same no matter what the overall stock/bond mix of the capital markets.__ To the extent that debt tends to decrease agency conflicts, a small nod may go to an increase in the overall debt/equity ratio. If everybody issues/invests in stocks, then stock returns must fall to the aggregate return rate. Which may actually already have happened. If all of the nation's pension funds and newly-privatized social security accounts shifted to stocks, they most decidedly would not obtain the historical 7%-8% real return." [Emphasis in original.] (URL:
http://www.efficientfrontier.com/ef/900/heisenbg.htm )

Andrews' critique is right on target, and makes the political case against privatization even easier. As Jacob Hacker's research shows, even when average earnings increase, the evaluations of voters will not favor the incumbent/policy if variability also increases. Why exactly would people want higher variance in their expected earnings for a retirement safety net? Poverty is lowest among the elderly precisely because Social Security has been stable. Over at MyDD they have been tossing around ideas for a political counterstrategy. I argued there and in a little more detail on my blog that these ideas can be communicated in a simple, accurate way which would undermine support for privatization among all but the most ardent "ownership society" ideologues. It cries out for a "Harry and Louise" campaign on the side of truth and light!

"very real" shortfall? See Cong. Matsui's wise observation that there is no shortfall. The economists of America have much to apologize for on this topic. They've supported the propaganda that social security is broken, when in fact the predictions of shortfall assume a self-contained system, which it plainly isn't, and very long term growth rates, which are inherently unknowable. All that can be said with certainty is that breaking the moral compact of social security is wrong, and the so-called reforms will do that.

I think we should acknowledge the risk of Treasury notes. Apparently the U.S. government can just wipe out the money it owes to the Social Security trust fund with a wave of its hand. The private sector couldn't do this - it might lose money for Social Security, but at least what it owes would have to be paid.

(For those who don't get it, that was sarcasm...)