The Social Security Trust Fund Holds Nothing But Government IOUs

Every few weeks, another story is written with impressive headlines about how the Social Security System will go completely broke by year 2037. A lesser known event is that the Disability Trust will be depleted by 2018, seven years from the date of this writing. This 2010 estimate from the Social Security Annual Report is grim, yet Congress will not act to make necessary changes to ensure the financial integrity of the Social Security Program. Everyone knows that the System will deplete its assets due to the Baby Boomers collecting benefits in their retirement years. The Baby Boomer generation is so large that the annual benefits that will be paid to them are well in excess of the annual contributions being put in by active workers. This has been predicted and expected for many years, yet our government refused to make the painful changes necessary to ensure the System would still be viable for generations to come. Several decisions were made last decade such as extending the retirement age, but it is not enough to stave off the coming disaster. Why? Because the really painful decisions were/are political suicide for Congressmen and President, and each past/current congressman/senator knows that he/she will not be around when the changes will be forced upon us due to lack of money to pay the monthly checks. President Bush made an attempt at change, for better or worse, but did not succeed. It is a fair guess that the Obama Administration will not touch the subject.

Questions in the minds of people are:

· Why is the System Going Broke since the Boomers have been paying into the System for their entire working careers?

· Why are not all the Surplus Assets (yearly contributions going in minus yearly benefit payments going out) which were contributed by the Baby Boomers and their employers not sufficient to pay the Baby Boomers’ Social Security for life? Did the Actuaries make mistakes way back when?

· Where are the Surplus Assets? Since the Social Security System is supposed to be a segregated financial system, separate from the federal government’s finances, shouldn’t all the Surplus Assets should be there to pay all the Boomer benefits?

Social Security was Designed as a Pay-as-You-Go system, or A Legal “Ponzi Scheme”

We have to think back to the 1930’s, vs. today, to understand how the system was designed. Back then, families were fairly large, meaning each average couple had 2, 3, 5 or more children. The designers based the system on simple population statistical projections.

Example to explain the theory:

· If one couple produces 4 children, each of those children will have 4 children (or 16 grandchildren), and each of the 16 grandchildren will have 4 children (or 64 great grandchildren) and so on. The Pay-As-You-Go system states that the original couple (2 parents) pays into the system retire and collect benefits. If their contributions were not enough to cover their benefits, their 4 children, who are now working, are making contributions into the system to cover their parents’ shortfall. When the 4 children retire and receive benefits, their contributions should be enough to cover their benefits. If not, the 16 grandchildren are now working and contributing to the system which will cover any shortfall. And on, and on, and on it goes FOREVER.

A Pay-As-You-Go System works if;

a) benefits are in the correct proportion to contributions

b) Only the employees who paid into the system receive benefits

c) People receive benefits for as long as the system assumed they would. In other words, people die when the actuary assumed they would die and not live longer and longer.

d) There is a steadily increasing stream of new workers paying into the system

This is exactly how a Ponzi Scheme is designed, thus allowing someone to steal large amounts of money without people catching on until it is too late. The most famous example is Bernie Madoff. Bernie was an Investment manager who managed a Fund. Investors poured money into the fund which Bernie began to siphon off for his own use. He would doctor the books, and use the contributions of new Investors to cover any withdrawals of the old investors. This works as long as the new investors are contributing more money into the fund than old investors are taking out. These schemes always eventually fall apart due to either someone discovering what is going on or new investors not contributing enough money to cover the transactions of older investors.

So what happened to the Social Security Ponzi Scheme? A combination of items similar to the above:

· With advances in science, people continuously live longer, thus receiving benefits longer – a violation of item (c) above

· Congress loved the system since it did not cost much to the government, and so they continually got more generous. They added death benefits, coverage for non-working spouses, benefits for disability and disabled children, etc. – violation of item(a and b)above

· The “biggie” – the post World War II Baby Boom. The operative words in item (d) above are “steadily increasing stream” of workers. The Baby Boomers, once they hit working age, caused a huge inflow of new contributions, which will be discussed later. Moreover, when the Boomer eventually retires (lead Boomers started last year, 2010), the outflow is going to far exceed the inflow of new contributions from current workers – Gen X and Gen Y. There will be a large drop in contributions into the system as more and more Boomers retire. So, there will no longer be a “Steadily increasing stream” of new contributions coming into the system; rather, there will be large withdrawals – a huge violation of item (d) above. This item is the normal reason all Ponzi schemes eventually fail.

Where is the huge amount of money Baby Boomers Contributed into the System?

The System designers could have set up Social Security as just another government promise, and implement a tax to be received into the US Treasury, just like income taxes. There were a number of reasons to establish the System as a separate legal entity, with its own tax base and liabilities. One of the major reasons was that Social Security was advertised as a savings program for the masses, and people needed to see their contributions going toward their own future benefits. It was known early on there would be a Surplus of contributions in excess of current benefit payments coming into the system, so the law mandated that a Trust Fund be established to hold and invest this large amount of money to pay for future benefits.

The System implemented its own tax on workers’ wages. This year a 10.4% tax on your wages (4.2% from you and 6.2% from your employer), officially called the FICA tax, will be contributed into the Trust Fund. The Trust Fund continues to grow year after year and currently contains assets in excess of $2 trillion. The average person views this Fund as he would a savings account, holding all the hard earned dollars of the workers who contributed into the Fund. Legally, this is correct, and it is how the Fund was broadcast. People felt safe knowing their money would be there when they retired. But idle cash needs to be invested. The designers prohibited the Trust Fund from investing in the Stock Market, or in the private sector, or to make loans as a bank would do. This was deemed too risky and would open the door to potential abuse.

 

The System designers wrote into law that all assets of the Social Security Trust Fund must be invested in US Treasury Securities. In other words, all the billions of dollars over the years get continuously invested in US Treasury T-Bills, Notes and Bonds. These investments are IOUs of the Federal Government, just like a US Savings Bond that you might buy for your child’s birthday present. Where do the investment dollars go when you invest in a US Treasury Security or US Saving Bond? The money goes into the general coffers of the US Treasury and you get a piece of paper stating that the US Government promises to repay the money back to you with interest at some future date. What is the US Treasury and where does its money go? The US Treasury is the US Governments “bank account”. From this account, money is disbursed to pay all government workers’ salaries, fund all the great projects that Congress enacts in new laws (much of it called Pork since it only helps certain groups of people), pays the Foreign Aid that our lawmakers approved to be given to other countries, etc.

Essentially, the Social Security Trust Fund consists of over $2 trillion of IOUs from the US Government. Now, we need to step back and look at all this from a general viewpoint. There are two ways to view the situation and these views are sources of constant criticism, explanation, battles and name calling.

· Legal and Investment View – the Trust Fund contains all the Surplus contributions you and your employer have made over the years. The money is invested in Treasury securities which are a legal promise of repayment of principle and interest. These securities are considered one of the safest investments in the world. Since the Baby Boomers are now starting to retire, these assets should be sufficient to pay benefits thru at least 2037, at which point the Baby Boomers will have depleted the Trust Fund. After that, no one is quite sure what will happen. The government could make up any shortfalls in benefits or the system could just stop paying benefits. Everyone knows something needs to be done, but no one has come up with solutions that are politically feasible, and acceptable to the masses. Congress has not made this a current priority since the Benefit Payment Trust Doomsday is still 26 years away, and ignoring that the Disability Trust Doomsday is 7 years away. They will happily leave this time bomb to future generations of Congressmen. It is not viewed as a current crisis, even though they all say differently.

· Holistic Government Cash Flow View – The Government receives in taxes and other revenues, and makes disbursements to wherever. If the government starts running out of money, they simply raise taxes in some form. They could also reduce expenses, though this has never been one of the hallmarks of any government, let alone our US Congress. State governments are even worse at cutting expenses. The government funds its activities by selling bonds to anyone who will buy them, including foreign governments (subject of other articles on how much of our government debt is owned by China).

The Social Security Trust Fund is just another buyer of government debt. The federal budget anticipates and expects the huge amounts of money that will come in from the Trust Fund. The money comes in via Bond purchases, is deposited in the US Treasury, and is spent on government activities along with all other taxes and revenues. Essentially, all your social security taxes have been lent to the federal government who, in turn, has spent your money on all the other Entitlement Programs and ludicrous favorite pork items of the Congressmen. In other words, the Surplus contributions are gone, but promised to be paid back by a government that is running higher and higher budget deficits every year. The huge amounts of contributions that came into the Trust Fund and, in turn Treasury securities, swelled the coffers of the US Treasury. These amounts also swelled the government liabilities, but we tend to ignore that side of the equation. We can blame Obama, Bush, or any other favorite president. But the simple fact is our politicians have a blank check book without having to worry much about balancing the account.

These two Views are the subject of constant heated battles in articles and blogs, but not so much on TV News shows. TV focuses on the point that the Trust Fund is going broke and benefits could cease. They do not focus on the effect of the government having to pay back the $2+ trillion it borrowed from the Social Security Trust Fund.

The main question in the minds of retirees is will the Trust Fund have sufficient assets to pay benefits in the future? However, under the Holistic Government Cash Flow View, an equally important question needs to be given more attention; Where is the government going to get the money to repay all the huge amounts of Treasury securities that will be liquidated or cashed out to pay for the Boomer social security benefits over and after the next 26 years. Logical answer to this is that the government will merely get the money by selling more treasury securities to whoever will buy them. We can continue to push the liabilities out into the future as we have done, but when do future generations say Enough. How long will Gen X and GEN Y put up with the financial pain that will be necessary to keep the Social Security financial system running. At some point, these generations are going to balk, and that is the point at which the current slate of Congressmen may take action to stop the entitlement programs or severely curtail their benefits. But a future Congress will have the same problem 26 years from now as they do currently. How do you tell Gen X and Gen Y to continue to put taxes into the Social Security System knowing they will receive no benefits when they retire? However, that future Congress will not be able to ignore the question as we do now, and will try to come up with solutions that push out the liabilities even further. They will be forced into making some fairly unpopular decisions. We are already hearing a lot of chatter among these two generations to cut out the Social Security Program now and let the Baby Boomers share in the pain. However, the Baby Boomers are having none of it. Social Security is currently considered almost a birthright and is sacrosanct. Gen X and Gen Y may just change the Boomers current view when they get mad enough to force action in Washington.

A popular joke of Baby Boomer has been “Be nice to your kids, they get to pick your nursing home.” Well, we should extend that joke to “…and decide how long you will receive your Social Security check’’.