Social Security: Bankrupt System Will Impact Markets Sooner than Expected

Steven Gross, the Chief Actuary of the Social Security Trust fund wrote a letter* on 9/15/2008. In that letter he included this graph (click to enlarge):


On 2/12/2009 Mr. Gross wrote a letter* to Senator Robert Bennet. That letter contained this graph (click to enlarge).


The two graphs describe a financial gearing ratio. Note that the data used in the 2008 graph shows a 'surplus' in this ratio through 2025. The updated 2009 graph shows that surplus is gone as of today. This represents a significant change in assumptions over the five month period. Mr. Gross is telling us 'something' is coming. That 'something' is likely to be on the front pages of newspapers as well as impact the markets sooner than was thought.

Here is a link to a report produced by the Trustees of the Social Security Trust Funds (“SSTF”).

This is a status report on the health of America’s Social Security and Medicare system. The conclusions contained in this report should come as no surprise. The system is bankrupt. It is just a matter of time. The magnitude of the problem is enormous. The Trustees estimate that the present value of the unfunded portion is $13.6 trillion. It is virtually certain that unless the imbalances are addressed in the near future, the U.S. Legacy Costs will destroy our economy.

The US is currently spending trillions of dollars in borrowed money to shore up a weakened economy. All of that money will be wasted. At best it will result in a resumption of economic growth for a few more years. By the end of President Obama’s first term the Social Security problem will already be a drag on the economy. By 2016 the damage will be impossible to reverse.

The 2009 SSTF report will likely show a continued deterioration in the footings of the Fund. The dynamics that impact the SSTF include: economic growth, prevailing short and long term interest rates and the rate of payouts. All of these factors are working against the Fund currently. These impacts will foreshorten the day of reckoning.

This observer believes that it is folly to be spending trillions today when it is a given that the system will collapse in less than a decade. Every prior effort to address the looming crisis has been dismissed by DC. That is understandable. It is perceived that this is a problem that will be realized in 2032. That is not correct. The problem is already affecting us. The negative impacts to the broad economy began a few years ago.

The recession that started in 2008 will negatively affect the results of the SSTF. Should economic growth hover near zero for the next twenty-four months the drag from entitlements will become meaningful as early as 2011.

This is from the 2008 SS Trustees report:

Social Security’s current annual surpluses of tax income over expenditures will begin to decline in 2011 and then turn into rapidly growing deficits as the baby boom generation retires. Medicare’s financial status is even worse.

The term used “current annual surpluses” requires a closer look. These surpluses have been a critical component in the success of our economy for the past 60 years. The SSTF has been a net saver since its inception. It currently holds $2.4 trillion of US Treasury IOU’s. That amount is approximately 1/4 of the entire US Public Sector Debt that has been accumulated since 1938. This pool of ‘savings’ helped finance the country’s ever growing deficit. The SSTF projected in 2008 that the annual surpluses would be eliminated by 2011. It is quite possible that this significant nexus has already occurred. Consider the following:

The following graph (click to enlarge) shows a blue average trend line for SSTF cash flow. Above that a green line that describes the significant month-to-month variations from the mean. Notice that in all of the trough cash flow months there were none that resulted in an actual shortfall.


Not recorded in this chart is the fact that in August and October of 2008 and again in February of 2009, the SSTF ran monthly deficits. The total deficits amounted to $2 billion. These are the only negative monthly cash flows over the past decade. An ominous sign.

The next chart (click to enlarge) shows the expense side of the Fund. The jump in outlays is due primarily to baby boomers who are just starting to enter the system. The March 2008-2009 rate of growth was 9.5%. The historical average is closer to 5%. This growth will compound at double-digit rates from now on.


The final graph (click to enlarge) shows the average yield on the SSTF. The return has been in a long-term decline. This is largely due to the fact that for several decades we have been in a low interest rate environment. The levels of interest rates being set by the Federal Reserve today for short and long term Treasury paper are hurting the Trust Funds results. The Fund is earning a rate far less than the rate of growth of its expenditures. The interest rates used are set by a formula. As a result, the impacts of lower rates are felt with a significant lag. This lag effect will be realized on June 30th of this year.



The Trustees of the SSTF do not mince words on the seriousness of the problem:

The financial condition of the Social Security and Medicare programs remains problematic. Projected long run program costs are not sustainable under current financing arrangements.”

It will be interesting to review the next Trustees up-date. My guess is that it will confirm that the economy is already being negatively influenced by the dynamics of the Social Security System. It could not be happening at a worse time. This could sucker punch an already weak system.

The reality is that the entitlement problem is a 2009 issue and not a 2032 issue. The Trustees of the fund recommend:

The system could be brought into actuarial balance with an immediate increase in payroll tax revenues of 26 percent (from 12.4 percent to 15.6 percent) or an immediate reduction in benefits of 20 percent, or some combination of the two.

A 26% increase in the payroll tax is out of the question today. Social Security payroll deductions totaled $637 billion in the past twelve months. On a tax adjusted basis this amount is equal to the entire two-year stimulus program recently enacted.

If SS payroll deductions were eliminated for one year, the economy would bounce back to life. A one-year suspension would also kill the SSTF. But, the system is dead already, we just think it is asleep.

There is a bright side to this. The issue of the Social Security System is about to come onto the table. Exactly where it belongs. It will be a gut-wrenching process. The outcome of this debate will shape the economy for the next generation. It is possible that the result will be the foundation for an extended period of prosperity.

There is a solution. We must acknowledge that a significant amount of the Entitlement promises that have been made simply can’t be met. In addition we must dramatically change our health care system.

There are three possible outcomes:

(1) We do nothing today to address the imbalances. The result will be that we fall into a long period of economic decline. That decline may have begun already. It will certainly begin in less than five years. Lights out.

(2) We take action to address the visible issues with social security by raising taxes. Raising payroll taxes is no solution. It would just slow economic growth. That runs counter to the long-term interests of the SSTF. In addition, it is simply unfair to ask workers to pay more for a broken system. Lights out.

(3) We accept reality. We recognize that we are not as ‘rich’ as we thought we were. It is not necessary that all existing beneficiaries have their benefits curtailed.

The following however is necessary:

a) All persons under age 60 will have their programmed benefits cut significantly.
b) There has to be a “means” test.
c) People under age 45 will lose most of what they have contributed.
d) The only lasting promise made is the availability of health care.

In return for these concessions American workers get back a significant portion of the $650 billion they are currently paying each year into a black hole. It is the only alternative that keeps the lights on. The good news is that the vast amount of American workers do not believe that they will ever receive SS benefits. Confirming that will come as no surprise.



*Link to Steven Gross's letters and the charts

Comments

[Tom Armistead:]

No, all those old people standing by the road with the signs saying "will work for food" would get on everybody's nerves.


On May 01 07:59 PM Frohickey wrote:

> Wouldn't it just be simpler to end Social Security?
>
> On May 01 07:39 AM Tom Armistead wrote:

May 01 08:03 PM

[Frohickey:]

There is too many what-ifs for your solution to work. It would require honest, even angelic, people to be administering the Social Security System. That will make your solution fail for sure.

Better way is to eliminate the program.


On May 01 09:02 AM a. palmer jr. wrote:

> I have a way to save Social Security....All we have to do is revert
> it back to it's roots, what it was designed for in the first place.
> First thing is to not allow anyone to draw Social Security that didn't
> pay into the system! I know that's not compassionate but it's fiscal.
> Second, not let Congress or the President dip into it for their various
> projects and replace it with an IOU; Al Gore's "lock box" if you
> will. Third, not let anyone draw Social Security until they get to
> be 62 years of age, and then at a reduced amount, as now. No more
> retirements at 45 years old just because they don't want to work
> and they know a friendly doctor. Keep Social Security as a retirement
> account and not a welfare fund. Keep the SS widows payment, assuming
> the widow is at least 62 years of age. No illegals on SS even if
> they do work here because they don't pay into the fund. See, it wasn't
> that hard!

May 01 08:08 PM

[Old Trader:]

I'm not quite retirement age, but getting close. I think I'm as patriotic as anyone (first generation US citizen, parents emigrated from Eastern Europe, post WWII to escape communism, and I was fortunate enough to go behind the Iron Curtain before it came down, and saw the "workers' paradise" at first hand), but I'm making plans to spend my "retirement" as a "live aboard"....probably in Central/South America, possibly in Asia.

Not a day goes by, that the values I was taught, and hold dear,are being scorned, ridiculed, or at best, ignored.

No mas....

May 01 09:02 PM

[Simon Smelt:]

Good points, thought the graphs used at the beginning of the article are misintepreted- they compare the current regime with different senators' proposals. They don't show changes in liabilities under the current regime. .

The Congressional Budget Office estimates the decline in the social welfare out to 2018 due to the present downturn as some $620bn; i.e. another $620bn to find. Their estimates are on the somewhat optimistic basis that the U.S. economy begins to grown in 2010 and returns to previous growth patterns of c2.5% real/capita/annum despite being saddled with debt and a battered financial sector. Lower rates of growth / slower recovery would lead to social welfare being a bigger drag again on the economy.

Tom Armistead suggests that a combination of tax increase, benefit reductions, taxation of Social Security income for the wealthy, and increased immigration would enable continued progress in funding the program. Well, that might help with the deterioration in social welfare from the downturn. But, as the government's own papers show, the underlying situation with both social welfare and with Medicare is so bad that huge taxation increases and benefit reductions will be required to keep them going. The Financial Statements of the U.S. government show the unfunded liabilities arising in future from these schemes to run at over $50 trillion (approximately the size of the world economy or the value of every physical asset in the U.S.A. - infrastructure, houses, cars, the lot.) Kent Smetters, former deputy assistant Treasury secretary and economist for the Congressional Budget Office, gives an interesting take on this.

The Obama government forecasts ongoing large fiscal deficits to the end of the next decade (and again using optimistic assumptions about economic recovery). As the future unfunded liabilities for social welfare and Medicare start to become current in the following decade, it is hard to see how they can be met, without destroying the U.S.$.

May 01 09:40 PM

[Bruce Krasting:]

Jimbo, Thanks for that information.
bk

May 01 11:07 PM

[Chancer:]

Here is my proposal (not desireable but necessary):

1- Remove cap and tax all earnings for Social Security (as Medicare already is).

2- Reduce COLA's as too generous.

3- "Means test" meaning those earning, say $200-$250,000 in retirement do not collect.

4- Raise retirement age for those over 50 to:

Early: from 62 to 66
Full: from 66 to 70
Max: from 70 to 75

5- As last resort: Increase payroll tax as necessary:
as much as from 7.65% to 10% per employee and per employer.
That is actually a 30% increase for both Soc. Sec. and Medicare.
But only an increase of 2.35% of wages.

I hate to see this, as it affects my kids and grandkids. Frankly, past president's and congress's should have dealt with this a long time ago and cut other spending, instead of these wasteful "new" programs. I think all of this could happen before benefit cuts, although benefit cuts for younger workers could happen combined with a better funded savings plan.

May 01 11:20 PM

[Bruce Krasting:]

kotika, I know what you are saying about SS and illegals. I have seen this as well. You sound like you know something about this. I think it is actually a big deal. I have had trouble getting a sense of this size of the issue.

Do you have some insight?

May 01 11:47 PM

[optionsgirl:]

***If you think it is time to impose term limits, please go to this website and make a donation. We all have the opportunity to have our voices heard:
termlimits.org/

May 01 11:49 PM

[fireball:]

old trader
check out ecaudor(sp?) and brazil. i did some looking awhile back. these were the most promising from my view.
i decided to stay here for good or bad as i am not willing to let the republic go down without a whimper. some say it is a lost cause. i say it should be an interesting contest.

May 02 10:01 AM

[Bruce Krasting:]

Note to readers:

My copy editor has swine flu. As a result there was a significant typo in this piece.

Mr. Steven Goss is the Chief Actuary of the Social Security Trust fund.

If Mr. Goss happens to see this, I extend an apology.

My copy editor is on Tamiflu and is recovering nicely. It is unlikely that an error of this magnitude will occur again...................

bk

May 02 10:48 AM

[ain't no fo...:]

I'm 59 and I'm fckn pist!


On May 01 07:01 AM User 353732 wrote:

> A minority of Americans have known for years that Soc. Security is
> an intergenerational income transfer program and tax and NOT a personal
> pension. This group has never expected to get anything much or anything
> at all and have tried,as best they can, to provide for themselves.
> For this group the Soc. Security tax is just an income surtax. Its
> failure will sadden but not disillusion them.
> I also think that many peope( coud be a majority) under 25 have little
> expectation of seeing a penny from Soc. Security.
> They have no illusions to be shattered as far as the govt. looking
> after them is concerned.
> Anyone under 60 in 2009 would be both naive and imprudent to think
> that they will see any material benefits from having paid into the
> SS system for decades.

May 02 08:05 PM

[DavyJ:]

Gee, first you say your "savings and 401K's have been ravaged", then you advocate "individual, self-directed retirement accounts" as being a better alternative to SS.


On May 01 12:57 PM optionsgirl wrote:

> Glad you are young enough to build up your portfolio and not rely
> on the govt. For those of us born during WW2 and for the older boomers,
> while our savings and 401K's have been ravaged, we have been paying
> into ss and medicare at max rates most of our working lives. For
> some of us, we are beyond our working lives. What you are seeing
> is the ultimate impoverishment of the middle class.
> If you care about this country and your future, you should be lobbying
> for individual, self-directed retirement accounts within current
> programs, or better yet, the end of SS and Medicare-- if you could
> just keep your own money and be responsible for how it is spent or
> invested, your future would be brighter.

May 02 09:23 PM

[Mike10613:]

The USA: Cut social security and healthcare. JAPAN: Build more robots and improve efficiency to provide for the "baby boom" generation. I like the latter solution. But I'm British!

May 03 04:55 AM

[r cohn:]

If the program is going to be means tested than call it by its correct name WELFARE
Among the solutions is to raise the age at which benefits can be received by 2 months/year.Raise the cap on income taxable by%25 per year. Index for inflation,not wages.Eliminate payments for illegals and for people who have not paid into the fund. If social security payments are reduced,then the guar anteed payment of local pensions and of Fedral government pensions must also be drastically reduced

The solution for Medicare is a bit more complicated.Since most of Medicare's costs occurr in the last 6 months of a person's life ,we must develop a method of triage where we give only palliative care.This may create a moral question,but so will the failure of the whole system.We have to stop approving procedures which benefit only a very small number of people at a very high price.We are going to have to slow down the purchase of extremely expensive medical technologies.
The probabilty for an aaceptabe political solution to these problems is low.The days of the Banana republic of the USA are coming soon.

May 03 08:44 AM

[john s. gordon:]

in 1888 germany instituted a number of socialist programs, including universal health care for all its citizens. another program was old age benefits. someone asked, at what age should a person be eligible to receive the benefit? someone else answered, hardly anyone lives past 65 yrs, let;s make it 65. so it was done.
in 1935 mr. roosevelt saw the need for some kind of a portable pension system for all americans, since corporations @ that time were certainly in no position to provide it (teachers already had it through TIAA as established by the carnegie endowment, although the TIAA income is taxable as received). the number 65 was taken over from the old german system.
with today's greater average longevity we can certainly expect in future that "66" will advance to "67" will advance to ....
> jack

May 03 02:50 PM

[john s. gordon:]

it was 1889, sorry about the error (but had been proposed as early as 1881 by prince otto von bismarck, not noted as a softie).
some interesting reading at www.ssa.gov/history.
> jack

May 03 03:10 PM

[Bruce Krasting:]

"a method of triage where we give only palliative care"

You are tough r cohn. I do not believe that we face such hash choices. The thought however gives me an idea for a new business.

Euthanasia centers. I will call them YD-LB. (Your Dead-Lets Boogie)

May 03 03:14 PM

[aflitzy:]

IMHO 1} a key portion is only those who have paid in can collect. When did it become a welfare system
2} disability SSI ????? agree it is too abused and needs to be stopped


On May 01 09:02 AM a. palmer jr. wrote:

> I have a way to save Social Security....All we have to do is revert
> it back to it's roots, what it was designed for in the first place.
> First thing is to not allow anyone to draw Social Security that didn't
> pay into the system! I know that's not compassionate but it's fiscal.
> Second, not let Congress or the President dip into it for their various
> projects and replace it with an IOU; Al Gore's "lock box" if you
> will. Third, not let anyone draw Social Security until they get to
> be 62 years of age, and then at a reduced amount, as now. No more
> retirements at 45 years old just because they don't want to work
> and they know a friendly doctor. Keep Social Security as a retirement
> account and not a welfare fund. Keep the SS widows payment, assuming
> the widow is at least 62 years of age. No illegals on SS even if
> they do work here because they don't pay into the fund. See, it wasn't
> that hard!

May 04 09:00 AM

[Frohickey:]

Why not have carousel ceremonies where 'old people' are euthanized? If some of these 'old people' want to run, we can institute the 'Sandman Corp' to catch them. We have facial transplants now, maybe there is a nurse at one of those facial transplant center named 'Holly'. :D

On May 03 03:14 PM Bruce Krasting wrote:
> Euthanasia centers. I will call them YD-LB. (Your Dead-Lets Boogie)

May 04 04:38 PM

[g452ooo:]

I thinks that we should drag all government workers screaming and kicking, over to those new Euthanasia Centers and hook them up to a Doctor Kevorkian machine.

May 06 01:11 AM