The Greatest Failure Of Common Sense In World History

Milton Friedman once observed, “If the government ran the Sahara, in five years there would be a shortage of sand.”  He is right.  The government has run Social Security for 70 years, and now there is a shortage of security. 

Conceptually Social Security is designed to provide insurance for old-age and disability, and now it only provides uncertainty.  Today more than 80% of Americans believe that Social Security is heading for crisis if the government does not implement a major reform.  Washington strangely enough does not see this result as abject failure for an insurance offering.

In Washington the debate is not about the effectiveness of the program, but how to pay for it.  ‘Reform’ consists of higher taxes and lower benefits.  The main ‘reform’ discussed is various versions of privatization which in some respects takes a failed government program and makes it bigger and more complicated.  If the government cannot run an insurance company, how can anyone expect it to run a retirement system?

The debate in Washington is completely misguided because it is rooted in the idea that the system will work if we tweak the price tags.  Washington sees the lack of money as the problem in Social Security.  Actually what Washington sees as a problem, is really a symptom of a deeper rooted disease.  The problem is that Social Security is a bad investment, and it should surprise no one that a bad investment runs out of money.

The experts want us to treat the symptom, and rather than the disease.  They will tell you that there are only two solutions – raise taxes and lower benefits.  We need to treat the disease.  Innovation is the cure, but those in Washington have never considered that innovation is possible much less desperately needed.

Any solution must improve the returns, or a generation will come along that says no.  The best way to increase the return on contribution is to address two basic design flaws in Social Security.  First, it has an investment policy that is completely inconsistent with the lofty goals of the system.  Second, the system applies a benefits formula that fails miserably to allocate risk efficiently.  This approach fixes a broken system where as raising taxes and cutting benefits pays for one.

Ultimately the solution for the system will involve variable benefits which enable those who wish to have less risk to trade traditional benefits for better security.  The solution will also enable those who wish to have better returns the ability to absorb the risk of having the portfolio invested in more productive assets.  Without risk, Social Security will over time fail to deliver the one thing that people want from the system: security.

To achieve reform, we need to focus on three things.  We need to increase the amount of choice.  Choice will invariably lower costs and give people higher quality benefits.  We should seek to lower the risk inherent in the system.  The only way to accomplish this goal is to incorporate risk into the benefits equation.  Finally, we need to improve the returns of the Trust Fund itself.  All of these goals can be accomplished at low cost with innovation.

MORE CHOICE

Social Security needs more choice.  Today Social Security is a one product offering which pays based on work and contribution.  The worker has no say in how the money is invested or how much risk he or she is willing to take. 

This is not only expensive but dangerous as well.  For example, I would gladly give-up 50% of my benefits in order to get more certainty about payment.  Unfortunately, the government does not offer people this choice – or any choice for that matter.  So the government pays twice as much in order to deliver lousy benefits.

LOWER RISK

As we learned in the debt ceiling discussion, the investment policy of the Social Security Trust Fund has put our seniors at risk.  The President said that he didn’t know whether checks could be paid despite a Trust Fund holding 2.5 trillion dollars.  This uncertainty is what we call overnight failure.

The Trust Fund should not ever be exposed to overnight failure because the audience served by Social Security does not adapt well.  The Trust Funds assets must be diversified.  We recommend the investments held by the Trust Fund in shared-risk model.  We let Americans decide how much risk Trust Fund should have rather than letting the politicians decide. 

HIGHER RETURNS

The investment strategy used by the Today the investment policy of the Social Security Trust Fund invests any excess cash in securities of the US Government.  By comparison, the S&P index has beaten this investment strategy by 50 to 1 since 1926.

I would hope that all Americans can agree on one thing: it is wrong to ask more of workers and give less to retirees because the system invests money so poorly.  Last year, the system took about 160 billion dollars from workers today, and invested the money in 2 7/8% government bonds.  Congressman didn’t do it with their money so it is only fair to ask why the nation pension is.  This strategy puts those with the fewest options at the greatest risk.