Thursday, September 29, 2011

Is Social Security A Ponzi Scheme?

Few people attract so much notoriety that their name is coined into a new word. One interesting example is the word “hooker”, meaning a prostitute, which came to us from General Joseph Hooker during the Civil War who reportedly had so many women of ill-repute hanging around his headquarters that they became known as “hookers”.

Another example is “Ponzi scheme”.

Recently, a Presidential candidate said that Social Security is a Ponzi scheme. What was he talking about?

According to the Securities and Exchange Commission, a “Ponzi scheme” is an investment fraud that involves the payment of “returns” to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest their money in opportunities that are claimed to generate very high rates of return with little or no risk. In many Ponzi schemes, the perpetrators focus on attracting new money to make promised payments to earlier-stage investors and to siphon off for personal use, instead of engaging in any legitimate investment activity.

With little or no real earnings, the schemes require a consistent flow of new money from investors in order to remain in operation. Ponzi schemes collapse when it becomes difficult to recruit enough new investors or when a large number of existing investors ask to cash out.

The schemes are named after Charles Ponzi, who conned thousands of New England residents into investing in a postage stamp speculation scheme in 1916. At a time when the annual bank account interest rate was 5%, Ponzi promised investors that he could provide a 50% return in only 90 days. Ponzi initially bought international mail coupons in support of his scheme with the intent of reselling them in another country at a higher price, but he quickly switched to using new investors’ money to pay the promised high returns to earlier investors. Once Ponzi was no longer able to persuade enough investors to keep giving him additional money, his scheme collapsed. Ponzi didn’t invent this type of fraud, but he took in so much money that his was the first to become widely known in the U.S.

Under the Social Security (SS) system, employees and employers pay into the system, and employees receive a monthly pension upon retirement.

The payments to current SS recipients are taken from current incoming SS money. Any money that is not paid out is put into certain special U.S. Government bonds. That is, the SS system loans any left-over money to the rest of the government, which immediately spends it, as part of general revenues, on defense, the federal bureaucracy, other entitlements (Medicare, Medicaid), interest, and miscellaneous spending. None of the SS money taken in every year is saved, invested, put aside, or any such thing. The money is either paid out to SS recipients or used for other government spending.

There is no SS “lockbox”. There also is no SS “trust fund” in the sense of a bank account somewhere with money in it that can be drawn on as needed. The SS trust fund, or lockbox, consists solely of promises by the rest of the government to pay the SS system back someday. But since the entire federal government is operating at a deficit and there is a national debt, there is no reserve money with which the SS trust fund can be paid back. The only assurance that the SS system can ever get this money back is the full faith and credit of the U.S. government.

The very first SS recipient, one Ida Mae Fuller of Vermont, received her first check of $22.54 on January 1, 1940. She had paid only $44 in SS taxes over a three year period, but collected a total of $20,993 in benefits, since she lived to be 100. Such high returns were possible in the early years of SS since there were many people paying into the system and only a few taking benefits out. In 1950, there were 15 workers supporting every SS retiree. Today, there are just over three. By 2030, it’ll be down to two. The “baby boomers” are starting to retire and it’s swamping the system.

Another issue affecting SS negatively is that people are living longer and therefore collecting benefits longer. Data from the National Center for Health Statistics show that in 1900 the life expectancy was 47.3 years; 68.2 years in 1950; and 77.3 in 2002. When SS was first enacted in 1935, people didn’t live nearly as long as now, and so the system wasn’t designed to handle an aging population.

In 2010, annual SS costs (benefits paid out plus administration) exceeded non-interest income. However, from 2010 through 2022, total SS income including interest will be more than enough to cover costs. Beginning in 2023, SS assets (bonds and interest) will start to diminish until they are gone in 2036. At that time, there will be no more bonds to redeem or interest income from them, so SS will have only current tax revenues with which to pay benefits. Unless something is changed, that tax revenue stream will support benefits at a level of 77% of what has been promised, and the benefit level will gradually decline thereafter. In order to keep benefits at 100%, either SS taxes will have to be increased significantly or benefits will have to be reduced significantly, or some combination thereof.

Is Social Security a Ponzi scheme? No, because Congress can simply raise taxes and/or reduce benefits in order to keep the system solvent.

But SS does bear some disconcerting resemblance to a Ponzi scheme. Both pay early participants with money taken in from more recent participants. Both function best when there is a continual supply of many new participants. Both systems are unable to pay all participants the full benefits promised.

The key difference is that a Ponzi scheme is doomed to ultimate implosion since it cannot, by its nature, restructure itself. A Ponzi scheme can only keep on keepin’ on until the day of reckoning finally comes. SS will not collapse; it will be fundamentally modified, some day when Congress gets the will, into a sustainable program given today’s demographics.

1 comment:

  1. Interesting post. I enjoyed to read it... Thanks a lot for nice sharing. I would like to see more updates from your side... Keep posting...