Monday, February 06, 2017

Ponzi Revisited

An engineer friend who is also a financial planner commented privately about the Slow Ponzi Scheme post.  I received permission to quote him at length.  He asked for editing, but I am too lazy.  I did put his emails in a different order. He also had a thought-experiment I may give its own post sometime soon.

"If you could somehow work in this Public Service Announcement for your young readers, you would do them more financial good than anything they learn in school today.
IF you save 15% of your income (every year), for 40 working years, and invest it to earn 4% (above inflation), and don't withdraw any, ever,
THEN you will accumulate just enough money to maintain your income level for 20 years of retirement. (AVI adds: and if you additionally had (even 70 cents on the dollar of) SS, received an inheritance, paid off the mortgage, worked part-time or any of the other common methods of having money in retirement, you would actually be richer than before.)
"Should some of your readers want the data, the basics can be found in the Social Security Trustees Report, here:
However, it does take a little study to understand its implications.  Buried, way deep in the report, is the money quote: 

"The OASI Trust Fund, when considered separately, has a projected reserve depletion date of 2035, the same as in last year's report. At that time, income would be sufficient to pay 77 percent of scheduled OASI benefits."

However, to get there, one has to wade through a mountain of obfuscation.  You might think that income to SS would simply be the taxes paid.  However, you'll find things like income taxes ... since most SS payments are subject to income tax, the Social Security Administration considers that income tax paid on SS benefits are actually income to the SS program.

In summary, the SS program has a structural imbalance.  The income from "investors" is just sufficient to pay 80% of the promised benefits.  To become and remain solvent, either the benefits have to be reduced, or the taxes funding the program have to be increased.  One can increase either the SS taxes, or increase the income tax, and use that money to subsidize the program.
"The key feature of a Ponzi scheme (corroborated by Wikipedia, no less) is that benefits to the early investors are drawn from the "investments" of later investors, rather than from a genuine return on the investment.  Don't react negatively to the "scheme" word in the Ponzi Scheme, react negatively to the process for transferring investments from the new to the benefits of the old.

In the specific case of Social Security, there is no "savings account" or pile of money, from which benefits are paid.  Rather, Monday's benefit check is just the transfer from someone else's pay last Friday.  The benefits now being paid are NOT a result of responsible savings or investment of their contributions ... rather, it is simply a transfer from the new "investors".

As a comparison, compare this to a "responsible" pension plan (for private employers), in which the savings for the pension are required to be set aside, or escrowed, at the time they are earned.  When my company offers a pension benefit, they are required to set aside that money, and "hold" it specifically for me.  If, in future years, the company gets smaller, or even goes bankrupt, that money has been set aside, and invested in someplace OTHER THAN the company itself.  The existence of the pension, and the size of the pension, is based entirely on events/payments at the time the promise is made, and NOT on anything that might happen in the future.

To carry the comparison even further (and support your idea than a financial collapse is coming), consider the bankruptcy in Detroit.  This was brought about because the promised pension benefits for public workers were NOT set aside at the time they were earned.  Rather, the assumption was made that future benefits would be covered by the contribution of later coming employees (again, fitting the technical definition of a Ponzi).  The problem came because in the boom times of Detroit, lots of benefits were earned.  Then, all the taxpayers left, and the benefits were left to be paid by the much smaller group of current employees.

Seen from this perspective, Social Security is actually more like hazing than a pension.  In the Greek fraternities (and other places), the initiation was often a brutal, humiliating abuse of the incoming freshmen by the upper classmen.  The excuse/rationale/justification was that someday the presently abused would be upperclassmen, and they could be the abusers. In our current system, we are left to argue that it is moral/desirable to take from the current generation, and give to the older generation, with only the promise that the next generation will be similarly abused.
"I studied to be a financial planner (it was my backup career), so I spent lots of time thinking about retirement planning, and investments, and Social Security.  My training led me to analyze SS from an almost purely financial and actuarial view, with relatively little consideration for the social/political aspects, and not much about its history.  It makes me sound rather cold and insensitive, and rather pessimistic about its future.

Having said that, the answer to your very initial query, about why, if SS is a Ponzi scheme, it hasn't failed quickly like most such plans, is actually rather simple.  The failure mechanism for Ponzi is when the income for the new investors is insufficient to pay off the old ones.  Word gets out, radically reducing the pool of new investors, hastening the failure.  However, in the case of SS, the stream of new investors never ends, because the government forces everyone to "invest".  The failure is slow, because the income stream doesn't stop catastrophically, but is just insufficient to meet the total need."


Sam L. said...

That's pretty much what I've read before. I do hope to live to 2035.

Christopher B said...

Much more eloquent than my truncated comment, thanks for sharing. The failure in the income stream has been long noted. We're now at 3 or fewer SS tax payers per recipient, down from 10 or more at the inception, and likely headed lower. It would be interesting to see the number of tax payers per recipient over time. I have a feeling it would track pretty well with the average contribution to payout ratio.

I agree with your conclusion that there is a moral/political 'investment' in this arrangement that makes it incredible difficult to unwind. People make have made significant plans based on the availablity of the SS saftey net. Trump's "grow out of it" plan is unrealistic given the increases in longevity and activity in retirement. I'm afraid the only realistic options are to either accept that a significant number of people are going to get, at best, payments that are barely greater than their contributions or expect some generation is going to fund not only their retirement but that of the preceding generation. In hindsight the economic boom of the 1990s, when SS contributions were significantly greater than payouts, would have been the ideal time to make that transition but we unwisely chose to go with the Clinton/Gore approach of declaring the existence of a phony 'lockbox' that transferred excess SS receipts into government spending.