February 29, 2016
Glenn Kessler, the Washington Post’s Fact Checker, gave former Secretary of State Hillary Clinton three Pinocchios for saying that the Republicans wanted to turn Social Security money over to Wall Street. I am afraid that I see this one a bit differently.
First, as a small point, the piece comments:
“We have explained before that “privatization” is one of those pejorative political labels used by opponents of the Bush plan…”
That’s not how I remember the story. In the 1990s many conservatives openly talked about their plans to “privatize” Social Security. At some point, they apparently ran focus groups and discovered that the term “privatization” did not poll well. At that point, they switched directions and starting talking about “personal accounts,” rather than privatizing Social Security. While the advocates of a policy certainly have the right to assign whatever name they like to the policy, it seems a bit extreme to criticize its opponents for using the term that advocates themselves had used in the recent past.
The piece then notes that President Clinton had openly advocated investing Social Security money in a stock index fund, therefore:
“One could certainly say that the first president who wanted to ‘give the Social Security trust fund to Wall Street’ was Bill Clinton.”
It is worth making an important distinction between the possible meanings of turning Social Security over to Wall Street. On the one hand, there is the possibility of directly investing some of the trust fund in the stock market. On the other hand, there are proposals to turn over the administration of individuals’ Social Security to private financial firms. These routes have very different meanings and implications.
The former proposal, which was advocated openly by President Clinton, would have relatively little value to Wall Street. While the sums would be substantial, these were funds that otherwise would have gone into government bonds. The effect of the shift would be to push up stock prices (which reduces future returns) and to push down bond prices (which raises future returns). It would be expected that private investors would respond by shifting money out of the stock market and into the bond market.[1]
The net effect would likely be a modest one-time rise in stocks and lower future returns for holders of stock and higher future returns for holders of government bonds. This would not be in any obvious way a major boon to Wall Street.
By contrast, turning over the management of individuals’ Social Security money to Wall Street would likely mean a large amount of money. President Bush’s Social Security commission estimated that the cost of these accounts would be 0.3 percent of the money placed in them. If we assumed that the annual payouts are roughly one twentieth of the stock of assets, then the annual cost would be 6.0 percent of the money paid out as benefits each year. By comparison, the administrative costs of Social Security are roughly 0.5 percent of benefits. In a program that pays out over $700 billion in benefits each year, if 6.0 percent of this money went to administrative fees, it would mean over $40 billion a year for financial intermediaries.
In fact, the bonanza for Wall Street from individual accounts could prove even larger in the long-term. While the commission was looking at centrally managed funds, which would limit costs, it was considering letting workers with large accumulations pull their money out of these centralized funds and put them into standard 401(k) type accounts. These have costs that average close to 1.0 percent annually, more than triple the cost of a centralized fund.
There also is a huge bonanza in the annuitization of these funds when people retire. The cost of annuitizing a sum of money is in the neighborhood of 5–10 percent of the account. In a mature system, if $500 billion of the money in these accounts were annuitized annually, it would translate into another $25 to $50 billion a year in revenue for the financial industry. (These calculations all are assuming the whole of the trust fund was turned into private accounts. The proposals for these accounts mostly had between 2.0 and 5.0 percentage points of the 12.4 percentage point tax put into individual accounts. The revenues would have to be adjusted for the actual portion of the tax that went into these accounts.)
In short, President Bush’s proposal for replacing a portion of the traditional Social Security system did offer a substantial bonanza for Wall Street in a way that was not true of President Clinton’s proposal for investing the trust fund. Secretary Clinton was not wrong to make this distinction even if some of her comments were not entirely accurate, as Kessler points out.
[1] It is worth noting that President Clinton’s ostensible motivation for putting Social Security money in the stock market was to get a higher rate of return. His economic team assumed that the return on money invested in the stock market would average 7.0 percent above the rate of inflation. In fact, the real return on S&P 500 since 1999 has been roughly 2.0 percent, less than what Social Security received from investing in government bonds.
While Clinton’s plans for Social Security did not go anywhere, the absurdly optimistic assumptions about future returns in a stock market in the midst of a huge bubble reinforced ridiculous expectations of returns. This undoubtedly encouraged many individuals to put their savings in the stock market. It also reinforced the overly-optimistic assumptions being made by pension funds at the time. This is a major part of the story of the problems facing many pension funds today. Because of these absurd return assumptions, they got in the habit of contributing little or nothing to their pensions. When the market crashed and the economy went into recession in 2001, they continued the pattern of not contributing with the hope the market would somehow bounce back to its bubble levels.
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