News Intelligence Analysis
From the New York Times
Social Security Reform, With One Big Catch
By EDMUND L. ANDREWS
December 12, 2004
OF all the arguments being made to replace part of Social Security with private retirement accounts, few are more seductive and more misleading than the prospect of earning higher returns.
Get ready to hear a lot about this next week, when President Bush is host for a two-day economic conference that is expected to focus sharply on Social Security.
Under the current system, investment returns from Social Security are "abysmal," Mr. Bush said in one recent speech, because the trust fund is allowed to hold only low-yielding Treasury bonds.
Letting working people invest some of their Social Security money in the stock market would allow them to earn higher returns, giving them more money at retirement than they would have if they let the government do everything for them, the logic goes.
It sounds like a no-lose proposition. According to the Social Security Administration, Treasury bonds can be expected to yield a real annual rate of return of about 3 percent. Equities, by contrast, can be expected to earn 6.5 percent.
That assumption is crucial to arguments that personal accounts can reduce Social Security's long-term shortfall - which the government estimates to be at least $3.5 trillion. Most of the proposals to overhaul Social Security call for steep reductions in future benefits that would be offset by the higher returns people would presumably earn on their investments.
Stephen Goss, the Social Security Administration's chief actuary, has endorsed the assumption of higher returns. In evaluating the major proposals for putting some payroll taxes into personal investment accounts, Mr. Goss estimated that even people who hedged their risk by mixing stocks and bonds could expect an average return of 4.45 percent.
But that logic is as flawed as a perpetual motion machine. If it were true, the government could erase Social Security's entire projected deficit by selling bonds at 3 percent and buying stocks that yield 7 percent.
Why doesn't the government do just that? Because higher returns are inseparable from higher risk. No risk, no reward. And if the goal is to enhance security, if people are to have a solid reason to expect a particular level of wealth at retirement, the risks have to be relatively low.
"The entire argument is absurd," said William C. Dudley, chief United States economist at Goldman Sachs. "These returns weren't free. You are getting these returns precisely because you are taking on risk."
To be sure, one of the biggest ways to reduce risk is to have a long time frame. People who invest at age 30 or even 50 have the time to ride out most of the ups and downs of the stock market.
But there are no guarantees. According to Ibbotson Associates, which publishes data showing average returns over different periods, large-cap stocks actually suffered a loss of 1 percent, annualized, from early 1929 to the end of 1942.
Granted, it is somewhat unfair to pick a time period that begins just before the great stock crash of 1929 and continues through the Depression. But many analysts contend that it is even more misleading to suggest that people should have complete confidence in their ability to earn above-average returns with no risk whatsoever.
Surprisingly, the Social Security Administration actually goes further than that. In addition to relying on the premise that equities will yield higher returns than Treasury bonds, Mr. Goss of the Social Security Administration suggested that returns in the future might be even higher than those of the past.
"A consensus is forming among economists that equity pricing as indicated by price-earnings ratios may be somewhat higher in the long-term future than in the long-term past," wrote Mr. Goss.
"This is consistent with broader access to equity markets and the belief that equities may be viewed as somewhat less 'risky' in the future than in the past," he added.
If investment funds or stockbrokers made that kind of claim, they would probably be breaking the law.
In an interview last week, Mr. Goss acknowledged that many experts believe investment returns should be adjusted for risk and that the common proxy for a risk-free return is the real yield earned on Treasury bonds.
The Social Security Administration's analyses do include lengthy disclaimers, noting that the projected returns are highly "sensitive" to what happens in the markets.
But other government analysts take a much more conservative approach. The nonpartisan Congressional Budget Office, which is run by a former chief economist in President Bush's own Council of Economic Advisers, assumes that equities and bonds will earn no more than Treasury bonds.
Strikingly, the White House's own Office of Management and Budget recently made the same assumption. The issue was not Social Security but rather the projected growth of assets in the railroad retirement trust. In evaluating the railroad retirement system, the White House budget office also assumed that investments would yield the same as Treasuries.
BUT the more basic question is this: Should a rational person believe that Social Security's very real financial shortfall can be reduced just by shifting from bonds into stocks?
Those who imply that stocks can promise higher returns without higher risk are essentially arguing that Social Security can be fixed with a huge exchange of paper.
If that is the government's strategy, people should by all means push for the right to shift all their payroll taxes to personal accounts and invest the money in gold.
Copyright 2004 The New York Times Company
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