[Marxism] The $4.7 Trillion Pyramid--why Social Security won't be enough to save Wall Street-Harpers Magazine

Jon Flanders jonflanders at jflan.net
Fri May 13 21:11:15 MDT 2005

The $4.7 Trillion Pyramid -- 
Why Social Security won't be enough to save Wall Street
Posted on Wednesday, May 11, 2005. Originally from April 2005.
By Michael Hudson

[About the Author:  Michael Hudson is Distinguished Professor of Economics 
at the University of Missouri, Kansas City, and the author of many books on 
international and domestic finance, including Super Imperialism: The Origin 
and Fundamentals of U.S. World Dominance.]

"They wanted something for nothing. I gave them nothing for something."

-J. R. "Yellow Kid" Weil

Social Security, formerly the "third rail" of American politics, has now 
been trod upon, in rather dramatic fashion, by George W. Bush. Given that 
the maneuver is both stupid and unnecessary, one must ask why. After all, 
the program's alleged deficiencies, if there are any, will not manifest 
themselves until at least 2018. This is not quite the same as worrying about 
the sun's eventual collapse into a black hole, but for most politicians a 
problem that lies thirteen years in the future is nearly the same thing. 
Clearly all is not what it seems.

Bush himself offers two reasons for the present boldness. The first-that 
Social Security is "in crisis"-is easily dismissed. Government actuaries, 
backed by economists from across the political spectrum, insist there is no 
funding problem. The Social Security Administration will take in more money 
than it pays out for the next thirteen years; it has built up a reserve of 
$1.8 trillion in interest-bearing Treasury bonds for the years after that; 
and any later shortfall can be covered easily by even a partial rollback of 
the recent tax cuts for the rich.

Bush's second argument sounds more promising. If the American people will 
simply follow his plan, he says, they too will become rich.[1]

The way the system works now, the government withholds 12.4 percent of your 
paycheck, up to $90,000 in annual income. In return, it promises to provide 
you a monthly payment-a pension-from the time you turn sixty-two until the 
time you die. As of this writing, the administration's alternative remains 
somewhat nebulous, but what is clear in all of the variations presented thus 
far is that you will be able to put some of your paycheck into the stock 
market. Bush calls these stock purchases "personal savings accounts."

Vice President Dick Cheney described the benefits of these personal savings 
accounts in January. His example was a young woman who put away $1,000 every 
year for forty years. The Social Security Administration currently puts her 
money into Treasury bills, which at present return about 2 percent, so in 
forty years that investment would have returned about $61,000. Not too bad. 
"But if she invested the money in the stock market," Cheney said, "earning 
even its lowest historical rate of return, she would earn more than double 
that amount-$160,000. If the individual earned the average historical stock 
market rate of return, she would have more than $225,000-or nearly four 
times the amount to be expected from Social Security."[2]

That's a lot of math. Cheney's main point is that an upbeat assessment of 
the stock market-about 7.5 percent annually over forty years, by his 
reckoning-would easily exceed the 2 percent offered by Treasury bills.

There is no arguing that $225,000 is more than $61,000. On the other hand, 
it's not as if you get a lump sum from the Social Security Administration 
when you retire. The woman Cheney cited could end up taking in much more 
than $61,000 if she lives long enough. (The average annual payment to 
retirees today is about $11,000.) Or she could die on her sixty-second 
birthday. Like any other investment-or any other form of insurance, for that 
matter-Social Security is somewhat of a gamble. But then so is the stock 
market. By Cheney's estimation, however, today's stock market is a much 
better bet. "Over time," he concluded, "the securities markets are the best, 
safest way to build substantial personal savings."

That is the argument, anyway. The stock market is the main chance in 
America, and Bush wants to let all of us in on the action.

The one sure mark of a con, though, is the promise of free money. In fact, 
the only way the stock market is going to grow is if we the people put a lot 
more of our money into it. What Bush seeks to manufacture is a boom-or, more 
accurately, a bubble-bankrolled by the last safe pile of cash in America 
today. His plan is a Ponzi scheme, and in that scheme it is Social Security 
that is being played for the last sucker.

* * *

Retirement savings are by far the most important source of money on Wall 
Street. The Federal Reserve Board reports that private and public retirement 
accounts, not including Social Security, had assets of $10 trillion at the 
end of 2003. Nearly half of that, $4.7 trillion, was held in stocks. By way 
of comparison, the total value of all domestic stocks listed on NASDAQ, the 
American Stock Exchange, and the New York Stock Exchange at the end of 2003 
was about $14.2 trillion.

In the past, few retirement dollars found their way to Wall Street. IRAs and 
401(k)s had yet to be invented, and few companies offered private pension 
plans of any kind. In 1950, General Motors-then, as now, among the largest 
employers on earth-began to change that with a new form of compensation. The 
company would withhold money from paychecks, much like the Social Security 
Administration was doing, and add money of its own to build up a reserve to 
pay retirees many decades into the future. Generally called a "defined 
benefit" plan, the scheme guaranteed retirees a specific (defined) monthly 
payment until they died.

Other giants of American industry soon followed, and the funds grew quickly. 
In most of them, at least half the money was put into the stock market. 
Workers thus would gain, at least in theory, a stake in the prosperity of 
their company, building loyalty to management while also providing companies 
with a captive source of credit-their own workforce. All of that new cash 
contributed to the bull market of the 1950s.

Management philosopher Peter Drucker called this process "pension-fund 
socialism" and hailed it as the most positive social development of the 
twentieth century, because it would at last merge the interests of labor and 
capital. Louis O. Kelso and Mortimer J. Adler even wrote a book called The 
Capitalist Manifesto announcing that a new epoch of harmony between workers 
and owners was at hand, because soon all workers would be owners.

It didn't quite work out that way. Many companies used retirement reserves 
to buy their own stocks, bidding up their share price and allowing them to 
take over other firms on favorable terms, especially as mergers and 
acquisitions gained momentum in the 1960s. The problem was that when 
companies went bankrupt-especially small firms-the collapse also wiped out 
the pension funds invested in those companies. Employees of such companies 
found themselves not only out of work but stripped of the money they thought 
was being saved up for their retirement.

Congress moved to limit such behavior by obliging corporate pension funds to 
be run by arm's-length trustees, although workers were still permitted (and 
often encouraged) to keep their pensions in the stock of their employers. To 
further protect workers, Congress created the Pension Benefit Guarantee 
Corporation (PBGC) in 1974. All corporate pension plans were required to buy 
federal insurance, through the PBGC, to protect workers in the event of a 
failed investment scheme or corporate bankruptcy. The plans themselves were 
still prone to risk, but at least the pensions would be backed by the 
government and workers could feel secure about their retirement.[3]

Most companies now offer their employees a broad array of mutual funds 
instead of just their own stock. In itself this is good common-sense 
investing practice, and it also protects fund managers from charges of 
scheming. The other result of this practice is that workers' fortunes are 
now tied not just to their own companies but to the market as a whole.

* * *

which is where and how we come to both the problem and the scam. While fears 
regarding the solvency of Social Security are unwarranted, many corporate 
pension plans-the ones that have been so important in bankrolling the 
stock-market rise of the past few decades-are themselves threatening to go 
bust, taking their parent companies down with them. The financial rot 
already has begun to seep into the airline and steel industries, and the 
auto sector may be next. (General Motors reports that its current pension 
obligations add $675 to the cost of every vehicle it produces.)

The shortfalls aren't just a matter of bad luck. For quite a few years now, 
companies simply haven't been putting away enough money to pay retirees what 
they are owed. The PBGC estimates that the underfunding of traditional 
defined-benefit plans, for instance, deepened by $100 billion last year, to 
a total of $450 billion.

The problem was created by fund managers and CFOs who believed-or at least 
pretended to believe-that pension reserves could grow at fantastic rates of 
return forever. Milliman USA, a benefits consulting firm, reports on the 
assumed rates of return on pension investments at the hundred largest firms 
in America. How high did these companies bet? In 2000 and 2001, the median 
projected rate of return was 9.5 percent. In 2002 it was 9.25 percent. And 
in 2003 it was 8.55 percent.

These are wildly optimistic projections, even by Dick Cheney's standards. 
Last summer the Financial Times noted that they conflict not only with 
present reality but with warnings from such mainstream investment experts as 
Peter Bernstein, Jeremy Siegel, and Jeremy Grantham that "we have entered a 
low-return environment" and that as a result many investors are expecting 
long-term returns closer to 7 percent or 5 percent. Even these rates seem 
overly exuberant, given that the top hundred corporate pension funds earned 
an average annual investment return of just 1.3 percent between the end of 
1999 and the end of 2003.[4]

At the beginning of 2001, for instance, IBM proposed that it would earn $6.3 
billion on pension-fund assets of $61 billion-about 10 percent. This was an 
astonishing demonstration of confidence given that IBM had earned only $1.2 
billion on those assets the previous year. In the event, IBM actually went 
on to lose $4 billion in 2001. Barely daunted, the company's managers 
predicted a 9.5 percent return in 2002. They lost another $7 billion. In 
2003 they predicted a return of $6 billion, and-as the market began to 
recover-they at last beat their prediction, by $4.4 billion. The result of 
this "recovery" is that, since George W. Bush took office, IBM's 
pension-fund assets have plummeted by more than $1 billion. Nonetheless, 
corporate fund managers across America remain optimistic.

Such errors in judgment are seldom accidental. In pretending that their 
funds could generate high returns, managers sought a real-albeit 
short-term-advantage. The faster companies projected their funds to grow, 
the less they had to set aside to pay their retirees. The lower set-asides 
in turn allowed them to report higher earnings, thereby driving up the price 
of the company's own stock to "create shareholder value." Faced with a 
choice between living up to their pension promises or reporting higher net 
earnings, companies simply decided not to live up to their employee 

The practice is not one that can be sustained across forty years. It is a 
kind of Ponzi scheme, in which present profits are paid for by the promise 
of future stock-market gains. At some point retirees are going to want the 
money they are owed. The last few years have seen the results of these 
broken promises in the form of lawsuits, bankruptcy, and, ultimately, 
retirees being forced to live on far less than they were promised.

In the end, it is the PBGC that pays when the plans go bust. Here, however, 
the problem deepens considerably, because picking up the total bill for the 
corporate sector's underfunding would bankrupt the PBGC itself.

Last November the PBGC reported that although it had "operated for several 
years with virtually no claims," the end of the stock-market boom has given 
way to "a period of record-breaking claims." As recently as 2001, the PBGC 
had a surplus of $8 billion, but a series of bankruptcy cases pushed it $23 
billion into deficit last year, a year in which it took in only $1.5 billion 
in premiums. The PBGC would need more than fifteen years just to make up its 
current deficit, with new claims arriving all the while. The PBGC has 
proposed that companies follow more realistic accounting rules and pay 
premiums that reflect the true risks of their underfunding. It also is 
asking for stricter limits on the ability of companies to escape their 
pension debts by declaring bankruptcy.[6]

Without such changes the PBGC will be forced into bankruptcy and the 
government will have to bail it out. That could cost as much as $95 billion, 
according to the Congressional Research Service. At that point only today's 
profits would remain private. The losses will have been fully socialized.[7]

* * *

Barring some sudden influx of capital, something has to give-either the 
hopes of retirees or the hopes of the stock market. Unfortunately, this is a 
zero-sum game in which many Americans are on both sides at once. Higher 
pension set-asides will diminish corporate earnings. Lowered earnings in 
turn will lead to dividend cuts and job losses. Low dividends and high 
employment will decrease the demand for stocks-leading to further declines 
in the ability of pension funds to pay retirees, with more defaults all 
around. Workers, retirees, investors, and taxpayers thus find themselves 
yoked to the fortunes of the financial managers who created this situation.

This is hardly the kind of happy pension-fund socialism that Peter Drucker 
had in mind, in which worker-owners share risks and rewards alike as they 
create the goods and services demanded by a thriving marketplace. In fact, 
what has happened is that companies have made a great effort not merely to 
share the risk but to off-load it entirely onto the backs of their 
employees, the government, and taxpayers in general.

This phenomenon of risk rolling downward can be seen most clearly in the 
move by many companies from defined-benefit programs-in which employees are 
guaranteed a specific retirement payment, based on their salary history-to 
"defined-contribution plans," in which workers know nothing else except how 
much is being deducted from their paychecks. The payout rate is decided by 
how well the stock market performs, which shifts the risk onto employees 
even as it frees up more revenue for their employers and generates rich 
commissions for money managers. The risk flows down the economic scale even 
as the cash flows up.

Given the widespread problems confronting pensions outside the embrace of 
the federal government, now would seem an odd time for the administration to 
campaign for Social Security privatization. Why would anyone want to invest 
America's last line of pension defense in so perilous a market? Are Bush and 
his advisers unaware of the odds?

Probably not. Therefore, they must have a particular idea in mind. 
Presumably they believe that some kind of market recovery is needed not only 
to rescue the PBGC but to rescue the pension funds, to rescue the stock 
market, and, for that matter, to rescue the political fortunes of the ruling 
party-that what is needed, in fact, is a Bush boom. After all, such a boom 
would allow us to "grow our way out of trouble," as we have done so many 
times before.

But where will the funds come from to bid up stock prices? The national 
savings rate is nearly zero, because most personal discretionary income-like 
that of most companies-is absorbed in repaying debts. Previously, the Fed 
could have flooded the capital markets with credit to lower interest rates 
and thereby spur a bond and stock-market bubble. But interest rates are at 
their lowest since the 1950s. They can go no lower.[8]

There is only one other place to turn. The new flow of funds into the stock 
market will have to come from labor itself, just as it did back in the 
1950s. Social Security is the greatest plum of all, so large as to virtually 
guarantee a boom.

* * *

Talk of bubbles has become popular in recent years, but most discussions 
miss the key point. Although optimism is inherent in the human spirit, it 
rarely effloresces into the kind of frenzy necessary to float a bubble 
without help from the government. In fact, many of history's most famous 
bubbles have been sponsored by governments in order to get out of debt. 
Britain, in 1711, persuaded bondholders to swap their bonds for stocks in 
the South Sea Company, which was expected to get rich off the growth 
industry of its day, the African slave trade. By the time the South Sea 
bubble collapsed, the government had indeed paid off its war debt-and 
speculators were left holding worthless "growth sector" stocks. In 1716, 
John Law organized France's Mississippi bubble along the same lines, 
retiring France's public debt by selling shares to create slave-stocked 
plantations in the Louisiana territories. It worked, for a while.

The U.S. government is now attempting to run the same kind of scam. Bush 
would like to persuade Social Security claimants to exchange the security of 
U.S. Treasury bonds for a chance to buy growth stocks on which a much higher 
return is hoped for. No modern blue-sky venture comparable to the South Sea 
or Mississippi companies is needed. The stock market itself has become a 
bubble, borne aloft from the burden of generating actual goods and services 
by a constant flow of new retirement dollars.

There is no denying that channeling trillions of Social Security dollars 
into the stock market would produce short-term gains. But once this money is 
spent, the markets are likely to retreat. That is what happens after a 
financial bubble. Then we will be right back where we are today, only much 
the poorer and with no guaranteed pension system for elderly Americans-who 
will, of course, need guaranteed pensions more than ever as they watch their 
stock holdings continue to shed value. Indeed, many other countries are just 
now recovering from their own dismal experiences with what Augusto Pinochet 
and Margaret Thatcher called "labor capitalism" and Bush calls, with no 
apparent irony, an "ownership society."[9]

In the 1930s, John Maynard Keynes urged governments to run budget deficits 
in order to increase the economy's spending power on goods and services. His 
point of reference was the "real economy"-the economy of production and 
consumption, of investment in capital and in the labor to operate that 
capital. Whereas Keynes spoke of governments priming the pump with public 
spending programs to get domestic investment and employment going, Bush now 
seeks to prime the stock-market pump with Social Security contributions.[10] 
It is the next natural step from our real economy to the economy of dreams.

1. Bush's opponents note a possible third reason, which is that he is hoping 
to roll back the New Deal in favor of smaller government. It may be true 
that Bush dislikes the New Deal, but it is hard to envision his proposed 
replacement as a small-government alternative. A federally mandated transfer 
of funds--whether it is from taxpayer pockets to Treasury bills, as with 
Social Security, or from taxpayer pockets to the stock market, as under 
Bush's proposed changes--is still a federally mandated transfer of funds. 

2. Any relationship between the solvency of Social Security and the prospect 
of these personal accounts is purely rhetorical. Just before Bush's State of 
the Union address a reporter asked a "senior administration official" at a 
background briefing whether it was accurate to say that personal savings 
accounts themselves would have "no effect whatsoever on the solvency issue." 
The surprisingly candid response was, yes--"that's a fair inference." [Back]

3. Although as former employees of Enron and WorldCom recently learned, the 
price of demonstrating loyalty still can be quite steep. [Back]

4. A three-year Treasury bill purchased at the end of 1999 would have 
returned 6 percent. [Back]

5. Plans with more realistic projected rates were deemed "overfunded" and 
emptied out. [Back]

6. Reasonable as these requests seem, they are being opposed by the same 
corporate managers who created the mess in the first place. Last year the 
American Benefits Council, the lobbying organization of pension-fund 
managers, persuaded regulators to even further loosen the requirement that 
companies estimate realistic rates of return. [Back]

7. That estimate is probably low. The precedent is the bailout of the 
Federal Savings and Loan Insurance Corporation, which ended up costing 
taxpayers $200 billion. [Back]

8. After World War II interest rates rose to a peak, in 1980, of more than 
21 percent. The result was nearly four decades of capital losses on 
bonds--whose interest rates are fixed at the time you buy them--and a steady 
rise in stocks. Since 1980, however, interest rates have fallen back, 
creating the greatest bond-market boom in history. [Back]

9. In Chile conglomerates invested employee paycheck withholding in their 
own stocks or in loans to affiliates whose value then was wiped out in 
financially engineered bankruptcies. The problem got so bad by 1980 that the 
government turned over management to American and other international firms. 
Most discussions of Chile's "success story" choose to start at the trough 
right after these fraudulent bankruptcies, which of course gives a steep 
trough-to-peak tilt for the rate of return that is claimed to be normal. The 
equivalent for America would be to start a new trend right after a 1929-type 
stock-market crash. When one starts from a peak, such as today, it is much 
harder to give the statistical impression that a fantastic takeoff is in 
store. [Back]

10. The genius of recent administrations, Democratic and Republican, has 
been to transfer inflation to the stock market--that is, to the prices of 
stocks and bonds instead of to the prices of labor and production. Real 
wages today are lower than they were in 1964. [Back]

This is The $4.7 Trillion Pyramid, a feature, originally from April 2005, 
published Wednesday, May 11, 2005. It is part of Features, which is part of 

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