Tuesday, January 6, 2009
By CHARLES MURRAY
GREAT BARRINGTON, Mass. — For weeks the U.S. and international media have been following the story of Bernard Madoff and his “giant Ponzi scheme,” as The Wall Street Journal called it, which may have cheated unsuspecting investors out of tens of billions of dollars. The Securities and Exchange Commission termed it “a stunning fraud that appears to be of epic proportions.”
But is this — as it is being touted — the largest Ponzi scheme in history?
The answer is no. That honor goes to a Depression-era creation of the U.S. government itself: the Social Security system.
As Ponzi schemes go, Social Security dwarfs Madoff’s con in both size and scope. Wikipedia, the online encyclopedia, describes a Ponzi scheme as “a fraudulent investment operation that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profits from any real business.” The high returns are used to lure new investors, whose money keeps the scheme going.
You have just met Social Security. The federal government today collects payroll taxes from approximately 163 million white- and blue-collar workers, which is used to finance the retirement benefits of 50 million Americans. In fiscal 2008, Washington collected $785 billion in taxes and paid out approximately $585 billion in benefits.
So what’s the problem?
The problem is that generations of U.S. workers have been misled to believe that Social Security’s annual surpluses accumulate in a trust fund that will be used to meet future costs. It is money that will be there, we have been assured, when “our day” comes.
Indeed, Social Security’s trustees reported that the trust fund’s assets reached $2.2 trillion in 2008. But like Madoff’s investment fund, these assets are largely smoke and mirrors.
All surplus Social Security taxes the Treasury collects are spent immediately, used to pay for government programs or interest on the national debt. In exchange, the Treasury gives Social Security non-marketable special-issue government securities: IOUs. That’s what accumulates in the trust fund.
These promissory notes are backed by nothing of tangible value, other than the political promise that Washington will come up with a way to redeem them when they’re needed.
That day of reckoning is coming soon. Though the current recession probably will delay the retirement of many baby boomers, who have seen their nest eggs depleted by the dramatic decline in equity values, Social Security actuaries have estimated that benefit payments will exceed revenues starting in 2016, less than a decade from now.
This date was based on intermediate assumptions: not rosy, nor worst-case.
If the current recession is especially long and deep — reducing payrolls, incomes, immigration, and revenues — it could come sooner.
The exact date, however, matters less than what will happen when we reach that date: Social Security officials will have to start cashing in some of the IOUs and the Treasury will have to find a way to come up with the money.
Many in the media are now asking how Madoff could have taken so many investors, regulators, and investigators for such a big ride for such a long time, despite numerous red flags.
Those who did their due diligence were not fooled. The abnormally generous returns, unusual fee arrangements, and lack of independent custodian all signaled trouble.
Likewise, Social Security should be considered too good to be true. We should not be fooled.
It is an unsustainable pay-as-you-go system — exactly what Charles Ponzi had in mind.
Just as the Ponzi and Madoff schemes collapsed, Social Security will become unsustainable when payroll taxes no longer cover program benefits. Then, either benefits will have to be cut or more money will have to be pumped into the system through increased payroll taxes, higher income taxes, or increased borrowing.
Ponzi and Madoff fooled many. If we ignore Social Security’s future problems we only fool ourselves.
X Charles Murray is president and CEO of the American Institute for Economic Research, Great Barrington, Mass. This commentary originally appeared in The Free Lance-Star of Fredericksburg, Va. Distributed by McClatchy-Tribune Information Services.