The Mortgage Insider

Perhaps the fact that we have seen millions voting themselves into complete dependence on a tyrant has made our generation understand that to choose one’s government is not necessarily to secure freedom.  ~ Friedrich Hayek 1960

 I guess it’s easy to “bait” me into a discussion that doesn’t otherwise directly pertain to mortgages. I think economic subjects are always relevant. After all, the economy is the biggest driver of real estate values and interest rates. So I hope you will indulge me again, as I respond to a reader’s suggestion. This month’s topic had to do with how to fix Social Security and if it is even desirable to do so at this point.

 First let me say that I think Social Security was, and is, an excellent idea from a conceptual standpoint. In fact, most economists believe that by providing this old age safety net, we created the modern consumer-based economy we all enjoy. It should also be pointed out that when the Social Security Act[1] passed in 1935, it was written as an additional tax on wages to be set aside in a trust fund. Starting in 1936, individuals were required to contribute 1 percent of their annual income, with a series of scheduled increases to 3 percent by 1948. Benefits started in 1942. For the average person who had earned $3000 per year, monthly payments were calculated at .05 percent, or $15.00 per month. In addition, if an individual died before turning 65, his or her estate would receive payments based upon their total wage and contributions. So the program was definitely sold to the public, as a forced investment into a sort of retirement plan that would provide payouts at retirement proportional to your contributions.

 Next, we need to know whether Social Security really is on the verge of bankruptcy or not. In other words, “Is it sustainable in its current form?” I don’t have a lot of space, so I will just give you the answers I found. Suffice it to say, if you hear someone say something like, “There is over $2.4 trillion in the Social Security Trust fund. All it needs are a few small tweaks and its fine”, then you know they are either ignorant of the facts or lying. Yes, on paper, there is $2.4 Trillion showing in the trust fund. However, the only investments allowed into the trust fund are US Treasuries. So this would be like you writing yourself $2.4 Trillion of IOUs and declaring yourself the wealthiest person in the world. The Social Security Trust fund exists only has an accounting device. It is shown as an asset on the Social Security of the ledger, but as an equal and offsetting liability on the Treasury Department’s side. Consequently, this trust fund is more accurately described as a “…budget authority giving the federal government legal permission to use general revenues to pay Social Security benefits, when current Social Security taxes are insufficient to pay current benefits–something that will happen in 2016.”[2] The only logical way to calculate Social Security’s long term cost is to do so in perpetuity, something my people would call “solving for present value”. On this basis, Social Security has $17.5 trillion in unfunded liabilities[3]. In other words, that is the amount that should be in a real trust fund today, earning real interest rates of return, in order to pay for the benefits already promised.

 So we’ve decided Social Security is a good thing for the country. However, the problem is the federal government obviously cannot be trusted with a large pot of money lying around, as is self evident by the amount of the shortfall they’ve created in just 75 years. So the last question is, “How could you reengineer the program to work for future generations, in a perpetually solvent state?” This, of course, rightfully leads to a discussion of “privatization”. And here, “privatization” simply means allowing insurance companies to hold and invest the money within the context of strict government oversight.

 Now, it took me a while to find all the data and put it together on a single spreadsheet and there is not enough room to print it here. So, for those of you who are interested, you can find the raw data posted separately below this blog entry. However here was my methodology:

 First, I went to the Social Security National Wage database[4] and pulled average income figures for a 40 year period; from 1969 and 2009. After all, who wants to work more than 40 years!? Next, I applied the combined (employee and employer) withholding rate[5] in each year to determine the amount of cash that was paid in. Then, for each year, I took that annual contribution and used it to purchase one of two competing investments. In this study, I wanted to compare gold to a stock index fund to see what results we might get. In the first scenario, I used the average annual price of gold[6] as the primary investment. With the other I used the average annual stock market returns[7] to simulate an indexed fund. So, I looked up the average annual rates of return for each and applied that factor to find out how much total cash would have accumulated by the age of 62. Finally, I assumed that accumulated amount would then be used to fund an annuity with guaranteed benefits for life, with any unremitted principal being paid out to heirs. Since our “average” person’s example results in retirement in 2009, I used the Social Security’s “average monthly benefit” at the end of 2009 for our benchmark to compare our results against. That average benefit was $1064.40/mo[8].

 Here are the results: Our test dummy, “Joe Average”, started off earning $5894/yr. in 1969, and finished his career in 2009 earning $40,712. Based upon the combined withholding rates, Joe would have had a total of $63,807 put into the system during his career. Had that money done nothing but purchased gold bullion over our 40 year time frame, he would have accumulated 201 ounces of gold. Based on 2009 prices, that would have amounted to $195,860 to go into the annuity calculator[9]. The resulting benefit would be $1130/mo. which handily beats the current pay out. However it should be noted that hundreds on millions of Americans socking away gold in this manner would surely have forced gold priced substantially higher over this period. Consequently, this is a very conservative estimate.

 However it was the stock market index scenario results that were truly amazing. Even with stock market losses in 1973 of (-14.31%), 1974 of (-25.9%), 2001 of (-11.85%), 2002 of (-21.97%), and a (-36.58%) loss in 2008 just before retirement, Joe’s indexed account would have been worth $399,863. That results in an annuity calculation of $2306/mo! So you tell me…How would it be for a guy who retired with an income of $40,712 per year to wake up the next day making $27,672? Gee, do you think he might be able to pay the individual group rate of $450 per month for his own health insurance? It seems very likely we wouldn’t even need Medicare, which, by the way, is at least another $24.6 trillion in unfunded liabilities. And that is according to the Medicare Trust fund’s own estimates[10].

 So in conclusion, it appears we can say a couple things for certain. First, even the most rudimentary attempt at privatizing Social Security would likely result in a doubling of our benefits. And having done so, we would likely also solve the same long term funding problem with Medicare. And secondly, trained chimps throwing darts at random stock market symbols would do a better job managing our money than politicians!

[2] http://www.forbes.com/2009/05/14/taxes-social-security-opinions-columnists-medicare.html

[3] http://www.cato-at-liberty.org/7176social-security-trustees-report/

[4] http://www.ssa.gov/oact/cola/AWI.html

[5] http://www.ssa.gov/oact/progdata/taxRates.html

[6] http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx

[7] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histret.html

[8] http://www.ssa.gov/policy/docs/statcomps/supplement/2010/5a.html

[9] http://www.immediateannuities.com/information/rates.html?rates=96ca3df0cb4d7097492d23267db7e690

[10] http://waysandmeans.house.gov/News/DocumentSingle.aspx?DocumentID=247999