Stocks Don’t Care Who Owns Them; Social Insurance and Private Markets Do Not Mix

Actuaries are bright people.  Okay, present writer excepted.  That’s a danger when you give a talk to a bunch of them.  Every now and then you will end up with a questioner who is a bit of a crank.  Now, I have a soft spot in my heart for actuarial cranks, because I have done more than my fair share to question other presenters over the years.

At my talk yesterday, one actuary suggested turning the Social Security system into a defined benefit plan, and having it invest in stocks, which would provide cheap capital to corporations.  The Social Security system gets better returns. Everyone wins, right?

Well, no.  Here is what is amiss with the idea:

  1. It would favor public companies over private companies.
  2. Active managers would be useless, because the fund would be too big.  They would have to index.
  3. Initially the stock market would shift up as the money began to be invested, but once fully invested, P/E multiples would be so high that future returns would be lousy.  Once the liquidation phase began, this fund would be so big that stocks would fall in advance of the liquidation, even if everything were indexed.
  4. Marginal companies with lousy profitability would come public to take advantage of the cheap funds.
  5. Corporate governance issues would be tough; how does the government vote its proxies?  How would activist investors get treated?  Which side would the government favor?  If they left this in the hands of active managers to take care of, could the managers stand up to all of the political pressure?
  6. Do we really want the Socialism associated with the government owning 20% of every corporation?  What additional regulations might be put on corporations that are owned or not owned by the government?
  7. Would we give the Fed a third mandate to try to improve corporate profitability, because it would have a greater effect on the economy?
  8. Why limit the asset classes invested in?  Why not other bonds, loans, commodities, real estate (commercial and residential) and perhaps international investments?  At least if we liquidate international investments, we don’t hurt our own economy.
  9. For that matter, the US government could contribute all of its property to a great big REIT, and use it to fund a small portion of Social Security.  Of course, the deficit would rise as the government made dividend payments.
  10. Medicare is the tougher issue to solve; Social Security is small compared to it.  Solve that one first.

My last reason is that for the most part, stocks don’t care who owns them.  In the long run, they are weighing machines, and not voting machines.  They will produce the stream of cash flows as a group that will be pretty invariant to who owns them.  Activist investors may have an effect in the short run, but on the whole, the effects of activism on the index returns as a whole will be paltry at best.

This tired idea of investing the Social Security trust funds in equities came up during the Clinton Administration (hopefully there will not be a second one).  I view it as the ultimate “dumb money” for the stock market.  If it were ever implemented, you would invest into the wave of new money, and create IPOs to sop up money.  Then once the money flow was largely deployed, you would sell along with other smart investors, and invest overseas.

My own view is that Social Security and Medicare should be wound down over a 80-year period.  They were bad ideas to begin with, but getting us out of that business with fairness to promises made would have to take two generations or so to complete.  I know, that’s a non-starter, but most reasonable ideas regarding social insurance programs are.  The eventual “solution” will come through higher ages for benefit receipt, lower benefits, higher taxes, limitation of inflation adjustments (already done, and quietly) and means-testing.  Not that I like it, but we will have to face realities eventually.

The same issues will apply to Medicare.  Eventually we will have a two-tier healthcare system (we won’t call it that), because we can’t afford the promises made to Medicare recipients.  It will be “The government pretends to pay us, and we pretend to treat you.”  It will be a mess, and that one should begin to come into clear focus within ten years.

PS — My talk went well yesterday.  If there is ever a recording of it on the web, I will put a link at my blog.