Fund Insiders See Social Security Quagmire: Argue Bush Privatization Plan Costly, Inefficient
April 18, 2005
As lawmakers in Washington continue their high-profile debate over Social Security privatization, mutual fund industry insiders are quietly conducting their own deliberations on the issue.
Some experts have said the fund industry could profit modestly from President Bush's proposal to divert about 4% of Social Security payroll taxes into personal retirement accounts. The proposal closely resembles the government's existing Thrift Savings Plan, a tax-deferred retirement plan that minimizes risk by providing just three to five diversified investment funds.
The government would track a worker's account and give lump sums to a financial services company to invest. That approach is meant to keep administrative fees low, Bush officials have said, and would probably mean limited profits for Wall Street. One opposition group, however, estimates that privatization could result in a windfall of upwards of $279 billion for money managers over the next 75 years.
Those same opponents argue that taking money out of the 70-year-old program and subjecting it to market forces is too risky. Transition costs could also be large, they claim. But by all accounts the program will be in the red by 2042 if left untouched. Last year, it paid about $492 billion in benefits to more than 47 million Americans.
Individual money management firms have yet to choose sides publicly, but the industry's two major trade groups have endorsed the Bush proposal. Most recently, a key fund industry executive, MFS Investments Chairman Robert Pozen, offered a plan he calls "progressive indexation." It sets benefit rates based on a wage or price index, which is determined by a household's income level. Pozen also proposes that 2% of Social Security payroll taxes go into private accounts. The president likes the plan.
During a recent panel discussion on investor behavior sponsored by fund manager Eaton Vance in New York, experts expressed mixed feelings over private accounts. Terry Odean, an associate professor of finance at the University of California-Berkeley, observed that, for the first time, American workers would be determining their standard of living in retirement.
"We're shifting the risk from companies and from the government on to the workers," Odean said.
According to Odean, what the everyday American doesn't understand is that private accounts may indeed give them more control over their retirement savings, as Bush suggests, but it will also give them more control over which stocks, or which funds, they'll hold in their private accounts.
"That's kind of like going to Las Vegas and being told that you're in control because you can choose the number at the roulette wheel," said Odean, whose research shows that investors are more sensitive to one-time load fees than ongoing expense ratios, an indication that they might not be sufficiently focused on the long term.
He called for a push towards designing plans that provide enough basic education so that people can understand the benefits of diversification, the impact of fees and taxes and the dangers of chasing performance.
Alice Rivlin, a visiting professor of public policy at Georgetown University and former vice chair at the Federal Reserve claims that Social Security is an easy fix while the real threat to the future of the economy lies in Medicare and Medicaid.
While she admitted that a serious shortfall looms for Social Security if left unreformed, Rivlin said that, given today's political system, the thought of it going bankrupt is downright "silly."
"I think individual accounts are a good idea. If we were already there, it would be a good system. But we're not there, and the transition is very expensive. At the moment, we can't afford it," said Rivlin, who thinks the transition would be risky and cost trillions of dollars in borrowing. "If we had acted when we had the budget surplus way back in [1999 and 2000] to finance the transition to individual accounts, it would have been quite a good idea. But now, we're running a big deficit."
Rivlin suggested a special commission, perhaps chaired by outgoing Federal Reserve Chairman Alan Greenspan, be formed to solve the dilemma.
Mark Weinberger, vice chairman at Ernst & Young, said the roadblocks to fixing Social Security are primarily political, especially when it comes to the sensitive issue of benefit cuts and tax increases, alternatives that very few politicians seeking re-election are willing to suggest. Weinberger, however, sees few alternatives.
"We will have benefit cuts or tax increases in our future. And the savers have to take that into account as they think about their private savings plans," he said. "Getting the investor class to expand beyond those who are just wealthy, to the middle class and people who can get the benefit of compound interest, is a good thing. The real question with personal accounts is how will they be funded?"