Monday, May 12, 2008

Tuesday, May 06, 2008

First Angry Bear Social Security Post

Well Reader Dan invited me to submit some posts on Social Security and so here I am. Depending on reader interest this is the first in a series trying to get us to a deeper understanding of what Social Security actually is and where it is likely heading. And that may be a much different place than most people currently think.

Social Security finance is a really odd beast, it has a strong up is down quality that tends to baffle people. For example I will be making the case in a later post that cutting Social Security benefits actually harms the long range financial stability of the system. Why this seeming paradox holds requires us to examine some mechanical peculiarities of a PayGo system given the details of the current state of its financing. But before diving into the deep end I want to establish a conceptual framework, that is to show you Social Security through my eyes.

First it all starts, and mostly stops, with the Trustees' Reports, more formally known as the 'ANNUAL REPORT OF THE BOARD OF TRUSTEES OF THE FEDERAL OLD-AGE AND SURVIVORS INSURANCE AND FEDERAL DISABILITY INSURANCE TRUST FUNDS'. Almost every fact, factoid and date cited in this debate comes directly or indirectly from this Report. (Certainly CBO has a slightly different interpretation but they don't really challenge the fundamental assumptions of the Trustees). For the most part in this game all of the players are playing out of the same playbook and more importantly out of a particular subset of that book. More on that point later. The first lesson people need to learn is that 'It is already built into the model'. This is particularly important in relation to the demographics, because the first response from those hearing that Social Security is not particularly in crisis is: 'What about the Boomer Retirement?' 'More retirees, less workers, what don't you get about that?' or 'People are living longer!" Well I know all those things mainly because the demographers working in the Office of the Chief Actuary know them full well and have already accounted for them in their models. Which are published in the Report. Which I read.

Second point. Social Security really and truly is Insurance. Endless efforts have been made to blur this fact, and I expect/hope to see some in comments, but they all fail in the face of the actual operation of the system. Social Security collects premiums from all wage workers up to a determined wage level and disperses benefits to qualified beneficiaries. Which is pretty much the same as what New York Life does, cash flows in one door and out the other. That varying things happen with excess cash in between are not really the concern of the buyer and future beneficiary of the policy, as long as they get the promised benefits when the time comes then all's fair. That is there is no functional distinction between drawing a benefit dollar from the existing investment pool as opposed to simply paying it out of current premiums, PayGo does not equate to Ponzi. Banks and Insurance Companies don't have current cash reserves equivalent to all of their obligations, instead that money is locked up in what may be long term investments, instead they rely on current cash flow to carry the load. Of course banks are required to hold some cash reserves with the Federal Reserve and Insurance companies themselves carry reinsurance, you can't get too close to the edge. And this is where Social Security Insurance departs from New York Life, instead of reinsurance it has Trust Funds.

Which gets us to the third point. Social Security is not the Trust Funds anymore than New York Life is its reinsurance policy. The Trust Funds are simply the numeric measure of how much Social Security has in long term reserves. This amount can over any given year or series of years trend up or down without directly effecting benefit payments. In an up year Income Excluding Interest exceeds Cost and so surpluses flow to the Trust Fund, in a down year Income Excluding Interest lags Cost and the Trust Fund has to be drawn down, but typically not by much, current income is always carrying much of the load and would even if the Trust Fund went to zero.

Last points for today. Trust Fund 'crisis' is normally set at two possible points. One is crisis at Shortfall, that point where Current Income is projected to fall behind Cost for an extended period. This would require a sustained drawdown on the Trust Fund as more and more interest is diverted to pay current benefits. Whether this really equates to 'crisis' requires an analysis of the actual dollars in context. That rarely happens, instead people jump right to 'Raise taxes to unendurable levels! or Slash benefits to the bone! We got to act now!!' Well this hysteria whether real or fake (and much of it is fake) is simply that. Absent an examination of the numbers it is simply as Shakespeare put it 'A tale told by an idiot, full of sound and fury, signifying nothing', In this particular case if you can't say it in numbers you really shouldn't be saying it at all.

The second 'crisis' point, and the more traditional one, is crisis at Depletion, that point where the Trust Fund has been drawn down to nothing. Once again the temptation is to jump to "Oh My God we'll have to raise taxes' or worse 'Its bankrupt!! Dead broke!!! Checks will stop!!' Well that too is mostly nonsense, by law we need do nothing at Trust Fund Depletion, instead benefits would simply be reduced to whatever level was supported by current income. Whether that adds up to 'crisis' is once again a matter of comparing the numbers to the actual schedule of benefits while comparing it to benefit levels today. In the event the relevent equation from the 2008 Report is 78% of 160% = 120%. More on that later.

So lessons attempted here?
1. Numbers matter and they are to be found in the Reports. Including all the relevant demographic ones.
2. Social Security is in fact a Pay as you Go Insurance plan with a certain level of reserves. It is not a Ponzi scheme.
3. That reserve is called the Trust Fund, but is not itself the whole of Social Security any more than your bank account is the whole of your finances.
4. No one likes to draw down their reserves as we would at Shortfall, but you have to put that in context of your entire financial position. Which means looking at the numbers, see point 1
5. You plan for your retirement and ideally meet 100% or more of your goal. Hitting 78% may or may not be some sort of crisis, it might just mean buying a smaller boat. We need to examine Depletion in the context of both absolute level of benefit cuts and probability that the current projection will come to be.

I'll be glad to answer questions and meet challenges in comments. In future posts I will be explaining some of the odd terminology used: Low Cost alternative, Trust Fund Ratio, Covered Worker Ratio etc. For those who just can't stand to wait you might want to browse the Nov. 2004 archives of the Bruce Web (

Monday, May 05, 2008

Angry Bear Blogging

I have been invited to join the posters over at Angry Bear. For a while I suspect I will use this place as a drafting board and only move it over when the piece is fully ready.

I don't check my traffic and so really don't know if I actually get much, but if someone wanders by feel free to drop criticism or suggestions into comments here and then maybe join the discussion over at AB.