In the discussion of Social Security, little is more unproductive and contentious than the assertion that Social Security is a Ponzi scheme. It marks the point where the discussion stops and the fight begins.

Is Social Security a Ponzi scheme? That entirely depends upon your meaning of the phrase.

If you use the term loosely to describe current investors relying on more future investors, it is. But there are many of these arrangements around if you define the word so broadly. On the other hand, some over-qualify the term to a point where nothing qualifies. 

Let's look at the two people most frequently associated with the concept of a Ponzi scheme: Charles Ponzi for whom the ploy is named and Bernie Madoff, now serving a 150-year sentence for investment fraud.

Who Were Charles Ponzi and Bernie Madoff?

Ponzi sold investors on a complicated investment idea that was guaranteed to make them large returns over a short period of time. Instead, he paid early "investors" with the money eagerly supplied by those who came later — pocketing millions for himself. His ruse lasted only a few months, collapsing under the weight of its own absurdity.

Madoff sold investors on the simple idea of safety, promising stable returns over long periods of time. In reality, he followed Ponzi's example of paying early investors with the money from later investors — pocketing billions for himself. Madoff's scheme lasted decades, and only collapsed amid a black-swan financial crisis during which spooked investors actually wanted to hold their own money.

What Do They Have In Common?

The one thing that these men have in common is that they personally benefited from the transaction. In every dollar invested, there was a substantial probability that a portion of it would wind up in the pocket of the operator. They have little else in common to bind them together in minds of Americans.

Would Social Security Have Made Madoff Proud?

The answer is no. It would have made him angry, period. While there are widely accepted rumors that the government has profited from Social Security, there is no actual evidence of it.

Today, the Social Security Trust Fund holds about $2.8 trillion. That reserve sounds like a lot of profit pocketed by the government until you break it down by source. Most of the sum comes from interest, which is a cost to the government for borrowing money from the program. Since inception, the program has collected about $1.9 trillion in interest and interest on interest. Separately, the government has paid subsidies of more than $600 billion to the system from the General Fund. Thus, virtually everything in the trust fund actually represents a cost to the government.

So What Happened To The Trillions?

Virtually all of the money ever contributed by workers (nearly 99%) has been spent on beneficiaries. Since inception, the program has collected $14.8 trillion in payroll taxes, and has distributed about $14.5 trillion in payments.. In total, the excess contribution borrowed by the government is not enough even to pay for the subsidies that have been made to the system. As a result, the government has lost nearly half a trillion dollars on the program.

Is Social Security Collecting A Fair Return?

Maybe the government benefited from access to the cash. Specifically, some economists argue that the excess cash that accumulated over years enabled the government to borrow at lower rates. In theory, it is possible because Social Security has created an undisputable supply of cash locked into government securities.

On the other hand, the math tends to discount the size of the savings. The interest rate earned on bonds held by Social Security is based on the yield of longer-term maturities traded in the public markets. That rate is applied to whatever cash is available in June of the year. Provided the long end of the yield curve is higher than the short-end, the government isn't making a killing on the program.

Did Early "Investors" Make Money?

Yes, they did. Typically, we hear about Ida May Fuller, the first beneficiary of the program who collected nearly $23,000 over the course of her lifetime against a contribution totaling less than $25.
The lesser-known fact is that she lived nearly triple the time in retirement as an average retiree of that era. Moreover, she had the good fortune to live through a series of expansions to the program via Congressional mandate, which accounted for the vast majority of her returns. As a consequence, it is exceedingly difficult to determine where the pork barrel politics ends and the Ponzi scheme starts.
To illustrate the distinction, the first farmer to receive agriculture subsidies enjoyed tremendous economic gains. Does that make agriculture subsidies a Ponzi scheme?

What Is In A Word?

The label "Ponzi scheme" isn't contributing to an informed discussion about Social Security or its financial challenges. It is a pejorative meant to scuttle the debate. The label offers no solution, and generates a bottomless rabbit hole of pointless bickering.

(Originally published on TheHill.Com)

 

Traditional coverage of Social Security tells voters that if Congress does nothing, the system will continue to pay scheduled benefits for nearly two decades. 

The problem with the analysis is of course that Congress is not in a position to do nothing. It cannot ignore Social Security as the relationship between Congress and the system evolves from private banker to creditor. Over the next 15 years, Congress will have to refinance debt held by the Trust Fund much to the chagrin of those who claim that the Trust Fund doesn't exist. 
 

The media and experts tend to view this process as a seamless transaction that will go unnoticed by the public markets. The reality is that the government will have to borrow more from the public markets at uncertain rates as it competes with private borrowers for cash. This likely means higher rates for both the U.S. Treasury and for private businesses.

The relationship of Congress and the Social Security Trust Fund was largely shaped by the 1983 Social Security Amendments which increased taxes and reduced benefit levels. The combine changes allowed the Social Security system to grow into the largest customer of the US Treasury Department, buying nearly $3 trillion dollars of debt from the government between 1983 and today.

This pool of money largely insulated the government from the reality of borrowing in the public markets. As excess cash from Social Security flowed into government securities, the borrowing cost of the government dropped from 10.8 percent to 2.9 percent.  The latest round of borrowing from Social Security was completed at 2.5 percent.

There is nothing illegal or unreasonable about this relationship.  What is unreasonable is to fail to acknowledge that the relationship is changing, and how the consequences will affect the way we pay for government. 

We are looking at unwinding 30 years of subsidized borrowing over a relatively short period of time. When the Social Security Trust Fund redeems a bond for cash, the Treasury Department must find a source of funds. The government has two options: It can increase taxes in order to buy the debt or sell new debt to a new lender. 
 
This refinancing burden arrives at the exact time that Social Security is reducing its role as the nation's private banker. In short, the best customer of the Treasury is about to become a direct competitor. Consider, if you owned a shoe store, and your best client was leaving you, it would be a worrisome event. The problem in this case is exponentially larger because the best client is leaving you so that he can open his own shoe store next door to yours.

This process is unfolding quickly.  Since 2010, Social Security has largely been a player on the sidelines, financing much of the interest that it charges the government for the use of the money. For the last 5 years, the Trust Fund largely allowed Congress to stand still while the imbalances continue to grow.  Every year from now on, Social Security will provide less buffer between Congress and its profligate ways. 

It would be wonderful if Congress could do nothing.