From: glevy@PRATT.EDU
Date: Tue Jun 07 2005 - 08:14:02 EDT
Why Social Security won't be enough to save Wall Street
by Dr. Michael Hudson, ISLET C
Harpers Magazine, April 2005
They wanted something for nothing. I gave them nothing for something.
--
J.R. "Yellow
Kid" Weil
Social Security, formerly the "third rail" of American politics, has
now been trod upon, in rather dramatic fashion, by George W. Bush. Given
that the maneuver is both stupid and unnecessary, one must ask why.
After all, the program's alleged deficiencies, if there are any, will
not manifest themselves until at least 2018. This is not quite the same
as worrying about the sun's eventual collapse into a black hole, but for
most politicians a problem that lies thirteen years in the future is
nearly the same thing. Clearly all is not what it seems.
Bush himself offers two reasons for the present boldness. The first- that
Social Security is "in crisis"-is easily dismissed. Government
actuaries, backed by economists from across the political spectrum, insist
there is no funding problem. The Social Security Administration will take
in more money than it pays out for the next thirteen years; it has built
up a reserve of $1.8 trillion in interest-bearing Treasury bonds for the
years after that; and any later shortfall can be covered easily by even
a partial rollback of the recent tax cuts for the rich.
Bush's second argument sounds more promising. If the American people will
simply follow his plan, he says, they too will become rich.1 The way the
system works now, the government withholds 12.4 percent of your
paycheck, up to $90,000 in annual income. In return, it promises to
provide you a monthly payment-a pension-from the time you turn sixty-two
until the time you die. As of this writing, the administration's
alternative remains somewhat nebulous, but what is clear in all of the
variations presented thus far is that you will be able to put some of
your paycheck into the stock market. Bush calls these stock purchases
"personal savings accounts."
THE ONLY WAY THE STOCK MARKET IS GOING TO GROW IS IF WE THE PEOPLE PUT A
LOT MORE OF OUR MONEY INTO IT
Vice President Dick Cheney described the benefits of these personal
savings accounts in January. His example was a young woman who put away $
1,000 every year for forty years. The Social Security Administration
currently puts her money into Treasury bills, which at present return
about 2 percent, so in forty years that investment would have r eturned
about $61,000. Not too bad. "But if she invested the money in the stock
market," Cheney said, "earning even its lowest historical rate of return,
she would earn more than double that amount-$160,000. If the individual
earned the average historical stock market rate of return, she would
have more than $225,000 - or nearly four times the amount to be expected
from Social Security."2
That's a lot of math. Cheney's main point is that an upbeat
assessment of the stock market-about 7.5 percent annually over forty
years, by his reckoning-would easily exceed the 2 percent offered by
Treasury bills.
There is no arguing that $225,000 is more than $61,000. On the other
hand, it's not as if you get a lump sum from the Social Security
Administration when you retire. The woman Cheney cited could end up
taking in much more than $61,000 if she lives long enough. (The average
annual payment to retirees today is about $11,000.) Or she could die on
her sixty-second birthday. Like any other investment-or any other form of
insurance, for that matter Social Security is somewhat of a gamble. But
then so is the stock market. By Cheney's estimation, however, today's
stock market is a much better bet. "Over time," he concluded, "the
securities markets are the best, safest way to build substantial personal
savings."
That is the argument, anyway. The stock market is the main chance in
America, and Bush wants to let all of us in on the action. The one sure
mark of a con, though, is the promise of free money. In fact, the only way
the stock market is going to grow is if we the people put a lot more of
our money into it. What Bush seeks to manufacture is a boom - or, more
accurately, a bubble - bankrolled by the last safe pile of cash in
America today. His plan is a Ponzi scheme, and in that scheme it is Social
Security that is being played for the last sucker.
Retirement savings are by far the most important source of money on Wall
Street. The Federal Reserve Board reports that private and public
retirement accounts, not including Social Security, had assets of $10
trillion at the end of 2003. Nearly half of that, $4.7 trillion, was
held in stocks. By way of comparison, the total value of all domestic
stocks listed on NASDAQ, the American Stock Exchange, and the New York
Stock Exchange at the end of 2003 was about $14.2 trillion.
In the past, few retirement dollars found their way to Wall Street. IRAs
and 401(k)s had yet to be invented, and few companies offered private
pension plans of any kind. In 1950, General Motors - then, as now, among
the largest employers on earth - began to change that with a new form of
compensation. The company would withhold money from paychecks, much like
the Social Security Administration was doing, and add money of its own to
build up a reserve to pay retirees many decades into the future.
Generally called a "defined benefit" plan, the scheme guaranteed retirees
a specific (defined) monthly payment until they died.
Other giants of American industry soon followed, and the funds grew
quickly. In most of them, at least half the money was put into the stock
market. Workers thus would gain, at least in theory, a stake in the
prosperity of their company, building loyalty to management while also
providing companies with a captive source of credit-their own workforce.
All of that new cash contributed to the bull market of the 1950s.
COMPANIES SIMPLY HAVEN'T BEEN PUTTING AWAY ENOUGH MONEY TO PAY
RETIREES WHAT THEY ARE OWED
Management philosopher Peter Drucker called this process "pension-fund
socialism" and hailed it as the most positive social development of the
twentieth century, because it would at last merge the interests of labor
and capital. Louis O. Kelso and Mortimer J. Adler even wrote a book
called The Capitalist Manifesto announcing that a new epoch of harmony
between workers and owners was at hand, because soon all workers would be
owners.
It didn't quite work out that way. Many companies used retirement reserves
to buy their own stocks, bidding up their share price and allowing them to
take over other firms on favorable terms, especially as mergers and
acquisitions gained momentum in the 1960s. The problem was that when
companies went bankrupt-especially small firms-the collapse also
wiped out the pension funds invested in those companies. Employees of
such companies found themselves not only out of work but stripped of the
money they thought was being saved up for their retirement.
Congress moved to limit such behavior by obliging corporate pension funds
to be run by arm's-length trustees, although workers were still
permitted (and often encouraged) to keep their pensions in the stock of
their employers. To further protect workers, Congress created the Pension
Benefit Guarantee Corporation (PBGC) in 1974. All corporate pension plans
were required to buy federal insurance, through the PBGC, to protect
workers in the event of a failed investment scheme or corporate
bankruptcy. The plans themselves were still prone to risk, but at least
the pensions would be backed by the government and workers could feel
secure about their retirement.3
Most companies now offer their employees a broad array of mutual funds
instead of just their own stock. In itself this is good common-sense
investing practice, and it also protects fund managers from charges of
scheming. The other result of this practice is that workers' fortunes are
now tied not just to their own companies but to the market as a
whole.
Which is where and how we come to both the problem and the scam.
While fears regarding the solvency of Social Security are unwarranted,
many corporate pension plans-the ones that have been so important in
bankrolling the stock-market rise of the past few decades - are themselves
threatening to go bust, taking their parent companies down with them. The
financial rot already has begun to seep into the airline and steel
industries, and the auto sector may be next. (General Motors reports
that its current pension obligations add $675 to the cost of every
vehicle it produces.)
The shortfalls aren't just a matter of bad luck. For quite a few
years now, companies simply haven't been putting away enough money to pay
retirees what they are owed. The PBGC estimates that the underfunding of
traditional defined-benefit plans, for instance, deepened by $ 100 billion
last year, to a total of$450 billion. The problem was created by fund
managers and CFOs who believed - or at least pretended to believe-that
pension reserves could grow at fantastic rates of return forever.
Milliman USA, a benefits consulting firm reports on the assumed rates of
return on pension investments at the hundred largest firms in America.
How high did these companies bet? In 2000 and 2001, the median projected
rate of return was 9.5 percent. In 2002 in was 9.25 percent. And in 2003
it was 8.55 percent.
THE CHOICE BETWEEN LIVING UP TO THEIR PENSION PROMISES OR REPORTING HIGHER
NET EARNINGS WAS EASY
These are wildly optimistic projections, even by Dick Cheney's
standards. Last summer the Financial Times noted that they conflict not
only with present reality but with warnings from such mainstream
investment experts as Peter Bernstein, Jeremy Siegel, and Jeremy Grantham
that "we have entered a low-return environment" and that as a result many
investors are expecting long-term returns closer to 7 percent or 5
percent. Even these rates seem overly exuberant, given that the top
hundred corporate pension funds earned an average annual investment
return of just 1.3 percent between the end of 1999 and the end of 2003.4
At the beginning of 2001, for instance, IBM proposed that it would earn
$6.3 billion on pension-fund assets of $61 billion-about 10 percent. This
was an astonishing demonstration of confidence given that IBM had earned
only $1.2 billion on those assets the previous year. In the event, IBM
actually went on to lose $4 billion in 2001. Barely daunted, the
company's managers predicted a 9.5 percent return in 2002. They lost
another $7 billion. In 2003 they predicted a return of $6 billion, and -
as the market began to recover - they at last beat their prediction, by
$4.4 billion. The result of this "recovery" is that, since George W. Bush
took office, IBM's pension-fund assets have plummeted by more than $1
billion. Nonetheless, corporate fund managers across America remain
optimistic.
Such errors in judgment are seldom accidental. In pretending that their
funds could generate high returns, managers sought a real - albeit
short-term-advantage. The faster companies projected their funds to grow,
the less they had to set aside to pay their retirees. The lower
setasides in turn allowed them to report higher earnings, thereby driving
up the price of the company's own stock to "create shareholder value."
Faced with a choice between living up to their pension promises or
reporting higher net earnings, companies simply decided not to live up to
their employee agreements.5
The practice is not one that can be sustained across forty years. It is a
kind of Ponzi scheme, in which present profits are paid for by the promise
of future stock-market gains. At some point retirees are going to want the
money they are owed. The last few years have seen the results of these
broken promises in the form of lawsuits, bankruptcy, and, ultimately,
retirees being forced to live on far less than they were promised. In the
end, it is the PBGC that pays when the plans go bust. Here, however, the
problem deepens considerably, because picking up the total bill for the
corporate sector's underfunding would bankrupt the PBGC itself.
Last November the PBGC reported that although it had "operated for several
years with virtually no claims," the end of the stock-market boom has given
way to "a period of record-breaking claims." As recently as 2001 the PBGC
had a surplus of $8 billion, but a series of bankruptcy cases pushed it $23
billion into deficit last year, a year in which it took in only $1.5
billion in premiums. The PBGC would need more than fifteen years just to
make up its current deficit, with new claims arriving all the while. The
PBOC has proposed that companies follow more realistic accounting rules
and pay premiums that reflect the true risks of their underfunding. It
also is asking for stricter limits on the ability of companies to escape
their pension debts by declaring bankruptcy.6
SOMETHING HAS TO GIVE - EITHER THE HOPES OF RETIREES
OR THE HOPES OF THE STOCK MARKET
Without such changes the PBGC will be forced into bankruptcy and the
government will have to bail it out. That could cost as much as $95
billion, according to the Congressional Research Service. At that point
only today's profits would remain private. The losses will have been
fully socialized.7
Barring some sudden influx of capital, something has to give either the
hopes of retirees or the hopes of the stock market. Unfortunately, this
is a zero-sum game in which many Americans are on both sides at once.
Higher pension set-asides will diminish corporate earnings. Lowered
earnings in turn will lead to dividend cuts and job losses. Low dividends
and high employment will decrease the demand for stocks - leading to
further declines in the ability of pension funds to pay retirees, with
more defaults all around. Workers, retirees, investors, and taxpayers
thus find themselves yoked to the fortunes of the financial managers who
created this situation.
This is hardly the kind of happy pension-fund socialism that Peter Drucker
had in mind, in which worker-owners share risks and rewards alike as they
create the goods and services demanded by a thriving marketplace. In fact,
what has happened is that companies have made a great effort not
merely to share the risk but to off-load it entirely onto the backs of
their employees, the government, and taxpayers in general.
This phenomenon of risk rolling downward can be seen most clearly in the
move by many companies from defined-benefit programs - in which employees
are guaranteed a specific retirement payment, based on their salary history
- to "defined-contribution plans," in which workers know nothing else
except how much is being deducted from their paychecks. The payout rate is
decided by how well the stock market performs, which shifts the risk onto
employees even as it frees up more revenue for their employers and
generates rich commissions for money managers. The risk flows down the
economic scale even as the cash flows up.
Given the widespread problems confronting pensions outside the
embrace of the federal government, now would seem an odd time for the
administration to campaign for Social Security privatization. Why would
anyone want to invest America's last line of pension defense in so
perilous a market? Are Bush and his advisers unaware of the odds?
Probably not. Therefore, they must have a particular idea in mind.
Presumably they believe that some kind of market recovery is needed not
only to rescue the PBGC but to rescue the pension funds, to rescue the
stock market, and, for that matter, to rescue the political fortunes of
the ruling party - that what is needed, in fact, is a Bush boom. After
all, such a boom would allow us to "grow our way out of trouble," as we
have done so many times before.
But where will the funds come from to bid up stock prices? The
national savings rate is nearly zero, because most personal discretionary
income-like that of most companies-is absorbed in repaying debts.
Previously, the Fed could have flooded the capital markets with credit to
lower interest rates and thereby spur a bond and stock-market bubble. But
interest rates are at their lowest since the 1950s. They can go no
lower.8
There is only one other place to turn. The new flow of funds into the
stock market will have to come from labor itself, just as it did back in
the 1950s. Social Security is the greatest plum of all, so large as to
virtually guarantee a boom.
MANY OF HISTORY'S MOST FAMOUS BUBBLES HAVE BEEN SPONSORED BY
GOVERNMENTS IN ORDER TO GET OUT OF DEBT
Talk of bubbles has become popular in recent years, but most
discussions miss the key point. Although optimism is inherent in the
human spirit, it rarely effloresces into the kind of frenzy necessary to
float a bubble without help from the government. In fact, many of
history's most famous bubbles have been sponsored by governments in
order to get out of debt. Britain, in 1711, persuaded bondholders to swap
their bonds for stocks in the South Sea Company, which was expected to get
rich off the growth industry of its day, the African slave trade. By the
time the South Sea bubble collapsed, the government had indeed paid off
its war debt - and speculators were left holding worthless "growth
sector" stocks. In 1716, John Law organized France's Mississippi bubble
along the same lines, retiring France's public debt by selling shares to
create slave-stocked plantations in the Louisiana territories. It worked,
for a while.
The U.S. government is now attempting to run the same kind of scam. Bush
would like to persuade Social Security claimants to exchange the
security of U.S. Treasury bonds for a chance to buy growth stocks on which
a much higher return is hoped for. No modern blue-sky venture comparable
to the South Sea or Mississippi companies is needed. The stock market
itself has become a bubble, borne aloft from the burden of generating
actual goods and services by a constant flow of new retirement dollars.
There is no denying that channeling trillions of Social Security
dollars into the stock market would produce short-term gains. But once
this money is spent, the markets are likely to retreat. That is what
happens after a financial bubble. Then we will be right back where we are
today, only much the poorer and with no guaranteed pension system for
elderly Americans - who will, of course, need guaranteed pensions more
than ever as they watch their stock holdings continue to shed value.
Indeed, many other countries are just now recovering from their own
dismal experiences with what Augusto Pinochet and Margaret Thatcher
called "labor capitalism" and Bush calls, with no apparent irony, an
"ownership society."9
In the 1930s, John Maynard Keynes urged governments to run budget deficits
in order to increase the economy's spending power on goods and
services. His point of reference was the "real economy"-the economy of
production and consumption, of investment in capital and in the labor to
operate that capital. Whereas Keynes spoke of governments priming the pump
with public spending programs to get domestic investment and employment
going, Bush now seeks to prime the stock-market pump with Social Security
contributions.10 It is the next natural step from our real economy to the
economy of dreams.
1 Bush's opponents note a possible third reason, which is that he is
hoping to roll back the New Deal in favor of smaller government. It may be
true that Bush dislikes the New Deal, but it is hard to envision his
proposed replacement as a small-government alternative. A federally
mandated transfer of funds-whether it is from taxpayer pockets to
Treasury bills, as with Social Security, or from taxpayer pockets to the
stock market, as under Bush's proposed changes-is still a federally
mandated transfer of funds.
2 Any relationship between the solvency of Social Security and the
prospect of these personal accounts is purely rhetorical. Just be/ore
Bush's State of the Union address a reporter asked a "senior
administration official" at a background briefing whether it was accurate
to say that personal savings accounts themselves would have "no effect
whatsoever on the solvency issue." The surprisingly candid response was
, yes - "that's a fair inference. "
3 Although as former employees of Enron and WorldCom recently
learned, the price of demonstrating Ioyal0 still can be quite steep.
4 A three-year Treasury bill purchased at the end of 1999 would have
returned 0 percent.
5 Plans with more realistic projected rates were deemed "overfunded" and
emptied out.
6 Reasonable as these requests seem, they are being opposed by the same
corporate managers who created the mess in the first place. Last year the
American Benefits Council, the lobbying organization of pension-fund
managers, persuaded regulators to even further loosen me requirement that
companies estimate realistic rates of return.
7 That estimate is probably low. The precedent is the bailout of the
Federal Savings and Loan Insurance Corporation, which ended up costing
taxpayers $200 billion.
8 After World War II interest rates rose to a peak, in 1980, of more than
21 percent. The result was nearly four decades of capital losses on
bonds-whose interest rates are fixed at the time you buy them-and a steady
rise in stocks. Since 1980, however, interest rates have fallen back,
creating the greatest bond-market boom in history.
9 In Chile conglomerates invested employee paycheck withholding in their
own stocks or in loans to affiliates whose value then was wiped out in
financially engineered bankruptcies. The problem got so bad by 1980 that
the government turned over management to American and other international
firms. Most discussions of Chile's "success story" choose to start at the
trough right after these fraudulent bankruptcies, which of course gives a
steep trough-to-peak tilt for the rate of return that is claimed to be
normal. The equivalent for America would be to start a new trend right
after a 1929-type stock-market crash. When one starts from a peak, such
as today, it is much
harder to give the statistical impression that a fantastic takeoff is in
store.
10 The genius of recent administrations, Democratic and Republican, has
been to transfer inflation to the stock market - that is, to the prices of
stocks and bonds instead of to the prices of labor and production. Real
wages today are lower than they were in 1964.
Michael Hudson is Distinguished Professor of Economics at the
University of Missouri, Kansas City, and the author of many books on
international and domestic finance, including Super Imperialism: The
Origin and Fundamentals of U.S. World Dominance.
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