Social Security Is The Post Office Of The Investment World

by JoeTheEconomist September 29, 2011 19:31 PM

Milton Friedman once observed, “If the government ran the Sahara, in five years there would be a shortage of sand.”  He is right.  The government has run Social Security for 70 years, and now there is a shortage of security.   Today more than 80% of Americans believe that Social Security is heading for crisis if the government does not implement a major reform.  So a system that is supposed to provide security, now it only provides uncertainty for the vast majority of Americans. 

Friedman’s quip about the Sahara is an amusing look at government.  The comment about Social Security on the other hand is rather frightening.  The difference between these similar outcomes is that few people depend upon sand in the Sahara; where as Social Security has become a sinkhole of dependence with millions dependent upon a system which is comically broken.

Just how broken is the Social Security system?  While people argue about the solvency of the system, the Social Security Trust Fund’s assets are managed with a 70 year-old investment policy that has underperformed the equity markets by nearly 50 to 1 during that time.  As a consequence, we are debating raising taxes which will be subsequently invested in bonds with a yield of less than 3%.

One day, economists will study this comedy because Social Security is the perfect storm of economics.  It blends the inefficiency of monopolies, with the incompetence of government, with the indifference of absolute pricing power.  This concoction isn’t just headed for failure.  It is headed for massive failure.

People tend to think of the Post Office as the poster-child of government ineptitude, but it is well run compared to Social Security.  The reason for its relative success is that the Post Office has to compete with private sector companies.  No one is forced to use the United States Postal Service.  We communicate by phone, email, and best of all private sector mail services which drive innovation into the business model of USPS.

Social Security competes with no one.  It could be the purest monopoly in the world.  While thousands of firms offer investment products, Social Security does not compete with any of them.  Social Security gets more than half a trillion dollars every year regardless of what happens in the outside investment world. 

As a consequence, innovation is driven by managers at the Social Security Administration rather than by market needs.  The Social Security Administration chose to add things like automated check deposit.  But it didn’t have to offer that service.  The Social Security Administration offers a website, but it didn’t have to offer one. 

So how bad is letting government drive innovation?  Only the government could create a retirement tool that is completely insensitive to risk appetite.  Social Security allocates risk in a one-size-fits-all model that is not only expensive but dangerous.  Imagine, the nation is engaged in a discussion about the solvency of a system, which has no way to allocate the risk associated with insolvency.

Can government innovation get worse?  Social Security is supposed to provide insurance, and yet it has no mechanism for price discrimination.  Survivor benefits are difficult to price – so we make them free.  The unhealthy cardiologist with a family of four pays exactly the same rates that a single person does.   According to the Social Security Administration, survivor benefits basically double the cost of benefits - but the benefits are given away for free.

Actually it can be worse still.  The Social Security system cannot invest in higher yielding assets because some critics feel that the financial markets are too risky.  As a consequence, Social Security invests 100% of its excess assets in a single issuer within an asset class that has enjoyed a 30 year bull market.  The issuer is the US government which has Debt/Annual Revenue of more than 500%.  But the financial markets are too risky.

In short, Social Security could be the only retirement product in the world that cannot allocate risk.  It is likely the only insurance product in the world that can’t price risk.  And it has an investment strategy which brings together low returns and maximum risk.  Social Security is broken because there is no private market where innovators can drive incompetence out of business.

In the private sector, profit and loss regulate the decisions of such managers.  Government has no way to incorporate profit and loss into its decision making process.  In the mind of its managers, positive cash flow is profit regardless of what happens to unfunded liabilities.  This is not a joke.   Politicians of both parties generally agree that Social Security has not contributed to the deficit, ie it makes money.   So Social Security will not be a problem until it is a catastrophe.

The consequence of absolute pricing is that no one who runs the system cares about whether the product is any good.  If the system runs out of money, the managers simply raise the price and shrink the box.  In terms of Social Security, raise the price and shrink the box means raising taxes and lowering benefits.  In the last 70 years, we have never had a single discussion about how to fix the system.

Today some actually argue that we should raise taxes and lower benefits because “Social Security is the most successful government program ever.”  It would be funny if millions of people did not depend upon the system.  As a system, Social Security does not attract money well.  It does not manage what resources it has well.  And it does not allocate its resources well to serve its purpose.  Social Security is horribly broken.  Our leaders don’t want to fix a broken system they want to convince us to pay for one.

That is not funny.

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