Discussions about the new individual private accounts, a partial alternative to the traditional social security system, have taken centre-stage in US politics. However, the volume of the accounts’ assets and their design are not likely to make them appealing to either industry or Wall Street, nor do they appear to be ‘the’ solution to the public system’s future crisis.
In the State of the Union address, President Bush broadly outlined the plan to partially privatise social security. A White House senior official says private accounts will be available from 2009 for workers under 55; they will be voluntary; people will be able to divert up to 4% of their wages (nearly one-third of the 12.4% that is the current contribution to social security) into private accounts; the initial maximum contribution will be $1,000 (e784), which would increase around $100 a year.
Bush outlines: “We’ll make sure the money can go only into a conservative mix of bond and stock funds.” This could be a portfolio of five investment options, similar to the current federal employees’ Thrift Saving Plan. Options include: a fund of US Treasury securities; a fund of corporate bonds; a US large-cap stock fund; a US small-cap stock fund and an international stock fund.
“We’ll make sure that your earnings are not eaten up by hidden Wall Street fees,” adds Bush. Investment options will probably be index funds, as in the Thrift Saving Plan, where management fees are 0.06%.
The next pledge is less clear. “We’ll make sure there are good options to protect your investments from sudden market swings on the eve of your retirement,” says Bush.
Lastly, the plan will prohibit pre-retirement withdrawals or loans from the private accounts, and retirement savings will be transformed in annuities to supplement social security cheques.
Also, Bush didn’t officially specify how the amount of social security benefits that will be cut for workers opting for private accounts will be calculated. But officials say: “The person comes out ahead if their personal account exceeds a 3% real rate of return,” which is the yield that social security gets on its treasury bond holdings on top of the inflation rate.
“This is not an overwhelmingly attractive option,” observes Jeremy Siegel, professor of finance at the Wharton School and an advocate of private accounts. If a worker invests in a “conservative mix of funds”, for example 50% stocks, 30% corporate bonds and 20% T-bonds, his expected real return is 4.6% a year according to the White House – or Siegel’s more realistic 3.9%. That would be a risky premium over the 3% rate.
Wall Street is not enthusiastic. With the $1,000 cap and the promise to keep fees very low, the new business does not sound very profitable for money managers. Only $65bn will flow into the accounts each year, compared with the $242bn into mutual funds, according to Robert Pozen chairman of MFS Funds and a member of the presidential commission that backed private accounts. The average account will be
$10,000-$12,000 at the end of the first 10 years, nothing to excite investment firms. Only the big groups specialising in passive management, such as Barclays (already involved in the Thrift Savings Plan), State Street Global Advisors and the Vanguard Group, are thought likely to bid for the new service.
Bush says that in 2018 the current social security system will start paying more in benefits than what it receives in contributions, and by 2042 the system will be bankrupt. Critics deny this because in 2042 the system will still be able to pay about 70% of the promised benefits; they add that private accounts will not eliminate any shortfall and instead they’ll require trillions of dollars in additional government borrowing to fill the gap created by the diverted 4% in taxes. That would be “immoral, unacceptable, and unsustainable”, according to a letter signed by several Democratic senators.
Bush agrees that to “save” social securities other measures are required. He suggests solutions such as delaying the retirement age; indexing the growth of benefits to consumer prices rather that wages; discouraging early retirement and reducing benefits for wealthier retirees.
Bush is clear that his voluntary personal retirement accounts are not a means to “fix social security” but “to make the system a better deal for younger workers”, or a way to promote his vision of the “ownership society”. The Democrats will fight against it to defend the New Deal’s principles embodied in social security.