Something’s been bugging me about private accounts. Correct me where I’m wrong here.
It’s difficult for me to imagine that any version of Social Security private accounts would offer account holders complete flexibility with their assets. Managing and ensuring the safety of millions of small accounts will be expensive under the rosiest assumptions. The fees don’t have to look like Chile’s, but they’re going to be considerable[1]. It seems reasonable to assume that any sensible administration would limit costs by limiting investment options to a small number of funds, something like a 401K plan.
The most appropriate investment vehicle would be a broad-based index fund such as the Wilshire 5000, which invests in pretty much every public company in the US, weighted for market capitalization. Index funds have a history of better returns than actively managed funds, and the broad footprint of the investment would minimize market distortions from the impact of (eventually) trillions in new investments. Most importantly, it keeps the government out of the business of picking winners and losers. The temptation to misuse trillions of investment dollars for political leverage will be awesome. A blind investment strategy also minimizes the reciprocal pressure on businesses to scramble to please the current administration in order to get under the umbrella of investments in a managed SS fund.
As an investment strategy, this would work pretty well for most Americans. However, a mandatory savings program isn’t for most Americans, it’s for all Americans. Since it’s a forced program, administrators will have to answer the question, “Why is my money being taken out of my paycheck to support X?”[2]
For example, a large number of Americans believe that abortion is the moral equivalent of murder. Look at this list of boycott targets by a pro-life group (Word document). It includes Citibank, Ford, Johnson & Johnson, Kraft, Nabisco, Prudential, and Target. People who engage in these boycotts will harbor a reasonable resentment about the money taken out of their paycheck and invested in these companies. After all, they believe that they are being forced to support baby-killers. Could they be denied?
We could accomodate them with a pro-life fund which doesn’t include the pro-choice rogue’s gallery, as determined by (say) the NRLC. (You could anticipate a problem here- since this could cost a firm millions or billions in market capitalization, they would try to get off the list. In this hypothetical, I’d expect that the NRLC would be awash in donations from penitent companies within the week.)
Will we accomodate people who don’t want to invest in tobacco companies? How about pacifists who wouldn’t invest in defense companies? Cultural conservatives who don’t want their money in entertainment companies? If GloboChem is accused of discriminating against African-Americans, there will be a movement from Operation PUSH to divest. Will it be accomodated? What about environmentalists? What about Bill O’Reilly’s campaign against Pepsi for hiring Ludacris? It never ends, and everyone can’t be accomodated.
Without forced investments, none of this is much of an issue. Investor boycotts and divestures are perfectly legitimate forms of protest, and people can avoid businesses for any reason they like. But if we’re going to force people to invest, we’ve got to answer a few questions. Will there be special “conscience” funds available? How we we decide whose conscience to accomodate? And how will the makeup of these funds be determined?
(Stocks are not the only asset, of course. There could be an all-purpose fund for conscientious objectors that invested solely in, say, municipal bonds. That would serve as a pressure valve, but I strongly suspect that well-organized interest groups would agitate against losing out on stock market gains in their retirement accounts because of their conscience.)
The new private accounts’ administrators could potentially be walled off from political pressure about investment strategy. It would take a lot of political fortitude and wisdom, but it could happen. (In a world where Dr. Bill Frist, Senate Majority Leader, refuses to contradict abstinence-only education materials that says that sweat and tears can transmit HIV, I’d say “not bloody likely”, but that’s just me.) Or they could respond to the loudest, best-organized voices, wreaking havok in the stock market with every change of power. Or, it could give in to temptation and use its stock-picking power to reward and punish.
In the best-case scenario, a private accounts program would be a bottomless pit of wedge issues and a moral irritant to many individuals. The worst-case scenario, in which a Tom DeLay-type figure has the power to pick stocks with public money, is just unacceptable. It’s something to watch closely.
fn1. I bring this up because I believe that one possible answer, letting individuals choose their own stocks with their private accounts, would be much too expensive to administer.
fn2. But my taxes already support programs and expenditures that I don’t like. How is this any different? Fundamentally, it’s not different. Most people feel that we have the right to have the government accomodate us, through the normal political process, on the subject of how our tax dollars are being spent. All I’m saying is that these same pressures and assumptions are going to apply to any investment decisions made, literally, in each of our names.
{ 26 comments }
Andrew McManama-Smith 01.27.05 at 7:38 pm
Why does this privitisation seem worse every time I read something about it?
Cranky Observer 01.27.05 at 7:58 pm
Just one observation: broad-based investment schemes have worked well for large numbers of Americans, where “large” doesn’t exceed 50% (and is probably more like 20 or 30% if participation in our 401k is any indication).
But they cannot work for “all Americans”, where all = 100%, for the same reason they everyone in the US cannot take a 1-year vacation living off their savings at the same time. Some people can capture wealth by trading paper rather than sweating, but we cannot all do it at the same time.
Cranky
cleek 01.27.05 at 8:14 pm
It seems reasonable to assume that any sensible administration …
yeah, well…
dsquared 01.27.05 at 8:16 pm
You could anticipate a problem here- since this could cost a firm millions or billions in market capitalization
Unlikely. Money’s fungible. There are billions and billions of dollars invested under trust agreements that won’t allow them to hold stocks that don’t pay dividends, and it never did Microsoft any harm.
abb1 01.27.05 at 8:17 pm
Everyone’s money should be invested in the new Iraqi dinar. We’ll be rich baby, we’ll be rich!
Lazygal 01.27.05 at 8:20 pm
Three things to remember
– Social Security is a New Deal construct, not something guaranteed by the Constitution, and was created before the Baby Boom happened.
– All investing is gambling, with some having more success than others.
– There are people today suing because they didn’t understand the risks inherent in their 401(k) choices, and this will only get worse if we privatize the accounts.
The system doesn’t work as well as it should or could, but thus far I’ve heard nothing better come along. The question that really needs to be asked is how much of a socialist net do Americans want. Only then should we discuss changing Social Security.
Ted Barlow 01.27.05 at 8:27 pm
Daniel,
You’re the finance guy, so I generally defer. But
(a) if I understand correctly, not paying dividends is a strategic choice for Microsoft with its own set of rewards, primarily a huge float of cash for acquisitions. The companies on the boycott list are presumably donors to Planned Parenthood, or something. There’s no economic benefit that would justify such a choice to your shareholders, who would love to be on the list of approved stocks.
(b) the equation changes somewhat when you’re talking about a portion of (say) half a trillion in pro-life private accounts, doesn’t it? Maybe it doesn’t.
Gareth Wilson 01.27.05 at 8:33 pm
Muslims and the current Social Security system may be a model for this. Social Security is an interest-bearing investment, and the Koran goes into some detail about the inferno awaiting investors in interest-bearing accounts. But Muslim Americans can’t opt out of Social Security, and this seems to have raised little controversy.
Gareth Wilson 01.27.05 at 8:35 pm
Muslims and the current Social Security system may be a model for this. Social Security is an interest-bearing investment, and the Koran goes into some detail about the inferno awaiting investors in interest-bearing accounts. But Muslim Americans can’t opt out of Social Security, and this seems to have raised little controversy.
dsquared 01.27.05 at 8:39 pm
I don’t think so. If there is a systematic pricing difference between SS-eligible and non-eligible stocks, then earnings will be cheaper to buy in non-eligible stocks. If that was systematiclly the case, then there would be lots more than half a trillion of money prepared to buy the cheap ones and sell the expensive ones, thus eliminating the gap. I don’t believe in market efficiency, but I don’t regard a gap of billions here to be plausible.
My guess is that going on and off the bad list would be a bit like S&P500 inclusion; there’s an effect, and it’s real, and you can trade it if you’re nimble, but it’s not persistent. I would hope that companies wouldn’t care so much about this since it would be extremely difficult for any insider or long-term holder of the stock to find the liquidity to take advantage of these fluctuations.
dsquared 01.27.05 at 8:53 pm
I don’t believe that Social Security is usury for the purposes of sharia law. An economically aware imam would realise that the bonds in the Social Security trust fund are just an accounting convenience for the institutionalisation of the arrangement whereby the old are supported by the young[1], fulfilling a religious duty of Muslims. Hence, Social Security is kosher (so to speak). NB that this does not constitute a fatwa.
[1]This is why I haven’t written anything about SS all that much; I find the whole damn debate about “solvency” to be much too depressingly moronic. A system of transfer payments can’t be “solvent” or “insolvent” unless the producing class isn’t actually producing enough to make the transfer payments. There is precisely no set of assumptions under which that is true, so there is no issue of solvency.
Darren 01.27.05 at 9:47 pm
“I don’t believe that Social Security is usury for the purposes of sharia law.”
Muslim finance is a fascinating subject: look-up the “Scottish Sheikh Abdulkadir As-Sufi (Ian Dallas)”.
Darren 01.27.05 at 10:07 pm
For instance we have this … “For most of his life, the sheikh went by the proper Scots name Ian Dallas. In the 1960s, he worked as an actor and promoter, making the scene in London and Paris and hanging with Allen Ginsberg, the Beatles, and other hippie icons. Increasingly disillusioned with the counterculture, Dallas wound up in Morocco, where he met the Sufi spiritual leader Sheikh Muhammad ibn al-Habib and became a Muslim. ”
and this …
“Sheikh Abdalqadir came to believe that if there was anything a group of Western Muslims was best positioned to contribute to the world, it was an Islamic cleansing of the global financial system. And so he set his closest followers – in particular Umar Vadillo – the task of studying classic Islamic texts on money, with a view to drawing out their modern implications. The result, published in 1991, was the “Fatwa Concerning the Islamic Prohibition of Using Paper-Money as a Medium of Exchange.””
from an old wired link
roger 01.27.05 at 10:09 pm
“The temptation to misuse trillions of investment dollars for political leverage will be awesome.’
To describe it as a temptation is to trivialize it. Unless there is some constitutional amendment directing this “blind trust,” the probability is that at some point the political leverage argument will guide investment. We know this in two ways:
a., the private pension plans of large corporations (GE, GM, etc.) have already displayed how pension money can be used to create short term profits, or to make the books look better than they are. Even though the regulations on private pension plans are lengthy and dense, they have allowed playing with the pension plans to accumulate to a crisis point, as anybody looking at the real crisis in retirement — i.e., the shortfalls in the Pension Benefit Guaranty Corporation — could predict. So we already see what organizations do, once they perceive the amount of money that they can potentially manipulate in the pension funds they administer.
The other reason, b., is, of course, that the federal government has onsistently “borrowed” the social security surplus to pay for its tax cuts and medicare benefit hikes and wars, etc. There is no way to stop this. There is no law to commit these funds solely to Social Security that can’t be overturned by the lawmakers. And they have to pay no price for breaking into what Gore quaintly called the ‘locked box.” That is, there is no record of taxpayers rising up in revolt about this issue. Given the choice of a tax break that is financed by diverting Social Security funds or a ‘locked box,’ the electorate has been very clear: break the piggy bank. The prediction that the legislators will be “responsible” lacks, I think, the democratic mechanism that makes legislators reponsible: a consituency tha would guard this blind trust from being misused by punishing the legislators who vote to misuse it.
So — ‘temptation’, here, rather misdescribes the rational economic action that will lead to pissing away Social Security. In the end, nobody will care, and when the shortfalls come, we will simply borrow the money. What is the world gonna do, stop lending the U.S. money? I don’t think so.
From one end of eternity to another, we are God’s favorite investment.
mw 01.27.05 at 10:10 pm
Though not in favor of privatization, I don’t see this as a particular problem.
It seems reasonable to think of the proposed system as the equivalent of requiring people to invest some percentage of their income in an IRA.
And I see no reason why the the government would be in the business of selecting a few funds to choose from–it would make more sense that it simply established standards that funds would have to meet in order to qualify for participation in the program.
People could choose low-overhead stock or bond index funds or managed funds or socially conscious funds, or whatever — just as people do now with their IRAs. There would be a requirement for a fund to disclose the fees it charged. And people could take that into account, just as they do now with their IRAs.
Uncle Kvetch 01.27.05 at 10:35 pm
Ted, thanks for raising this issue. “It’s your money” only makes sense in this context if it’s immediately followed by “therefore, we are dismantling Social Security–you’re on your own.”
Contrast with:
“It’s your money, therefore we’re going to take it from you, and then give it back to you, but only on the condition that you invest it in ways that we see fit.”
“Choice” and “flexibility” are smokescreens in this debate, meant only to obscure the fact that Social Security must be destroyed because its record of success is ideologically inconvenient for the people in power.
Sebastian Holsclaw 01.27.05 at 11:30 pm
“The most appropriate investment vehicle would be a broad-based index fund such as the Wilshire 5000, which invests in pretty much every public company in the US, weighted for market capitalization.”
I would think the bolded section would provide a partial answer. Boycotts would still be effective in causing pressure. I also suspect that standards of investment vehicles would be workable.
I’m against large-scale privitization because it would provide a huge incentive to tinker with the markets in ultimately unproductive ways. Furthermore given any bad year or two in a row there would be huge pressure to make up the difference which would encourage risky investment (yes I know there is a specific economics term for this, but for the life of me I can’t remember it) and would strongly encourage the government to take actions which would likely be inappropriate in the long run (see Sarbanes-Oxley).
“A system of transfer payments can’t be “solvent†or “insolvent†unless the producing class isn’t actually producing enough to make the transfer payments.”
Umm sure if you are willing to tax everything out of the producing class and they are willing to let you do it. (See black markets in countries with high taxation as just one possible response). It still might be worth avoiding the problem if possible.
Ginger Yellow 01.27.05 at 11:46 pm
This is grossly simplified, and doesn’t apply in every Muslim country, but Islamic finance usually has a way around the usury prohibition. But you need an income generating physical asset (property being the most obvious type). Interest payments are replaced by rents or “profit sharing” from the use of the asset. Each country has a group of Islamic scholars who decide what finance techniques are sharia compliant and which are not. Of course in America Muslims can decide for themselves.
As far as I’m aware, there’s nothing stopping Muslims from investing in stocks – dividends and capital gains are not interest, after all. Bonds are another matter entirely.
Scott 01.28.05 at 12:49 am
One of the objections to “private accounts” made by anti-govt nutjobs (a group of which I’m a proud member) is that w/ govt money comes govt control, and investing SS money in the stock market will socialize the market more than it will privatize retirement.
How about just investing what’s taken from me at gunpoint into t-bills, and handing me the bundle when I retire (or let me leave them to whoever I want if I die before then)?
trostky 01.28.05 at 3:20 am
How does the complaint about investment choices honestly differ from the usual complaints from pacificts (“Why do I have to pay for warplanes?”), health nuts (“Why do I pay for tobacco subsidies?”), the childless (“Why do I have to pay for schools?”) and libertarians (“Why do I have to pay for anything?”).
Investing in a total-market index would give everybody an equal right to gripe, and meanwhile the pro-lifers could put themselves in hock to MBNA instead Citibank, while the pro-choicers could do the reverse (and there’s your economic benefit to the shareholders).
Darren 01.28.05 at 9:13 am
One issue wrt pensions is that Western stocks are being dismissed by stock pickers (the ones I read, anyway) because a profit analysis shows that the investors profit is being syphoned-off to pay someones pension. Why bother buying shares in a company with a huge pensions overhang when you buy shares in a company in another part of the world where the labour looks after there own welfare. (This issue is negligible compared to the currency issue though).
Jack 01.28.05 at 12:54 pm
darren,
Syphoned off! These are promises the companies made to their workers in order to get them to do work. The syphoning off is just asking them to pay up.
I would have thought that your quest for real money would lead you to demand that these promises be kept.
Darren 01.28.05 at 1:52 pm
“I would have thought that your quest for real money would lead you to demand that these promises be kept.”
Well, yes. But how will the promise be upheld?
Why should you invest in a company to forfeit return just to pay someone’s pension? Or, if you invest your life savings in a pension fund why should your fund invest in a company that gives a poorer return because a part of the profit is being diverted to the companies pension fund?
To clarify – I’m not talking about the company who made the promise being allowed to default. Certainly, not. I’m saying that the company will not be in a position to uphold the promise because they will not be able to attract the capital required for production and hence to generate profits.
TM Lutas 01.28.05 at 6:59 pm
For every person who wants to stay away from a tobacco company’s stock, there’s somebody playing catchup who will want the higher yields of “sin” stocks. The social security accounts will be the ultimate in-house trading exchange. You don’t have to actually trade a stock at commission when two countervailing orders come in on two accounts. The computer can merely reassign the stock from one account to another at incredibly cheap prices with actual trades only occuring at the margin. The huge pool of equities available and the wide pool of investors means that most of the time, the vast majority of “morality” trades will be done incredibly cheaply.
But the perfect does not have to be the enemy of the good. The current federal investment system works reasonably well, provides superior returns to the current situation, and is run with few expenses. There’s no reason not to simply supersize the system, let everyone in, and worry about further improvements down the road.
If the federal employee system is not right for everybody, why is it acceptable for our federal employees? The bugs have already been worked out, people. All we need do is not commit to reinventing the wheel and just strive for improvement.
I want us to get our public pension scheme to actuarial solvency and away from the pyramid scheme aspect of the current system. We can take significant steps to make things better with private accounts and should not forego the benefits because version 1.0 isn’t perfect. The current system isn’t perfect either.
It’s your body doesn’t mean we toss toddlers out of the parental home. It’s your money doesn’t mean that we leave them without a long transition to financial independence. Let’s be real.
Nicholas Gruen 01.29.05 at 11:24 am
I can’t see the problem. 1. Obviously any govt investment in stocks has to be at arms length and managed the way the Fed manages monetary poliy. 2. One can allow people to choose private funds – providing they conform to whatever guidelines one wants to promulgate about such accounts, and those accounts can market their ‘sin free’ investments, according to their own various definitions of ‘sin’.
Anticorium 01.30.05 at 2:49 am
If GloboChem is accused of discriminating against African-Americans, there will be a movement from Operation PUSH to divest.
How could they divest? Globochem owns everything so you don’t have to.
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