The following is a guest post from Marotta Asset Management. The combination of a controversial topic and the "popularity" of the Marotta articles made me think twice about running this piece. But if the numbers on the returns offered by Social Security are even close to being true, then I think the article makes some very compelling arguments that deserve consideration and debate.
Between 2037 and 2075, the Social Security program is projected to run deficits totaling $30 trillion. And annual shortfalls could be a problem as soon as 2017.
Privatizing the system could break the political deadlock between cutting future benefits and raising payroll taxes. We can have both our benefits and lower taxes if we finally admit that socializing retirement was a mistake and once again trust in the power of free markets.
For some people, the current volatility and decline in the stock market makes the best case against privatizing Social Security. Why would we want to inflict market shocks on every American's retirement? Isn't Social Security at least secure? Unfortunately, it is not.
Computing a return on Social Security as though it were an investment is difficult but not impossible. For example, my average annual return is about negative 7%. It is so poor for three reasons. First, average lifetime annual incomes above $60,000 produce miserable returns. Second, because I fall at the end of the baby boomers, my Social Security withholdings are at the current high rate of 12.4% rather than the lower rates that might have produced a better return. Finally, for those born my year (1960) or later, the age to receive full Social Security retirement benefits was raised from 65 to 67, further lowering returns.
A negative 7% return is huge. That's like investing $100 and 30 years later getting back $11, or investing $100 a year over 30 years and getting back $1,177 of your $3,000 investment. If recent shocks in the stock market seem difficult, imagine losing 60% of value over 30 years of investing!
Not everyone's return on Social Security will be as bad as mine. On average, Social Security provides a return of about 1.2%. If you don't work and therefore haven't paid into the system, your return is a complete gift.
As a comparison, the S&P 500 closed at a low on October 10, 2008, at 899.22. It closed exactly 30 years earlier on October 10, 1978, at 104.46. Even with the recent losses, investments in the S&P 500 have gone up 8.61 times, reflecting an average annualized return of 7.44%. Bond investments show a similar return with much less volatility. In fact, nearly any kind of investing has done better than the return within Social Security.
Proponents of the system view the redistribution of wealth from workers to retirees as positive. They believe we should pay whatever it takes to preserve the program in its current form. That the system destroys wealth and property rights is ignored because the system impoverishes the elderly more equally.
The proposal for privatizing Social Security is simple but elegant. Allow younger workers to deposit part of their Social Security taxes into a private account. If it produces a better retirement than Social Security, they can refuse Social Security and keep the private account. Otherwise they can take Social Security. Given my expected rates of return, putting just a tiny fraction of my withholding into a private account will do better than getting a negative rate of return in Social Security, even using the poor rate of return to where the market bottomed.
For more typical people who might receive the equivalent of a 1.2% return on their Social Security, they would get just as much benefit earning 7.44% on a third of the contributions. Thus 4.1% invested privately could do the job that 12.4% in Social Security can't seem to do without massive deficits. The proposals for privatization suggest allowing younger workers to invest 5% on their own. The other 7.4% would continue to be confiscated to pay aging early baby boomers the normal Social Security entitlement. A few years of deficit spending will be necessary before private accounts begin to relieve the deficit. But ultimately, private accounts will yield a greater benefit than Social Security ever provided. And when the baby boomers are off the Social Security dole, tax rates could be reduced to 5%.
Rather than relieving the problem, raising taxes exacerbates the inequities of Social Security and sends the average returns negative. Additionally, no matter where they are found, the higher taxes required to bail out Social Security would stifle economic growth. Most of the solutions that propose raising taxes result in top margin rate increases of over 15%. This level of curtailing freedom would kill economic growth and innovation.
Of course, cutting benefits is hardly a more attractive option.
Interestingly, either increasing taxes or reducing benefits sets the bar lower for private accounts to beat by any comparison. Privatization simply eliminates benefits for all the workers who can do better with 5% of their payroll taxes than the government does with the entire 12.4%.
Some people like the idea of using the growth engine of private accounts. But they suggest the government maintain control of the money. They would allow the government to invest retirement accounts directly in the private markets. So the government supposedly would protect citizens from their own ineptitude.
Others suggest that governmental involvement and oversight in the financial markets would bring a welcome measure of accountability to corporate America. They favor the so-called good intentions of politicians over the greedy motivations of the financial world.
Although tempting, this idea would be disastrous for freedom and for free markets. Even Alan Greenspan, former chair of the Federal Reserve, warned that governmental investing would "have very far reaching potential dangers for a free American economy and a free American society."
With private Social Security accounts, millions of workers would make independent investment decisions. But if the government took it on, the impact would be unified and rigid. And concentrating that power in a single government entity would magnify its effect. Having a Social Security trust buying and selling in the markets would be like turning on every electrical appliance in your house at the same time. The government retirement monopoly would short-circuit the free markets.
Overnight the government would have a controlling interest in virtually every major company in America. We should have learned from the scandal of political appointments to Fannie Mae and Freddie Mac that political power breeds political corruption.
The federal system would become swamped with feel-good laws requiring investments designed to stimulate the economy, create jobs or develop alternative energy sources. Federal advisors would shun investments that did not pass the litmus test of political correctness.
Some have suggested limiting the government's investments to passive index funds. But that leaves unanswered the question of which indexes will be used and in what percentages. Would all the investments be in U.S. stocks and bonds? If so, the resulting asset allocation would only use two of the six asset categories we recommend.
Ironically, the goals of collectivism are best achieved by respecting individual liberties. When well-intentioned bureaucrats force choices on workers, the incentive for innovation and risk vanishes. As a result, society hardens into a rigid structure that cannot easily align itself with changing market conditions.
Collectivism starts with the premise that the common people cannot be trusted to make their own choices. Once you have accepted that premise, you will take whatever you need and give whatever you want without regard for individuals who would have done otherwise.
Acting on behalf of a collective often justifies imposing our priorities on individuals. For example, if the few in charge believe that foreign investing costs American jobs, they will not allow us to invest overseas. Or if they believe that companies who develop alternative energy sources are a good investment, they will force us to invest in them.
We certainly know by now that not even smart people can force the markets to behave in a certain way. You might as well pass laws outlawing hurricanes.
These are some of the socialistic assumptions that caused the current Social Security system to fail. Privatized accounts could turn that around. It would be a shame to make the same mistake a second time and destroy the engine of capitalism in the process.
Privatization uses the strength of America's capitalist engine to solve the weakness of socialized retirement. Do your part by asking your senators and representative to support privatizing a portion of Social Security. And then assure your own retirement by saving 15% of your take-home pay regardless of what happens in Washington, D.C.
this morning (I actually listened to it on CD.) I liked the book a lot as it gives great insight into Warren Buffett the man (not just the investor.) I've commented on the book a couple times previously (see 
Why We Should Take a Solutions Approach to the Crisis and Look at Some Things Differently
The following is an excerpt from The Little Book of Bull Moves in Bear Markets: How to Keep Your Portfolio Up When the Market is Down (Little Books. Big Profits)
by Peter Schiff. I am NOT endorsing this book and I'm sure many of you will disagree with this piece. That said, I'm always open for new thoughts/ideas/comments, and I felt his writing was good enough to share.
I don't think we're going to see any light at the end of the tunnel until we have a clear, objective understanding of how we got into this mess in the first place. There is a tendency whenever major problems occur in the economy to place blame on external factors and to assume that the external factors can be prevented from causing similar problems in the future by expanding the government's
regulatory powers. The problem I have with this kind of thinking is that it makes government bigger and more intrusive without ever getting at the root of the problem, which is usually the government itself. The other thing it does is reduce the sphere in which market forces move freely and would otherwise prevent the problem from recurring. Finally, as we face the challenge of rebuilding an economy, whatever lesson might have been learned from the government's role in the problem is lost on us because it was never brought to light in the first place.
The real estate meltdown provides an excellent example. Here we are about to give the Federal Reserve Board new powers to regulate mortgage lenders, appraisers, and other parties to a crisis that would never have occurred if the Fed hadn't taken upon itself the responsibility, better left to the free market, of determining what interest rates should be, particularly true with the absurdly low rates set after the bursting of the tech bubble and the tragedy of September 11, 2001.
The Fed's decision to set rates at artificially low levels to stimulate activity and growth in the real estate sector was directly responsible for the environment that naturally spawned such innovations as teaser rates, negative amortization loans, and other variations on adjustable-rate mortgages, which in turn had consequences that were extremely problematic. But the mortgage brokers and lenders weren't responsible for the root cause of the crisis, nor were the investment banks that securitized the mortgages, nor the hedge funds and institutions that purchased them. The Federal Reserve was. Yet the Fed is now being rewarded with additional powers to regulate Wall Street as well. So the fox ends up guarding the henhouse, which is bad enough, but anybody looking for the guiding lesson of the crisis probably wouldn't find it. The real lesson is this: Interest rates represent the price of money (or more precisely, the price of credit). A government agency has no more business deciding what the price of money should be than it has deciding the price of a pair of tennis shoes. Why are we so surprised that central government planning works no better when it comes to setting the price of money than it does in setting prices for other goods?
The price of oil is being blamed on speculators, big oil companies, environmentalists, and other external factors -- but never on the Federal Reserve, which created the inflation that debased the dollars in which oil is traded and is thus principally responsible for increased oil prices. Priced in gold, which adjusts for inflation, oil has actually changed very little in price.
What worries me most, however, is the almost automatic backlash that attributes the present economic collapse to a failure of capitalism and free-market economics and turns it into an argument for expanded government. Never mind that government created a crisis that the free market would have avoided altogether; the problem with this case of mistaken identity is that it almost certainly will result in expanded government, much as the New Deal did during the Great Depression. Of course, the greater problem today is that we can barely afford the old New Deal, let alone the modern version we're about to be dealt!
The approach we need to take to our present crisis is not to expand government, but rather to understand government's role in creating the problem. The solution is to limit and control the power of government, not to create more unnecessary regulation to interfere with the free market forces that would have prevented the problem.
Thoughts on the Upcoming Presidential Election and How It Might Affect Our Economy
I think what we've learned from this historic economic breakdown is that it represents a colossal failure of government planning. When you have the government taking control of something as important as setting interest rates, this is the kind of disaster you get.
At this critical political juncture, are we going to compound the problem by giving the government even more power, making it even bigger, and putting it in a position to do even more damage? The alternative, of course, is letting the free market self-correct, which I believe in strongly but which is not, I'm afraid, the way Americans are inclined to lean in a time of economic crisis.
The impending failures of Freddie Mac and Fannie Mae, events I forecast in my book Crash Proof, in commentaries on my web site, and on television, and the government's intention to bail them out, is a huge step in the wrong direction. These quasi-governmental agencies, with their implied government guarantees, provided much of the air that inflated the housing bubble, and should be
allowed to fail. Instead, they will be pumped up with more government money, compounding the fundamental problems in the housing market and worsening inflation.
In fact, early on in the housing crisis, most in government and on Wall Street were still so clueless that these agencies were actually touted as being the solution to the problem. In sharp contrast, I wrote in an August 2007 commentary entitled "It's a Shoo-In":
"In order to breathe life into the dying secondary market for nonconforming mortgages, some have suggested that Fannie Mae and Freddie Mac be allowed to buy jumbo mortgages. This overlooks the problem that many of these larger mortgages also feature adjustable rates that will likely show greater default levels when payments reset higher. Allowing Fannie and Freddie to buy larger loans now merely sets up a more expensive federal bailout down the road, as both of these entities themselves will likely need to be bailed out when the conforming ARMs they already insure go bad as well."
Bailing out Freddie and Fannie, as well as all schemes to bail out overextended homeowners and artificially prop up home prices are doomed to failure, and will only compound the problems they are attempting to solve. The recent failure of California-based IndyMac, a former leader in nontraditional mortgage lending, resulting in long lines of angry depositors, is but the tip of the iceberg. As more banks fail and the FDIC runs out of funds, the Fed's printing presses will be operating until they run out of ink.
Without getting into a contentious political discussion, I do see a parallel between the 1976 election of Jimmy Carter and the Reagan succession in 1980. Carter had taken office at a time when inflation and unemployment were issues. Voters were disenchanted by Gerald Ford and alienated by his pardon of Richard Nixon, whose abuses of power were still very much on their minds, and whose failed policies led to higher inflation and unemployment. The mood was very strong for a change from the traditional ways of Washington. The economy was so bad that Gerald Ford was even challenged in the primary by Ronald Reagan, who at the time was dismissed by the media and the party elites as too outside the mainstream to be electable. Carter ran as a Southern modernist and Washington outsider. He promised change and won. A similar situation exists today.
The Carter administration proved to be a turnoff and a disappointment for a majority of Americans, as the bad economy he inherited got even worse under his stewardship. As a result, the emergence of Ronald Reagan, an improbable candidate under normal circumstances, was actually welcomed as a timely alternative. Voters generally bought his mantra that government was the problem, not
the solution, and he won the election. Reagan and Federal Reserve Chairman Paul Volcker took on double-digit inflation with double-digit interest rates, inflation was pronounced dead, striking air controllers were simply fired in a no-nonsense way, and the Reagan years generally got high marks. The mainstream world was now finally safe for a conservative promising limited government, provided his predecessor had exhausted the public's tolerance for big government. Unfortunately, Reagan never really followed through with his promise to rein in government spending, the consequences of which we are struggling with today.
Similar to Gerald Ford, John McCain had one challenger in particular whose message of limited government and sound money resonated with a small but organized minority. I am referring to Congressman Ron Paul, who, despite being marginalized by his other opponents and the mainstream media, struck a chord unheard elsewhere in modern politics, and managed to raise more money than any of the mainstream Republican alternatives.
The 2008 election features two candidates likely to make the current problems worse. Ironically, Barack Obama, whose policies would likely prove even more disastrous than McCain's, probably represents the lesser of the two evils. This is because Obama is perceived to be the candidate of big government, while McCain has wrapped himself in the false trappings of small government.
In the unlikely event McCain wins, he will be the Herbert Hoover of the modern era, completely discrediting capitalism in the minds of the electorate and setting the stage for a disastrous ideological counterreaction in the election that follows.
If Obama wins, however, while the economy will fare even worse, it will at least be clear that big government is to blame. By the end of Obama's term, the voters will have had such a bellyful of noxious government solutions that the mere thought of any more will put them squarely at the wheel of the porcelain bus. In such an environment, a Ron Paul type of Republican, dismissed as unelectable à la Ronald Reagan in 1976, may actually be in a position to capture the White House in 2012 and finish the job Ronald Reagan started.
Ultimately, we are going to need a free-market president, who understands sound money and Austrian economics and has the toughness, courage, and leadership talent to take the bull by the horns and begin the process of shrinking government, dismantling programs we can't afford, minimizing regulation and taxation so businesses can operate without competitive disadvantages, and generally taking the steps that will put us on a path to becoming a nation of savers and producers once again. If suffering though four years of hellishly misguided big government is the price we pay for true reform, it may in the end be worth it.
Posted on October 24, 2008 at 09:06 AM in Commentary | Permalink | Comments (10) | TrackBack (0)