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The trust fund myth!                                                                                    

Posted at: Feb/08/2011 : Posted by: mel

Related Category: Politics & Gov,

I am here to tell you that the Social Security “Trust Fund” is an illusion. Did I say something wrong? This essay is not meant to scare you; this is meant to educate you. Social Security is most likely the largest single federal program that there is. I am not sure if basing a program of this scale on an illusionary title is good governmental policy, or just accidently misleading, others can debate that point. What I will do here is attempt to explain how Social Security actually works and why you need to be worried if it is all you are depending on for your retirement years.

I’m sure your conventional image of a trust fund is not too far removed from a piggy bank, you put money in and it is there to be taken out at some later time. In a more sophisticated version you might go to the bank and take out a CD or open a money market account that offered a small, but consistent rate of return. Still more sophisticated is the potential to invest in mutual funds or stocks that would include some degree of risk. For most of us though, the vision we conjure up with the term trust fund is of some big gothic looking bank where our investment is earning a small but consistent rate of return. All these are wonderful images could be true if you elect to create your own “private” trust fund, but this is not how our federal social security program actually works.

Let’s return to the piggy bank for a quick example. If you want to think about the current Social Security Trust Fund like a kid's piggy bank it might be something like this. The kid is putting money in the piggy bank, but the parents are living well beyond their means so they borrow from their kid's piggy bank. But if the kid wants to buy a new video game with the money they have saved the parents will have to pay that money back that they borrowed from their childs piggy bank. Unfortunately, it really does not matter where the money comes from, you have to pay your kid back. Now...Imagine that for whatever reason these parents have credit cards galore so really it doesn't matter to them which credit card they are putting it on. They will put other stuff on plastic and pay back the kid. This is a similar situation to what our federal government is in right now. The federal government’s plastic is currently held by China and a host of other countries. It really doesn’t matter who the plastic is with, they know they need to pay back their kids piggy bank.

Now let’s do one more slightly more complicated example. We will begin our story with Bob and Betty Smith (any resemblance to actual people is purely a coincidence). Bob earns $60,000 per year and Betty earns an additional $40,000 per year, so their household income is $100k. The Smith’s are like most in their neighborhood and spends $70,000 a year on things like rent, food, and utilities. Unfortunately, Betty’s parents are sick so Bob and Betty give them $40,000 a year to help out. Most of us would look at this and now say the Smiths are running an annual $10,000 deficit, which unfortunately is placed on Bob's credit card. Bob and Betty actually view this as a retirement investment, are you confused? Betty’s parents have promised them that “someday we’ll pay you back.” But the $40,000 is not going to something tangible like a house payment; it is being used for their apartment rent, food, utilities and medical expenses. Should we be laughing at Bob & Betty for believing that they have a retirement account while their credit card balance also continues to grow? If Betty’s parents were using this money for a house payment and leaving the house in their will to Bob and Betty, this might work, otherwise the money is just gone.

This, in a surreal and simplistic way is how the Social Security Trust Fund works. Substitute yourself for Bob and Betty, any your FICA taxes for the money given each year to Betty’s parents and you have how the Social Security Trust Fund currently works.

The social Security Board of Trustees recently reported that the programs trust funds have $2.5 trillion in them, but the bigger question is if any of that money really exists. There is no doubt that over the last 35 years they have collected $2.5 trillion more than they have paided out. The way this trust fund works at the federal government level is something like the following. Virtually every dollar that you or your employer pays into Social security is either paid out to retirees or invested in government Treasuries. These Treasuries are simply the way the government borrows money, it’s literally an IOU from the government. So, the government gets money in from Social Security payments, takes that money and loans it to itself, and then gives itself an IOU to pay the loan back. Are you confused, it sure sounds like one of those complicated investment schemes that were commonly pushed from the various Wall Street investment banks…and we know how that plan worked.

The truth is that it kind of has to be this way. I know…on the surface it sounds like a ponzi scheme. Our federal government is not allowed to actually compete with business or the private sector. The main reason for this is that our private sector is allowed to take risk and even to potentially fail (ignore too big to fail). Since our government is not allowed to fail, and can even print extra money to cover its mistakes it has an unfair advantage against private business and banks. If the government did compete, they would eventually own the economy. The middle ground for all of this is when our government takes in any money it collects in taxes, it must either build roads, or stimulate the financial sector with low interest guaranteed treasury notes. I know…it still sounds a lot like a ponzi scheme.

For most of the last 30 years there has been more people paying into the system than those who had retired and were now collecting benefits. In fact, this ratio was often referred to as a social security surplus. Unfortunately, that is no longer true. With “baby-boomers” entering retirement in larger and larger numbers each year the ratio has now flipped.

This was the same challenge Social Security was facing in 1983. At that time the solution was to reduce benefits and increase the payroll withholding tax. This is the example referenced when some say, "we have fixed it before...we can fix it again." But in this real life example the surplus collected did not truely enter a trust, it got recycled into the economy.

On the one hand it would be easy to say that the administrators of the Social Security Trust have done a great job. They have collected more than they have spent for decades, but if you asked to see the money, it just isn’t there to be seen. The trust fund does exist, but is in reality the full faith and assets of the U.S. government which is not the same as cash in the bank. Unless we decide to sell interstate highways and aircraft carriers to pay Social Security benefits, the Social Security system currently has no real money at hand, or at least not enough to meet its obligations. This is not by the way mismanagement, the system by design only works as long as more people are paying, than taking out during any given year. Under those rules Social Security really only works as long as the economy is healthy, employers are hiring and the working population is growing.

Unfortunately, in very simple terms it seems clear to me that much like Bob and Betty, the Social Security System does not in truth have anything set aside. In simple business terms if your expenses now exceed your income you are insolvent and for all basic purposes bankrupt.

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