It is human nature to look for the easy solution. My kids do it. Our politicians do it.
It is one thing when my kids believe the tooth fairy will fix their cavities. It is another thing when politicians try to convince the public at large that there is no shortage of ways to reduce the growing gap between the projected revenue and expense of Social Security.
There is no free lunch anywhere in the system. If, for example, you remove the maximum taxable wage cap, the system will generate more revenue. At the same time, the change will make it harder to raise revenue for other governmental needs, such as paying down our debt. Increasing payroll taxes is a political statement that Social Security is relatively more important than other governmental priorities.
The Center for Retirement Research at Boston College released a study that suggests it has identified the free lunch solution for Social Security. They believe that we can solve the financial gaps by investing some of the existing surplus in marketable securities.
The research reached an astounding conclusion:
At the 50th percentile of outcomes, equity investing has the potential to maintain a healthy Trust Fund ratio through the 75- year period.
The concept holds the appeal of the easy solution. If we were just smarter about the way we handle the existing resources of the system, all of the difficulties in the program would melt away.
Is it possible? Maybe. The Social Security Administration (“SSA”) doesn’t belief so. Its research suggests that investing 40 percent of the surplus in marketable securities will increase the exhaustion point by a total of 1 year, rather than 75. So success isn’t a sure thing.
The success, or failure, of this concept largely rests upon the investment returns generated by the Trust Fund. Typically, the baseline for most of this type of research is based on historic market returns.
This theoretical assumption isn’t a realistic expectation. Social Security’s revenue is correlated to wages which is correlated to the stock markets. The connection means that Social Security will statistically overbuy market tops and under-invest in market bottoms. It is a statistical anti-dollar cost averaging concept.
Secondly, the index return does not incorporate the cost to buy and sell the security. This problem is largely overlooked today because capital inflows of the typical index fund are sufficient to meet redemptions.
That will not be the case with Social Security. The investment redemptions of Social Security will be priced at the bid. The size of these redemptions may well move the market down as the government sells its positions. A theoretical return of the index never prices in the spread.
The paper from CRR looks at the returns of the Wilshire 5000, an index that includes highly illiquid stocks. One example is Acme Corporation, ACU, a $20 stock which trades with a spread of $0.50 on an average daily volume of 2000 shares. In other words, the loss starts at 2.5 percent and rises as the price of the stock falls.
This solution does not fix Social Security. It redistributes the allocation of associated risk. Investing the surplus in marketable security lowers the risk of insolvency by investing in assets with higher returns that introduce credit risk that isn’t present today’s portfolio.
This concept introduces the possibility that Social Security will be adversely affected by a credit market disruption. That risk will be borne progressively by future workers. The possibility that a credit event will occur over the next 10 years is less than over the next 50 years. In this respect, the policy option is no different from the standard line that we will tax future workers more.
Redistributing risk might be a good idea. It isn’t a good idea to base that decision on market returns that Social Security will never achieve.
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