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The Point of No Return

I first became interested in Social Security back in the 80s.  In order to become a Fellow in the Society of Actuaries you had to study all manner of insurance programs, both private and social, to understand the framework in which insurance and pension products existed.

The Greenspan Commission back in 1981-1983 proposed another large increase to Social Security taxes.  The system only needed a small lift to get it past some demographic difficulties, but the Commission proposed, and Congress passed a large change, which would mean that the Social Security would develop a large base of Treasury Notes, because income to the system would outstrip benefit payments for a long time, and the proceeds would be invested in Treasuries, because they are a neutral asset.  Investing in other assets would invite socialism and cronyism.

But really, what was needed was to move to a pay-as-you-go system, as Pat Moynihan suggested in the early 1990s.

But the fix could never be permanent, because even as taxes were increased, the benefits increased along with them, and there would come a day of reckoning.  But when?  There are three dates that many would point to:

  1. When the excess of taxes over benefits would peak.
  2. When benefits and taxes would be equal.
  3. When the trust fund would be broke.

I always looked at the first of these, whereas most commentators looked at the last of them.  My reasoning worked like this: the Federal Government has cynically integrated its budget with Social Security to make its deficits look smaller.  This is like a drug to the government; the real pain will come to it when the subsidy begins to fall.  By the time it goes negative, the US Government will account for it separately, so as to minimize the deficit again.

Given my view of how the US Government could no longer balance its books, the real change would come when they would have to increase their borrowing because there was not as much excess from the Social Security system.

When I first started looking at the Social Security system, the three dates in question were in the 2010s, the 2020s, and in the 2040s.  I thought that those dates were optimistic, but what I did not expect was that the current economic crisis would accelerate the first two dates dramatically.  As it is, date one has passed in 2008 (+/- a year), and I think the second date is happening in 2010.  Bruce Krasting’s post highlights the details, but I would concur, this recession will not end rapidly in the place where is counts for Social Security — employment.  We are not likely to see Social Security deliver surpluses to the US Government anymore.  Thus I expect deconsolidation of Social Security’s finances with that of the Federal Government.

What I never expected was that dates one and two would come so rapidly — almost together.  Let the morons who talk about trust fund exhaustion pontificate.  “We have all of these assets with which to pay future benefits….”  Nonsense.  As they sell bonds issued to the Social Security System, they must issue even more debt to the public.  How much can they bear, and at what yield?

Going back to my trip to the US Treasury, I want to remember one particular incident:

After the meeting, I said to one Treasury staffer, “One of the quiet casualties of this crisis is that you lost your last bit of slack from the entitlement systems.”

“What do you mean?”

“Just this, prior to the crisis, Social Security and Medicare would produce cash flow surpluses for the Government until 2018.  Now the estimates are 2016, and my guess is more like 2014.  The existing higher deficit takes us out to the point where the entitlement systems go into permanent negative cash flow.  This means that the US budget is in a structural deficit for as far as the eye can see, fifty years or more, absent changes to entitlements.”

He looked at me and commented that it would be the job of a later administration.  No way to handle that now.  To me, the answer reminded me of what I say to myself when I go on a scary ride at Six Flags with my kids.  There is nothing we can do to change matters.  The only thing to adjust is attitude.  So, ignore the fact that you are afraid of heights, and enjoy the torture, okay?

The crisis has accelerated that date to 2010.  That’s a lot of change in just eight months.  The long-term problem is upon us now.  We are at the point of no return, absent large changes that those influenced by Keynesians will resist.

There are no good solutions now.  Budgetary cuts and tax increases reduce the possibility of government default.  They also will tend to slow the economy, unless the tax increases stem from cutting cheating, and the budget cuts affect only things that are a fraudulent waste.

Once you reach the point of no return, it doesn’t matter what prescriptions one follows — failure is coming.  One can shape the type of failure, but not that there will be failure.

All that said, there are still options, though none of them are good.  Will the currency be inflated?  Will the government default?  Will taxes be raised dramatically? I don’t know.  Be alert; be ready.  The endgame is here; we will see what moves the government makes.

PS — I have a signed copy of A. Haeworth Robertson’s book, Social Security: What Every Taxpayer Should Know.  He was the Chief Actuary of the Social Security System for a time, and a noted skeptic of the program.  He sent me the copy after I shared some of my misgivings with him in the 1990s.

Alas, but the average actuary has been skeptical of the Social Security system, and I have met many actuaries that work there, and they agree.  But leaders of the Society of Actuaries, when asked to give a clear warning on the troubles to come have refused.  I have my theories as to why — they curried favor with politicians for their own personal reasons.  Sad.

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Bonds, Macroeconomics, Pensions, public policy | RSS 2.0 |

12 Responses to The Point of No Return

  1. AS says:

    Thank you for this summary and your insights, and for reminding everyone of yet another area in which Mr. Greenspan helped inflict long-term pain with short-term “solutions”. He had many helpers. Sad indeed.

  2. I’m curious why this, as opposed to so many other events and forces tending toward structural deficit, constitutes a “point of no return”? Not that I disagree with the importance of SS no longer being a tailwind, but would this situation, if widely recognized (say by cause of the accounting change you foresee), be generally seen as a real watershed?

    I ask because it is of immense practical importance for every investor to estimate when (I think when, not if) the US dollar loses its safe haven status.

    If your points 1 and 2 are a turning point that could trigger a major change in investor sentiment, then there is more of a rush than I would have otherwise thought to be less exposed to the dollar.

  3. Ryan says:

    David,

    I appreciate your willingness to stick with the subject of our government liability problems; not many want to talk about it and very few are qualified to do so cogently. My question for you is do you believe that there is a good way to profit from the coming shortfalls at the Federal, state, and municipal levels as it pertains to pension liabilities? It seems like an unmistakable trend and one that is unlikely to be resolved cleanly given our society’s/government’s penchant for avoiding pain in the short term.

  4. Lord says:

    It is a political crisis, not of SS but of general funding. The freespenders will have to cut, tax, or borrow. When we are adding a trillion a year, two trillion has been reduced to an inconvenience. Fortunately safe assets are in immense demand that will only increase so there is little doubt about what will be done. A falling dollar would increase inflation but also exports boosting the economy making it easier to pay.

  5. Peter says:

    The “solution” here is very obvious — although it is not what anyone wants to hear:

    Younger generations, who do not get pensions and will never get their social security taxes back in real terms, have no skin in this entitlement ponzi scheme.

    These promises were made by older generations, and were of benefit only to older generations. In legal terms, they are odious debts.

    Entitlements will be “strategically defaulted”.

    And I would give the exact same prediction to all the ponzi promises (pensions?) made by and to municipal employees… except that this is no longer a prediction. Municipalities are already using Chapter 9 to jettison these unfair burdens that yesterday’s leaders made, but did not fund.

    Social Security is in its last years. We can’t pay it, there for we won’t. No point in wasting time fretting over something that can’t be changed.

    Every American should assume that these “entitlement” programs will not be there in the future.

    If we ever get courageous leadership, they might admit so and phase the programs out.

    Far more likely, two or three presidents from now will “strategically default”. Even “rappers” are doing it today — the stigma is gone. The burdens on younger generations unjust.

  6. Ian says:

    David, I really wish someone would be honest enough to admit a simple economic truth about social security taxes: they are a form of default.

    While we can debate the legal meaning of “is” is, from an economic view point the following scenarios are EXACTLY the same:

    1) Raise taxes now, but keep benefits the same in the future
    2) Keep taxes flat, but cut benefits in the future

    Whatever legal hairsplitting the politicians try to use, these scenarios are the exact same thing.

    Raising taxes and defaulting are not separate choices. One is stealing from the future, one is being honest — but they are both default

  7. AllanF says:

    I don’t know if the SS Ponzi will last this long, but I guarantee it won’t last longer than Gen Y coming into greater power than the Boomers.

    Gen X have always been apathetic as regards the action of the Boomers. And Boomers are their parents after all, so they may be inclined to let the status quo be one last time. But Gen Y has none of that “baggage”. They know they’ve been short-shrifted by the Boomers at every turn and will spare no antagonism towards them.

    So what is that, 15 years? Yeah, hard imagining this could last another 15 years, but then didn’t the Big 3 last an extra 15 or so themselves?

  8. But What do I Know? says:

    @Peter–I agree with you in the main, but it’s even worse than that. The Gen Y’ers are now being stripped of their pension benefits even as we will be forced (absent a miracle) to pay for the unsupportable pensions of current and future retirees which will be paid under the old system. It’s not even as easy as walking away saying “SS won’t be there for us,” we will also be paying for the benefits of the baby boomers for our working lives. Given the political clout of the retiree class, it’s hard to see any lessening of payouts to them.

    This is the cruelest trick of all.

  9. Brent says:

    Not sure if you’ve seen this, but this chart highlights the risk:
    http://www.strategicanalysis.ca/images/Phoenix%20Rising/Phoenix%20Rising%20Chart%203.png

    Full report from Canada’s Strategic Analysis Corporation at:

    http://www.strategicanalysis.ca/Library/Phoenix.aspx

  10. gaius marius says:

    i think we can go one horrid further step and rule out some apparent solutions.

    i’m of the mind that richard koo has correctly diagnosed our problem, that this is a balance sheet recession and that private sector loan growth will be net negative for years to come. if so, only large government deficits will create the illusion of even economic stagnation. any effort to close those deficits will result in a GDP collapse, crushing tax revenue and restoring (at a lower level of economic activity) even larger deficits commensurate with the further collapse of asset prices. government deficits are, then, inescapable — the product not of policy but of the private sector’s imperative to net save, policy arbitrating only at what level of GDP and asset prices we get deficits.

    this being so (as i think it is), the government may try budget cuts and tax increases — austerity — but it can not and will not succeed. in fact the problem will not only not improve, it will get worse. ireland is the best current example.

    that leaves in the last resort either default or devaluing the currency.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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