The Problem With Guaranteeing Privatized Accounts

by JoeTheEconomist October 12, 2011 9:31 AM
Investment without risk is like Christianity without Hell.”

~Warren Buffett

We generally oppose any privatized solution which guarantees the investment returns of a retirement account.  If workers want to invest their retirement money in lottery tickets, it is up to them and they must accept the consequences.   This isn't cruel.  It is necessary to protect the rest of us from fools armed with other people's money.

Guarantees encourage unwarranted risk taking.  Guarantees enable workers to invest on unnatural terms.  If the investment wins, I win.  If investment loses, the taxpayer loses.  This is the exact mindset which enabled our economy to position itself on a financial apocalypse. 

Washington expresses its concern by seeking to create oversight boards.  These policy wonks who have never bought or sold a stock completely miss the point of risk.  Risk isn’t just in the viability of the business.  It is expressed in the price of ANY asset.  If Washington creates a narrow list of approved investment, risk-tolerant money will chase safe investments until they are risky.  When you subsidize risk, you will create risk.  In short, Washington’s solution is to create risk in our most stable companies.

On a very good day, this idea is simply foolish.  It strays into the realm of dangerous because Washington, which clearly does not understand risk, wants to be in the position to manage risk on our behalf.  They want to create an investment list of suitable investment to ensure the safety and soundness of the system.  

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other….  In our view derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal..”

~Berkshire Hathaway Annual Report 2002

 Fair enough.  How successful has Washington been in protecting the safety and soundness of any system.  Let’s look at banking.  The government was surprised by the dangers of 35 to 1 leverage in the banking industry.  Washington described “derivatives” as useful tools held in the hands of well-capitalized sophisticated investors.   Half were, and the other half was in the hands of AIG.  Over a period of a few months, these investments wiped out Bear Stearns, Lehman Brothers, and AIG costing the tax payers hundreds of billions of dollars. 

How did you possibly miss the housing bubble? How could you say at the peak of this three-Sigma event--a one in 1,000 year event at the top of 2006--how could you say the U.S. housing market merely reflects a strong U.S. economy? Surrounded as you are by all this statistical help, and with your experience with the Great Depression, how could you miss it?

~Jeremy Granthom A Question For Ben Bernanke

Let’s look at housing.  In 2006, Washington said that the strength of housing prices reflected a strong economy.  Washington didn't just misgauge the housing market.  It suggested that the housing market was fine despite being a levels of overvaluation that occurs about every 1,000 years.  And you want to allow government to define how you can invest your retirement funds?




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