To Andrew Sullivan's readers, who weigh in on the accusation that Social Security is a Ponzi scheme. Several excellent comments. It's also what I wrote about, in a less explanatory and more mocking way, over at Greg's place yesterday.
Very simple: anyone who says that Social Security is a Ponzi scheme either misunderstands Social Security, misunderstands Ponzi schemes, is deliberately lying, or some combination of those.
In my view, saying that Social Security is a Ponzi scheme is a more awful thing to say than Romney's "corporations are people" thing or Perry's "pretty ugly" comment, although it's not far from Perry's accusation that Ben Bernanke would be committing treason if he tried improve the economy over the next year. After all, a Ponzi scheme is a deliberate fraud. Saying that Social Security is financed like a Ponzi scheme is factually wrong, but saying that Social Security is a Ponzi scheme or is like a Ponzi scheme is basically a false accusation of fraud against the US government and the politicians who have supported Social Security over the years.
Wednesday, August 17, 2011
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Pointing out that a Ponzi scheme requires a fraud is logically sufficient to explain why Social Security isn't a Ponzi scheme. But I'd like more people to take this opportunity to discuss the fact that the main program in Social Security is a form of insurance, specifically a form of longevity insurance (meaning it essentially insures against living longer than average). And I'd like more people to be aware of the concept of longevity insurance because it in turn helps explain why defined contribution plans (e.g., 401Ks) are not an adequate substitute for Social Security and other retirement plans with this longevity insurance component built in.
ReplyDeleteBrianTH -- Whatever its social purpose, isn't Social Security run like a pension system? By those standards, it brings in a poor rate of return, since its trust fund can only invest in Treasury securities.
ReplyDeleteCouves,
ReplyDeleteMy answer to the first part of your question is a qualified yes: defined benefit pension plans typically serve to provide longevity insurance to the members of such a plan. Life annuities, available from insurance companies, are also a form of longevity insurance.
With respect to rates of return, that is a much more complex topic. The return on the Trust Fund Treasuries doesn't really set the rate of return of Social Security "investments". For individual beneficiaries, their expected ROR is determined by the Social Security benefit formulas, and it varies by group (in that sense, Social Security also provides other forms of social insurance at the same time as providing longevity insurance). Meanwhile, to pay those benefits it has additional funding available (aside from returns on the Trust Fund) through its pay-as-you-go components. The implied "rate of return" on those components is itself a complex topic, but comes close to the real growth rate of the general economy.
Thinking a little more big picture: it can make sense to invest some of the premiums in a longevity insurance pool in risky assets, but you have to be careful when doing so to make sure you are not putting the promised insurance benefits at risk. This gets even more complicated when the promised insurance benefits adjust for inflation, as in Social Security, and in fact you will notice if you shop for life annuities with inflation adjustments the implied rate of return on your premiums will go down considerably.
Thinking even more broadly, the ultimate limit on average long-term return on financial assets is approximately the real growth rate of the general economy. So as you hypothetically scale up any longevity insurance plan, and assume it has to be careful with the risks it can take, in the limit the rate of return it can get is going to converge on the real growth rate of the general economy.
So Social Security really isn't far off from where it should be. It could probably invest some of the Trust Fund in riskier assets and do a little bit better, but it wouldn't be a lot better.
The fact that we're referencing a "trust fund" pretty much sums up the reason why folks view Social Security as a ponzi scheme.
ReplyDeleteTake tax dollars, spend them, but put IOU's aside, fixed to no hard assets. That's the "trust fund".
The market doesn't even consider intragovernmental debt when it reviews credit worthiness, to my knowledge. They know that "trust fund" is just a lighted match away from dissolving.
That's the whole problem here. We're using terms inaccurately. We don't want to terrify people by pointing out that there's nothing in the "trust fund" but scraps of paper, which we may or may not redeem. The market's are counting on "may not", or at least that they will be paid first before a "may" order is issued. Thus Obama's first private then very public assurances to the market a couple weeks ago.
A Ponzi scheme always fails when too many recipients of funds pile up on the back end, with too few new investors to pay out demanded returns. We can argue technicalities, but in essence SS is in jeopardy for precisely that reason.
ReplyDeleteAs much as I enjoy Sullivan's effort, his comments were almost grueling to read. The first person said SS was not a Ponzi scheme because it doesn't require geometrically increasing participants (per wikipedia: 1940 = 222,000 beneficiaries; 2008 = 51 million). Then there was a writer arguing an irrelevant legal technicality about the definition of a Ponzi scheme, and then the cringe factor went into overdrive with the writer who thinks the sine qua non of a Ponzi scheme is someone living in a mansion worthy of MTV's cribs.
I should have known better. I'm a rubbernecker, its one of my flaws. So I read on, and hated myself for it, because the next commenter was the worst of all:
The problem with a Ponzi scheme is that, at the sorts of exorbitant rates of return that are generally promised in a successful Ponzi scheme (see Madoff, Bernie)
That's just staggeringly ignorant about how Madoff's fraud worked.
Anony,
ReplyDeleteAn economist will tell you that the Trust Fund is "real" to the extent it increases national savings. Economists will also tell you that there is little evidence the Social Security Trust Fund has done so to date, but I think the important point is that is really a choice, not a metaphysical fact, whether or not the Trust Fund is "real" savings.
CSH,
You dismiss as "an irrelevant legal technicality" what is in fact a defining characteristic of a Ponzi scheme. It is not a Ponzi scheme without the fraud of telling the victims that their money is being put into certain investments, when in fact it is not.
But again, I think rather than deal solely with that should-be-trivial subject, it is important to actually talk about what Social Security truly is (not just what it isn't), which is a collection of different insurance programs (longevity, disability, and some others).
BrianTH - you're right, I should have clarified: the legal technicality is irrelevant in the sense of the discussion whether SS is Ponzi-(ish), but obviously not in the sense of the dictionary definition of the term.
ReplyDeleteCSH - Maybe we can just call it Ponzi Schemey?
ReplyDeleteBrianTH -- My state pension plan is run nothing like SS. It invests in the market and gets a good return -- and there’s zero risk that anyone’s benefits will be cut because of the market downturn. Social Security recipients, on the other hand, will most likely have their benefits cut, in spite of the program’s “no risk” investments.
Of course, some state pension plans are completely mismanaged and even in my state the new treasurer is beginning to target investments at politically favored groups. So I’d rather just let people keep their money and convert SS into a social insurance program for the disabled and the poor.
Folks,
ReplyDeleteSS has nothing in common at all with a Ponzi scheme. The financing basically is irrelevant: forget about the trust fund or anything. The government is perfectly capable of raising taxes to pay for then-current benefits whenever it wants to.
What's risky about SS isn't the financing; it's that future Congresses could choose, whenever they want, to end the program (or reduce benefits). That is exactly the same risk that any other government program has. Actuarial balance is IMO only a very, very minor factor in that risk; the main issues are about the popularity of the program, which has always been through the roof. As we saw in 2005 (and since recipients are big voters, it's pretty likely it will always be that way).
None of this in any way remotely resembles Ponzi schemes.
Couves,
ReplyDeleteI don't know which state you live in or how it has structured its pension, so I can't independently pass judgment on whatever risks the pension fund in question might be taking. But in general I do think you have to be careful comparing portfolio returns in various pension plans with Social Security "returns", since Social Security benefits are not primarily funded through any particular porfolio returns.
Anyway, I'm not sure what "letting people keep their money" means to you, but if you are talking about eliminating the longevity insurance aspect of Social Security without replacement, I think that is a very poor idea. Of course people can buy longevity insurance on their own, and some people do that with their defined contribution accounts and IRAs.
Bt if you tried to scale that up to match the total amount of longevity insurance being provided by Social Security, I think you would find you needed all sorts of mandatory reinsurance that may not be worth the administrative hassle. Still, at least that is an interesting conversation (to imagine alternatives to Social Security that would provide the same amount of longevity insurance). Alternatives that don't provide longevity insurance, however, are missing what the pension portion of Social Security is really all about.
Jonathan,
ReplyDeleteI mostly agree, but I would note you could imagine scenarios in which the future economy simply could not support the level of promised benefits, regardless of policy choices. That doesn't make Social Security like a Ponzi scheme, and those scenarios typically seem pretty far-fetched in the near term, but there is a certain amount of long-term risk of fundamental economic changes that would require benefit changes which can't be entirely eliminated.
But, of course, the rational thing to do is make our best guess and go from there.
BrianTH, Massachusetts is the state I'm referring to.
ReplyDeleteJonathan, Social Security is a bad deal for me -- I’d be happy to walk away from my investment if I were permitted to do so. If not “ponzi scheme,” is there a Plain Blog-approved epithet I can use? ;)
I agree that the government's power of the purse is the critical relevant distinction between SS and a Ponzi scheme. But for that detail, the two are conceptually quite similar.
ReplyDeleteAfter the way the recent debt ceiling disaster was managed, the power of the purse seems to me a thin line to draw between SS and a Ponzi scheme. By their popularity, entitlements may still draw 'printed'/(inflationary) money if worse came to worst, but that's a little bit like taking comfort being on the front half of the Titanic after the back half has snapped off and sunk.
Mr. Bernstein,
ReplyDeleteThat's the whole point. The entitlements are going to drive us into insolvency, as currently blocked out.
Many of us have known this for many years, and have basically laughed at this notion of "trust fund". But others use that phrase as cudgel, whenever reform is broached.
So then, we'll see your "trust fund" and raise you one "ponzi scheme".
That's the plain politics of it.
Couves,
ReplyDeleteI looked very briefly into the Massachusetts public pension scheme. It appears that some of its distinguishing features are that it requires a relatively high employee contribution, caps benefits at a relatively low level, doesn't include automatic COLA adjustments, and caps ad hoc COLA adjustments at a low level. A program structured like that should indeed be able to take more risks with its portfolio (just as a life annuity program structured with similar characteristics could take greater risks with its portfolio).
CSH,
The differences between Social Security and Ponzi schemes include not only that they are financed differently, but also that Ponzi schemes are frauds in which the operator intends to steal a large portion of the proceeds rather than fulfilling his promises to the investors. The remaining commonalities between Social Security and Ponzi schemes are things most insurance plans would share in common with Ponzi schemes.
Honestly, I just don't see anything useful to be gotten out of the comparison. In fact, I would suggest politicians who insist on comparing Social Security to Ponzi schemes are more likely de facto announcing their intentions rather than providing an objective analysis--Social Security as it stands isn't a Ponzi scheme, but they intend to unravel it in a way which will leave many people having been effectively defrauded out of a portion of their retirement savings.
BrianTH,
ReplyDeleteI think you make an important point bringing up the insurance analogy to SS. Important because I think SS was probably originally conceived as an insurance policy, but over time it has shifted into something more similar to a Ponzi scheme.
Why do we pay a couple dozen $$/month to insure our homes against catastrophic loss? Because we know that an extremely small percentage of us will unfortunately experience such loss, and the pooling of all our funds covers off against that loss.
As I mentioned above, around its outset (1940), SS benefits were drawn by 222,000 Americans, or about 0.2% of the population. Probably not out of the ballpark of the percent of people experiencing a significant insurable property loss, no? So as Roosevelt imagined it, SS was like homeowners insurance, a common safety net for the small percentage of people really needing it.
By 2008, fully 50 million Americans - a whopping 16% of the population - were drawing social security. That's an 80-fold increase vs. 1940. Does that make it a Ponzi scheme? Maybe not legally, but you could perhaps forgive skeptics for sort of seeing it that way as recipients start to pile up on the back end, in a very Ponzi-like fashion.
Or to put it another way, suppose, 50 years from now, homes started burning down 80 times as often. Might your homeowner's insurance start to feel a bit like a Ponzi scheme?
CSH,
ReplyDeleteInsurance does not need to be for only low-probability events. Consider, for example, health care insurance--many people make frequent use of it. The ultimate net beneficiaries of a health care insurance plan are the ones who make more use of it than their share of premiums would imply, and the ultimate net contributors to the plan are the ones who make less use of it than their share of premiums of premiums would imply. In other words, the people who end up healthier than expected end up transferring funds to the people who end up less healthy than expected: you are insuring against bad luck when it comes to health.
To slightly oversimplify, in the case of longevity insurance, anyone who lives longer than an actuary would expect can be seen as a potential net beneficiary, and anyone who lives shorter than an actuary would expect is a potential net contributor. So the shorter-lived people end up transferring funds to the longer-lived people, and you are insuring against bad luck when it comes to longevity. Which sounds like an odd sort of bad luck, but it can be a very serious one, such as if you are no longer able to work and support yourself once you reach that point of unexpected longevity.
As for Ponzi schemes, I might suggest that what you actually have in mind is a pyramid scheme. People often associate the two because if you want to keep a Ponzi scheme running for an extended period of time, you might need to continually attract new participants, and you might eventually get caught if you run out of potential suckers (although it doesn't have to work that way--you could just attract one new set of participants after paying the first set of false returns, and then run off). In a pyramid scheme, there isn't a fraud about what is happening with the money (that is a key distinction from a Ponzi scheme), but the nature of the scheme strictly requires an exponentially-growing amount of new participants to keep functioning.
The thing is, Social Security isn't a pyramid scheme either. It is true that in setting the required contributions and future benefits, Social Security makes certain assumptions about various matters, including the future number of people who will be participating in the program. But it doesn't strictly require any particular growth in participation--if at some point you end up predicting a different amount of future participation, you just need to readjust your contribution and/or benefit formulas accordingly.
So conceptually, a pyramid scheme is at least a little closer to Social Security as currently structured than a Ponzi scheme, but Social Security isn't really a pyramid scheme either. Accordingly, I'd still end up in the same place: politicians calling Social Security a pyramid scheme (or calling it a Ponzi scheme but meaning pyramid scheme) are more making a statement about their own intentions than about the actual nature of the program, specifically that they intend to oppose making adjustments in the contribution and/or benefit formulas as necessary if our predictions about future participation change.
BrianTH,
ReplyDeleteI just looked up 'insurance' on dictionary.com, where the first definition describes it as a system of insuring ___ against harm from specific contingencies, in consideration of payment proportionate to the risk.
IOW, we don't pay for health insurance in order to cover our yearly checkup or our kid's occasional stitch-needing cut. If that were the certain extent of our interaction with the health care system, 100% of us would choose to pay out of pocket. We pay a proportionate (!) amount in health insurance to cover off against the (hopefully) smallish tail risk of a catastrophically expensive health care need. So it is, essentially, with all true insurance. So it probably was with SS in Roosevelt's day. So it surely isn't with SS, now.
If we are comparing SS with a Pyramid, Ponzi, or other type of scheme, first it depends on what we think the essential feature of those systems are. For me, the key defining difference between a Pyramid and a Ponzi scheme is who is responsible for finding the bulge of new investors to keep the thing afloat. In a pyramid scheme, that responsibility is openly on my shoulders. In a Ponzi scheme, the onus falls secretly on the plan administrator.
SS is therefore not at all like a pyramid scheme for the simple reason that beneficiaries are under no obligation, direct or implied, to find the workers to fund their retirement. The plan administrator (US govt) supposedly does that for them, a Ponzi-like feature.
Finally, as I replied to Jonathan above, it is clear that Congress has the statutory obligation to render SS definitively unlike a Ponzi scheme. If Congress did what they were supposed to do, there would be no reason whatsoever to suspect that SS had Ponzi-like characteristics.
Of course, if Congress could be trusted to do what they were supposed to do, I probably wouldn't be here...:)