Fact Finding on Social Security

http://news.morningstar.com/articlenet/article.aspx?id=567437

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Fact Finding on Social Security

Retirement columnist Mark Miller responds to reader feedback about his recent Social Security myths commentary.
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By Mark Miller | 09-14-12 | 06:00 AM | Email Article

"Facts are stubborn things," John Adams said in 1770. My recent Morningstar column on myths and facts swirling around the Social Security system stirred quite a bit of passionate political debate, judging by the comments posted to the article. But even amid stark disagreement, at the core of the system are certain facts that can be useful to any investor trying to understand Social Security and where it fits into his or her retirement plans. Several aspects of the program are worthy of debate, and by clarifying the facts, I hope to make those

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About the Author Morningstar columnist Mark Miller writes about trends in retirement, aging, and the economy. He is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living, and writes a syndicated column for Reuters. Mark blogs at RetirementRevised.com Twitter: @retirerevised. Contact Author | Meet other investing specialists

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conversations more productive. In that spirit, and in response to some of the most interesting comments from readers of my first article, here are some further facts on Social Security.

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Fact Finding on Social Security

http://news.morningstar.com/articlenet/article.aspx?id=567437

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I.O.U.s Social Security critics argue that the Social Security Trust Fund is an accounting gimmick because its assets have been lent to the government via special-issue Treasury bonds. I pointed out that the bonds are "full faith and credit" obligations of the government--therefore, they are real assets.

"How can you possibly believe that the special-issue bonds represent real assets?" writes John Dewey in a typical response. "The special-issue bonds are nothing more than IOUs from one part of the government (the taxpayers) to another. There is nothing in current law that requires these bonds to ever be redeemed." In fact, under federal law, the financial assets held by the retirement and disability trust funds can be used only to meet the obligations of these programs. (See Section 201(d) of the Social Security Act.) It's also important to understand that the special notes aren't just sitting in a vault--they are being redeemed regularly. Steve Goss, chief actuary of the Social Security Administration, describes the process: "New bonds are purchased every day from the revenue coming into the government, and they are credited to the trust funds. Similarly, whenever any money is expended from the trust funds, for benefits or for any administrative expenses, this comes from redeeming bonds. So, bonds are issued and redeemed all the time.

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Fact Finding on Social Security

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"This is significant because there is a strict rule on the priority order for redemption of bonds. Anytime a bond is redeemed, we redeem from among those bonds with the shortest remaining duration to maturity, and redeem the bond from that group that has the lowest interest rate. New bonds issued are always issued with an interest rate compounded semiannually at the average effective market yield determined by the Treasury Department at the close of the prior month for all outstanding marketable Treasury securities that are due or callable four years or more in the future. We also have specific procedures for the term of bond issues and the date of rollover." Although most trust fund assets are held in the special Treasury notes, Goss says that the key legal requirement is that the funds be invested in interest-bearing securities "backed as to principal and interest by the full faith and credit of the U.S. government." The trust funds don't have to invest solely in special-issue bonds and have not always done so in the past. "Marketable Treasury securities and some mortgagebacked securities also qualify, but none are held by the trust funds currently," he says. For more on this, see Social Security Administration actuarial note 142--the first memo on this page. Why doesn't the trust fund also invest in corporate bonds or stocks? Politics. When the Social Security Act was passed in 1935, the original intent was to invest in all kinds of private-sector assets--an idea that sparked resistance from conservatives, who disliked the socialistic implications of having the government invest directly in the private sector. Senator Arthur Vandenberg, a Michigan Republican who was a key opponent of most aspects of the New Deal (but did support the creation of Social Security), was concerned that the large trust fund Social Security was expected to build up would result in a kind of socialism. "He had a somewhat famous exchange with Arthur Altmeyer, the first chair of the Social Security Board, in which he asked Altmeyer what the trust fund assets might be invested in," says Eric Laursen, author of The People's Pension: The War Against Social Security from Reagan to Obama. Altmeyer replied, in 'social undertakings such as . . . low-cost housing, schools, hospitals,' and even in manufacturing 'that could be justified from the point of view of social welfare.' "That scared the bejeezus out of Vandenberg, who went on to insist that the trust

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fund be shrunk and invested in Treasury bonds." We're All Greek Now Some readers just aren't buying my argument that Social Security can't bankrupt the federal government because the U.S. government has the power to tax and print money, unlike the troubled Mediterranean country that is the poster child of the European sovereign debt crisis. Inspectorgadget's comment is typical of the thread: "Essentially [Miller] says, in several different ways, 'Don't worry, the government owes Social Security all this money, future taxes can be raised to cover Social Security.' That's the problem, isn't it? Taxes on whom? On the shrinking workforce to pay for a growing retiree population? Has this expert looked at the newspaper lately to see news about Greece (for example), to see where this leads?" Of course, Greece is a eurozone country, at least for the moment--which means it is in a monetary union and can't make decisions on its own to print money. Furthermore, financial markets don't seem to share the reader's concerns. Ten-year U.S. Treasury notes are yielding about 1.6%--not far off record lows and hardly a rate that any sane investor would accept for 10 years from a borrower that is headed for bankruptcy. Compare that to recent 6.8% yields on the 10-year notes of Spain, another stressed eurozone country. This is not to dismiss the long-range importance of the debt problem for the U.S. economy--or the inflationary risks inherent in printing money. But the option to inject liquidity into the market does mitigate the crisis notion of a sudden bankruptcy where debts cannot be repaid, as we are seeing in Greece and Spain. Moreover, the market itself is not pricing U.S. sovereign debt anywhere near crisis levels. China Syndrome I argued that Social Security isn't, per se, a contributor to the national debt. In fact, the program is a lender, not a borrower. Just like the Chinese. "The truth is that to say Social Security will not be a major, and growing, contributor to the national debt is simply intellectually dishonest," writes damich44. "The Social Security Trust is the single largest creditor of the U.S. government, and it isn't close." My point on this is simple: debt obligations are debt obligations, whether they are to a sovereign foreign government or to Social Security. And remember--an

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obligation to Social Security really is an obligation to the American people, who have "lent" their FICA tax contributions to the government--tax contributions that were made with the promise that they would be used to fund their future Social Security benefits. Social Security's old-age and disability trust funds currently hold $2.7 trillion in bonds. As of June 2012, the two biggest sovereign holders of U.S. Treasury obligations were China ($1.164 trillion) and Japan ($1.119 trillion). At $5.292 trillion, all foreign sovereign debt holdings dwarf Social Security's holdings.
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Fact Finding on Social Security

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SteveM Sep 14 2012, 6:15 AM Flag

Mark, you are either a very brave man or a glutton for punishment to wade into these waters again :-)

kayaker Sep 14 2012, 7:13 AM Flag

I just flagged Mainstreet100 as inflammatory - if everyone who has gone through Medicaid and a nursing home process with a relative does the same maybe we can get this ignorant, cruel and insensitive remark removed. While some right wing philosophy may have intellectual basis most of it is propoganda fed to parts of the lower class that mysteriously supports them in the face of what is not best for themselves, at least financially. I often wonder why? I guess they hate minorities and are religiously brainwashed about women rights so much that it overcomes the fact that they will never be the person to benefit from the economic agenda espoused by the rich. They actually believe that the freeloaders in our society pay no taxes and that robs them when they often are un or underemployed and pay little tax themselves while relying on the benefits they decry. Watch out right wing if they ever wake up.

Mainstreet100 Sep 14 2012, 7:28 AM Flag

capecod Sep 14 2012, 7:36 AM Flag

There is no way to overcome the loud, adrenalin-soaked, hair-on-fire (and sometimes purposeful) misunderstandings about social security, the national debt, and taxes that have been sparked and fanned by a decade of the radical politicization of everything in our society. Facts no longer matter.

yrag46 Sep 14 2012, 7:40 AM Flag

Mainstreet100..... To the point and well put.

Mainstreet100 Sep 14 2012, 7:41 AM Flag

Kayaker I think you misunderstand my post. I am sure that process is soul draining and was not directed to those that have to do it. It was directed to the hypocrisy of those that take advantage of it who do not have to while espousing philosophies ignoring the poor.

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academic Sep 14 2012, 8:41 AM Flag

Mr. Miller describes some details of the mechanics of the SS Trust Fund to argue that it is an "asset", but none of these details address the key issue: the existence of this fund does not change the net financial position of the US federal government at all. At best, you could try to argue that the trust fund is an accounting mechanism to determine how much taxpayers "owe" Social Security. But even that is not correct. The Supreme Court has ruled (e.g. Flemming vs. Nestor, 1960) that Social Security is not a contractual obligation to SS taxpayers. Rather, it is a spending program that Congress can revise at any time as it sees fit. So according to the law, Social Security does not "owe" future beneficiaries anything. Congress could, if it wished, reduce benefits at will and never redeem a dime of the "trust fund." In the setting of these benefits, the trust fund will play at best a minor role. Yes, its existence will provide some ammunition to argue in favor of maintaining benefits when SS taxes fall short of benefits. But it's just a fact that Congress bases its decisions almost totally on demand from constituents for higher current benefits and lower current taxes, not rational long-range financial planning. The only relevance of the "Trust Fund" is that it plays a small role in the purely political decision of how to adjust benefits in the future. Other than that, it is meaningless and irrelevant.

polkster0 Sep 14 2012, 8:44 AM Flag

Mark, how then do you explain President Obama's statements during the debates over raising the "debt ceiling" last summer? On several occasions Obama said that if we didn't raise the debt ceiling by the required date, "we might not be able to send out Social Security checks". If there are actual assets in a Social Security trust fund, why would the president of the US say something like that? Does he know something you don't?

capecod Sep 14 2012, 8:51 AM Flag

Yes pollster.....as Treasury cash balances approached zero because it needed to continue making contractual payments but could not borrow, its lack of cash would ultimately have made it impossible to redeem the Treasury debt in SS to supplement or make cash payments to SS beneficiaries. See, it really isn't the conspiracy theory of everything if you actually bother to think it through....of

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Fact Finding on Social Security

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course, if that's too much of a challenge....

colorado43 Sep 14 2012, 10:27 AM Flag

Mark, What has been the fund's real investment return to recipients on their contributions?Like every other investment, the real return is calculated by adjusting for inflation. How will today's low Treasury yields influence the real return?
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