Common Sense on Social Security

A Centrist Perspective on the Social Security Reform Dilemma


Social Security Reform: Breaking the Stalemate

Section 11. A Low Risk Trust Fund Strategy

Although a strong Trust Fund has a vital role to play in a compromise settlement, two key issues must first be resolved. The current relationship between the Trust Fund, the U.S. Treasury, and the Congress is riddled with flaws. There's no point in fattening up the Trust Fund until it has been intelligently re-chartered. Second, as the Nadler example illustrates, it wouldn't be difficult for a healthy Trust Fund to end up with a controlling interest in every corporation traded on the U.S. stock market. The ownership concentration issue must also be effectively addressed.

Securing the Trust Fund's Independence. The U.S. Treasury currently uses the Social Security Trust Fund as its captive lender of choice. Treasury collects Social Security's taxes, banks its money, and writes its checks. Treasury borrows every penny of the Social Security surplus, issuing government bonds to Social Security in return. When interest falls due on its bonds, Treasury issues still more bonds as payment on the interest due. By law, the Trust Fund is required to invest its entire surplus in U.S. Treasury bonds. It lacks the authority to purchase and manage a broad portfolio of securities. It isn't supervised by a sufficiently independent board, nor have its assets been properly insulated from the risk of political tampering.

If Social Security is to move beyond its youthful past into its new role as a mature, adequately-funded retirement program, these wrenching weaknesses must be overcome. Robert Reischauer has suggested the creation of a Social Security Investment Oversight Board, modeled after the Federal Reserve Board. The Oversight Board should be responsible for contracting out the management of Trust Fund assets to a wide selection of independent firms. Those managers, in turn, should have the authority to invest Trust Fund assets in a wide range of securities, including corporate bonds and index-based portfolios of common stocks.

The Oversight Board, I might suggest, must also have the authority to ask the Treasury to redeem the government bonds now owned by the Trust Fund. Properly phased in, such a redemption can be a rite of passage for Social Security, a step symbolizing Social Security's transition to full maturity. At the same time, from Treasury's perspective, redeeming the debt now owed to the Trust Fund may require a modest refinancing of the national debt but won't increase its overall size by one iota.

When Social Security was younger, the limitations and weaknesses of its Trust Fund weren't an issue. But the day has come for Social Security to be restructured in a way that mirrors the professionalism of private sector retirement funds. Given the vital responsibilities that lie ahead, a new charter for the Social Security Trust Fund is a must.

Minimizing Ownership Concentration Risk. The ownership concentration issue is an inescapable corollary of the Baby Boomer retirement wave. Given the awesome magnitude of the assignment - adding 40 million beneficiaries to the rolls - an equally awesome pool of capital is essential. While a portion of the gap must be closed by other means, the remainder can be closed by allowing the Trust Fund to invest half its portfolio in stocks and capitalizing it with assets equal to 50% of GDP. An awesome response to an awesome challenge.

Think of it. A Trust Fund equal to 50% of GDP. Half of its portfolio invested in stock index funds, worth 25% of GDP. It's not unreasonable to assume the total value of the stock market in years to come might average 120% of GDP or thereabouts. If this is how the future of the market unfolds, then more than a fifth of all U.S. stocks will end up belonging to the Trust Fund.

Such a prospect raises warning flags across the political spectrum. Yes, the Boomer retirement challenge is stupendous in its size. Yes, Social Security needs an equally mountainous pile of retirement capital. But must we therefore grant Social Security the means to acquire nearly a quarter of the entire U.S. stock market? Isn't there some way to avoid putting ourselves in such a fix?

In the interest of mitigating ownership concentration risk, liberal supporters of a stronger Trust Fund have recommended several changes, including those itemized in the previous section. To secure the Trust Fund's independence from Congressional tampering, appoint a new, Senate-confirmed Social Security Investment Oversight Board. Confine the Trust Fund's stock holding to index funds. Hire a number of blue chip investment firms to manage the Trust Fund's portfolio and vote its stocks.

If one views these proposals with detachment, they are powerful indeed. As a practical matter, Social Security's Investment Oversight Board would have much less influence over the economy than the Federal Reserve's Board of Governors, and no one has complained seriously about the reach of the Fed's power for quite a long time. Were these structural precautions to be implemented as proposed, a mild regime of value-neutral portfolio management would almost certainly be the outcome.

On an issue so potent, however, detached rationality is never the order of the day in Congress. Even though a stock-rich Trust Fund might well be an effective tool for protecting retiree benefits and ensuring Social Security's lasting solvency, any solution that enables the Trust Fund to buy up as much as a quarter of the stock market is doomed to failure.

Combining the Trust Fund with PRA's is a much better choice. It's far easier to whittle the ownership concentration issue down to a manageable size if a strong Trust Fund is teamed with a vigorous PRA program.

In a two-track investment strategy, half the financing load can be assigned to PRA's. This automatically cuts the Trust Fund's target size by half, from 50% of GDP to 25%, and trims its eventual ownership stake in the stock market from nearly a fourth to only a tenth.

More to the point, though, the Trust Fund-plus-PRA combo allows control of the Trust Fund stock portfolio to be profoundly decentralized. Dozens of firms, perhaps hundreds, will step forward to serve as PRA asset managers. Management of the Trust Fund's asset pool should be contracted out to these same firms, allocated among them in proportion to their popularity with employees. If two percent of all employees select Merrill Lynch to manage their PRA's, for example, then two percent of the Trust Fund's assets should be assigned to Merrill Lynch as well. The asset management firms so hired would vote all the Trust Fund's stocks. As a further safeguard, all Trust Fund stock assets would be invested exclusively in market-wide index funds.

A dual-track, Trust Fund-plus-PRA strategy has an important additional advantage. It brings the American people into the equation. The act of deciding on a PRA manager gives every PRA owner an equal voice in allocating responsibility for the Trust Fund's assets. With 170 million separate PRA owners each having their say, every penny of Trust Fund assets is allocated to fund managers according to the decisions of the American people. Ownership concentration truly becomes a non-issue. In a two-track strategy, decentralized PRA's quite neatly cancel out the ownership concentration drawbacks of a centralized Trust Fund.


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Common Sense on Social Security
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Revision Date April 13, 2006