Inventing a Crisis

[DanS]

From the White House:

Dude, you're finding ghosts where there are none. What the web site is saying is that people can opt in to a private account or not. They have the choice.

It says absolutely nothing about the nature of the choices once they opt in.

If you want to find out about the nature of the choices for people who opt-in, look at the Thrift Savings Plan and then add on some guidelines/controls about investment allocations. This stuff's neither a mystery nor in any way exotic. I would happily put my retirement money in such a system with nary a blink of doubt.

[Kidlicious]

Originally posted by Tingkai
You assume that the money that individuals invest privately would automatically go back to the government. That's not the case. A large chunk of it would be invested in equity markets by mutual funds (because most investors will not put 100% into slow growth, balanced investment funds).

The government will have to borrow money from the international community and the international community is already signalling a reluctance to finance significantly more US gov't debt. And any money borrowed would put further downward pressure on the dollar.

The increase in interest rates will be felt market wide. There is nothing that will soften the impact.

The result will be an economic downturn.

I don't think the deficit will cause the decrease in economic activity. DanS is mostly right that we will fund the new addition to the deficit with the new savings, but it will result in less spending which will hurt the economy and that will make the deficit bigger.

[DanS]

I would wish that some of the investment heavy hitters would come out in support of one or more of these plans. We need the Warren Buffetts of the world to give their imprimatur.

[Kidlicious]

DanS,

Your reasoning is the same reason that tax cuts for the rich don't stimulate the economy and don't raise interest rates. Because the tax cuts are just saved, and there's no downward change in interest rates.

[MrFun]

Originally posted by DanS


Dude,

word

[DanS]

Here's an excellent WaPo editorial on the subject. I like the fact that they are keeping cool heads about this issue.

The Cost of Reform

Monday, December 6, 2004; Page A20

THE DEBATE over Social Security has begun with an argument that highlights the difference between idealized visions of reform and the imperfect real world. The argument concerns the transition costs associated with partial privatization. The administration and its allies say that these costs should not be counted; critics regard this as accounting trickery worthy of Enron. In theory, the administration has the better argument. In the real world, however, the critics may be right.

Social Security privatization would allow current workers to divert part of the payroll tax into personal retirement accounts. That diversion would leave the government short of money, so, assuming no tax increase or spending cut would be enacted to offset the shortfall, the government would have to borrow more -- issuing perhaps $2 trillion in extra bonds over the next generation or so. But, in a soundly designed privatization, this transition cost would generate an equal and opposing transition benefit. The workers who divert part of their payroll tax into personal accounts would accept an offsetting cut in future Social Security payments from the government, thus reducing the nation's debt to future recipients. In sum, privatization would merely substitute new promises to pay bondholders for old promises to pay retirees. In a properly designed reform, the net transition cost should be zero.

Likewise, the effect of privatization on interest rates and the dollar's value ought also to be zero. The prospect of an extra $2 trillion in bond issuance sounds scary. Won't extra government borrowing drive up interest rates? What if foreigners, who buy a large share of Treasury securities, balk at buying even more? These concerns miss the fact that the increased government bond issuance would be countered by the new pool of capital accumulating in private retirement accounts. Government borrowing would increase, but private saving would increase equally. Net national saving would not be altered, so interest rates and the U.S. dependence on foreign savers would not change either.

Those are the theoretical arguments. But there are reasons to believe that in the real world privatization would have real costs. It's easier to wriggle out of promises to retirees -- by raising the retirement age, for example -- than it is to renege on bond payments, so Social Security privatization might make the national debt harder to manage, even if it isn't larger. It's also possible that bond markets might be spooked by a flood of new issues, even though they shouldn't be; markets can be at least temporarily irrational, so privatization could hit the economy with a period of high interest rates or dollar weakness.

But the biggest reason to fear that reform would be expensive is that in order to sell it politically privatizers might well be tempted to sweeten it. This could happen in several ways. Reformers might promise to bail out private-account holders who suffer big investment losses, or they might end up bailing them out some time in the future. That would be a real cost. Reformers might allow a large diversion of payroll taxes into personal accounts while imposing only a small cut in future Social Security benefits. Again, the gap would generate a real cost. The private accounts in the most popular reform model advanced by President Bush's Social Security commission include a subsidy to account holders that measured in today's dollars would come to more than $1 trillion, according to Peter Orszag of the Brookings Institution and Peter Diamond of the Massachusetts Institute of Technology. Reformers have to make the case that these costs, as well as the risks that privatization might pose to a system that protects vulnerable members of society, are justified by the benefits that private accounts could bring.

[chequita guevara]

It forgets about interest rates. The money we borrow today will be quite a bit larger after sitting around for a couple decades collecting interest.

[DanS]

No it doesn't forget about interest rates. Read the editorial again. I've now bolded the pertinent parts.

[el freako]

I think you've misunderstood him DanS,

He's talking about the interest the government will have to pay if it borrows now as opposed to later.

[DanS]

OK, as the article points out, the present value (i.e., the net transition costs) of all of those changes is zero.

[chequita guevara]

I wanna see the math before I believe them. Interest rates are generally higher than inflation and COLA, so I suspect we will pay more in the long run borrowing now than borrowing later.

[Ogie Oglethorpe]

A question. With all that extra capital isn't there a risk of creating a substantial bubble?

[Tingkai]

Originally posted by DanS
Yes, the government will have to borrow more money. And the interest rates for the government will go up. Isn't that what I just got done saying? (You appear to be doing your level best to misconstrue what I am writing.) However, extra money will be going into the private sector, partially offsetting this increase for the private sector (i.e., the spreads will decrease).

Dans, you're assuming there is a closed loop, but it is not closed.

Let's say the gov't cuts social security taxes by $10 billion. Individuals now have this money and let's say 20% goes to govenment bonds and the rest goes to equity markets. These individuals buy $8 billion of stock from institutional and private investors.

These investors won't lend all of this money to the gov't. They want to diversify their investment. Some of the money will go back into the US stock market, but a chunk of it will be invested overseas, a declining dollar makes overseas investments even more attractive. So let's say 20%, or $1.6 billion, goes overseas* (it would likely be a much higher percentage) and investors buy $6.4 billion of bonds ( there are numerous levels of investors, with money being diverted overseas at each level, but I don't want to make this complicated .

So the private retirement savings and the investor's money provide the government with $8.4 billion. The gov't gets the rest of the money by raising interest rates which pulls $1.6 billion from the private market into the gov't coffers. Private companies that need to borrow money will have to raise interest rates. Those higher bond rates filter down to consumer rates. Net result is decreased consumer spending and decreased private investment which causes an economic slowdown.

The upward force on interest rates can be absorbed by overseas investors and that's what's been happening in recent years, but foreign investors are becoming less and less willing to invest in the United States. This year, there has been a net outflow of long-term investment from the US. Even without the Bush social security plan, American interest rates will have to rise.

* Overseas investments push down the US dollar as US investors sell their greenbacks for the foreign currency to buy foreign stocks.

[Tingkai]

Originally posted by DanS


Dude, you're finding ghosts where there are none. What the web site is saying is that people can opt in to a private account or not. They have the choice.

It says absolutely nothing about the nature of the choices once they opt in.

If you want to find out about the nature of the choices for people who opt-in, look at the Thrift Savings Plan and then add on some guidelines/controls about investment allocations. This stuff's neither a mystery nor in any way exotic. I would happily put my retirement money in such a system with nary a blink of doubt.

Dude, show me where the White House says that people will be forced to buy a limited number of mutual funds.

The White House document makes no mention of funds. It says specifically that investors will be free to choose what they invest in. It says "workers can sell company stock and diversify into other investment options, minimizing their risk".

If you have documents that say people will be forced to buy a limited number of mutual funds then let see it.

I agree that the TSP would be a workable model, but as I said before, Americans would never accept being forced by the government into investing into a limited range of funds.

[DanS]

I've read and reread the page that you quoted, and it seems crystal clear to me. I suggest that you just don't know how our system works if it's not so clear to you. Not knocking you, of course. I don't expect you to know because it doesn't impact you.

Here's what it says...

All of those who are in 401(k)s for 3 years will be guaranteed a certain amount of choice in their 401(k)s. Right now, some companies require that employees purchase that company's stock in their 401(k). Enron had such a system, so when Enron went bust, so did all of the employees' 401(k)s. Bush is proposing that this requirement by some companies be removed, thus allowing employees to sell their own company's stock, buy other companies' stock (mostly through mutual funds), and reduce their risk through diversification. "[W]orkers can sell company stock and diversify into other investment options, minimizing their risk" refers to the 401(k)s and has nothing to do with social security.

In addition, employees will be given the choice to opt-in to private accounts for social security, whereby a portion of their payroll taxes are invested. The text doesn't say how this will be invested.