Darryl Cramer
June 3rd, 2005
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Social Insecurity

“Woe unto them that decree unrighteous decrees, and that write grievousness which they
have prescribed; to turn aside the needy from judgment, and to take away the right from the
poor of my people, that widows may be their prey, and that they may rob the fatherless!”

Isaiah 10:1-2

The concept that individuals and nations will be judged by the way they treat the weakest and
most vulnerable (e.g. widows and orphans) in their societies is as old as the Bible. In the United
States, no other federal program demonstrates our nation’s compassion for the weakest and
most vulnerable (e.g. the elderly and disabled children) more than Social Security. Nevertheless,
since the last election season and even more so since the President’s most recent State of the
Union, where he proclaimed that “society is measured by how it treats the weak and vulnerable”
(narrowly referring, of course, to abortion), there has been a cacophony of discussion,
information and, as always, misinformation regarding the Administration’s plan to partially
privatize the nation’s largest entitlement program. Where one stands with respect to the
proposed privatization might depend on one’s views towards the weakest and most vulnerable
members of society, but it most likely rests with one’s understanding of private retirement
accounts and, more importantly, whether or not one views Social Security as retirement
“investing” or retirement “insurance”.

From the perspective of retirement planning, the overarching principal of giving individuals the
ability to manage their own retirement portfolios by investing in stocks and bonds is laudable.
Longstanding asset allocation principals, validated by substantial academic and empirical
research, clearly indicate that individuals investing with a lengthy time horizon, such as for
retirement, would be foolish to devote 100% of their funds to low-yield treasury bills. While
stocks and bonds certainly entail greater risk, a diversified portfolio will, over time, generally
overcome short-term fluctuations in value and ultimately produce higher returns. This is
especially the case for investors who provision their accounts using dollar-cost-averaging,
which is, once again, the case for retirement investing.

That being said, it is also a fundamental principal in free-market economies that one cannot
achieve higher returns without accepting greater risks. Should a situation such as this ever
exist, market forces would intervene to make the necessary corrections to eliminate the
inconsistency. Therefore, while the median return for private retirement accounts invested in
stocks and bonds might be higher than a portfolio of T-bills, the normal distribution of returns
will inevitably produce some individuals who, through no fault of their own, gross
mismanagement and wanton recklessness, or something in between, will bankrupt their
accounts or arrive at retirement seriously under-funded.

The former employees of Enron know all too well how their private retirement accounts, in this
case 401(k)s, are doing. Of course the Administration quickly clarifies that under its plan people
will only be able to invest their personal Social Security retirement accounts in well-diversified
portfolios of low-risk stocks and bonds. While this is a long way from plunking down the whole
ball of wax on a single company, even if it was at one point the 7th largest in the country, it
should not be forgotten that the S&P 500, obviously a diversified composition of domestic
equities, plunged 49% between March 24th, 2000 and October 9th, 2002. This slide would have
certainly been a particularly disastrous scenario for a great number of people, especially those
retiring in 2003, should private accounts had already been in place.

Nevertheless, at some point in the future, should the push for private accounts be successful,
everyone should expect the “low-risk stocks and bonds” Trojan horse to be followed by
arguments to the effect that individuals should have the freedom to strengthen (“free” and
“strong” never being hackneyed) their retirement accounts by deciding for themselves what is
the most effective allocation of their capital. In other words, why should liberals prevent
hardworking, patriotic Americans from reaping rewards generated by hedge funds invested in
emerging market biotechnology?

Yet even if no one ever jumps out of the Trojan horse, some accounts will still go bust.
Arguments as to how many individuals that may or may not entail would be entertaining, but
the ultimate problem is nonetheless, “What are we, as a society, to do with these people?”

This question is really only pertinent when referring to, once again, the weakest and most
vulnerable: the rest will make due with their personal savings and IRAs. Sadly, as is typically the
case, the weakest and most vulnerable will be disproportionately represented amongst the
“mismanagers” and “reckless”.  Lest one think that the government will have to step in to bail
these people out, reconsider. Providing any sort of “safety net” or “security” for those accounts
that go bust will perversely affect the risk profiles of every member of the system; if one knows
that he or she is not going to be left to starve to death by the side of road, why not swing for
the fences? (As an analogy, imagine a gambler who, walking into a casino with $1000, knows
that, no matter what happens, he or she will be bailed out if the return from the weekend is
below a certain level. How would the risk profile of that gambler differ from someone without a
safety net? Furthermore, what might the risk profile of the gambler be if, right before having to
get back on the bus, he or she was down to something way below the pre-determined bail-out

Regrettably, the answer to the question of bailing out busted or severely under-funded
accounts must be, “no dice.” As callous as that seems, no matter who the individual might be,
poor, elderly, disabled, or otherwise, for the reasons mentioned above the government cannot,
and must not, step in to bail out those people. As a result, those without other means will, in
effect, be left to their own devices – a potentially tricky proposition for destitute
septuagenarians. While it is not clear how many people are aware of this fact, a recent
Newsweek poll reported that 73% of young voters, the group most likely to support
privatization, say the government should protect them if their accounts go bust. A responsible
Administration would take care to clarify this misunderstanding. Do not hold your breath.

Fundamentally, this is where the issue of “investment” versus “insurance” becomes apparent.
Investment accounts can, and do, go bust. Insurance accounts do not. That is precisely why
people pay the premiums. Insured individuals sleep well at night knowing that they are
protected. It should be noted, furthermore, that insurance is not incompatible with capitalism;
it is, in fact, indispensable to its smooth operation. Rational individuals do not have a problem
with this as they recognize that the purpose of insurance is to mitigate risk and protect from
devastating loses, not generate a return. Unaware or uninterested in this distinction, many
conservatives complain that Social Security is a massive transfer of wealth from the working to
the elderly. This is no more the case than medical insurance being a massive transfer of wealth
from the healthy to the sick or automobile insurance being a massive transfer of wealth from
the guys who enter the intersection at an inopportune time to those that do not. Continuing
with this logic, it should be observed that insurance premiums are never refunded, even if no
claims are ever made. Nor are they bequeathed to heirs. Moreover, some insurance policies,
such as automobile, are compulsory because of the financial and societal damage that would be
caused by uninsured third-party liabilities. Social Security is no different. Some might not see
any third-party liability associated with escalating poverty amongst the elderly or disabled
children, but they would be mistaken; that problem affects the efficient functioning of our
society as a whole, and thus all Americans.

Be that as it may, whatever anyone’s particular take on what Social Security should be today,
investment versus insurance, Franklin D. Roosevelt clearly intended the program to be the
latter when, upon signing the Social Security Act on August 14th, 1935, he declared, “We can
never insure one hundred percent of the population against one hundred percent of the
hazards and vicissitudes of life, but we have tried to frame a law which will give some measure
of protection to the average citizen and to his family against the loss of a job and against
poverty-ridden old age.” As demonstrated in the graph below, it appears to be working. While
the poverty rate amongst the elderly used to be three times that of those between 18 and 64
years of age, since the 1990’s their rate has coincided with the rest of the population.
Capitalists may not have much sympathy for the reckless, incompetent or lazy, which is fine,
but there is no shame in providing a means to care for those who cannot care for themselves.
To the contrary, there is considerable honor in it.

There are, however, legitimate concerns about the ongoing solvency of pay-as-you-go
retirement programs, especially with an aging population. Tragically, by the Administration’s
own admission, private Social Security retirement accounts will do nothing for the solvency of
the program as a whole. If the President had any interest in actually resolving this “crisis,” as he
constantly refers to it, he would be working with Democrats to do the obvious: raise the payroll
tax ceiling, add means testing or, oddly enough, do what Clinton proposed in his 1999 State of
the Union address, which involved “investing a small portion [of the Social Security surplus] in
the private sector, just as any private or state government pension would do.” Unfortunately, it
can only be assumed that the President’s interests lie not with resolving any solvency issues
but with dismantling the nation’s biggest and greatest entitlement program.

How we treat the weakest and most vulnerable in our society not only reflects deeply upon the
character and civility of our nation, but also is an important measure of our society. The
President recently declared, “The essence of civilization is that the strong have a duty to
protect the weak.” He was, once again, using sweeping rhetoric to refer to an extremely narrow
issue, Terry Shiavo in this case. Then again, maybe taking care of the weakest members of
society is not the most prominent ideal in capitalist, free-market societies. (One might be
surprised, or not, to find that a search on Google for “treat the weak” produces only 1,800
hits, almost half of which point to a song, True Nature, by Jane’s Addiction. By interesting,
although certainly unfair, comparison, “get rich quick” produces 1,300,000 hits.) On the other
hand, perhaps helping Wall Street generate massive fees is. (Professor Goolsbee at the
University of Chicago business school estimates the Bush plan will generate $940 billion in fees
over 75 years.) Conceivably Mr. Bush has spied an opportunity to capitalize on this perceived
mentality by making the dismantlement of Social Security part of his overarching philosophy of
transferring wealth from the working middleclass and the poor to the rich. Woe unto him.

Darryl Cramer