Wednesday, March 4, 2009

Madoff learned tricks from Social Security

A Ponzi scheme is a "swindle in which a quick return, made up of money from new investors, on an initial investment lures the victim into much bigger risks." Social Security collects money from almost all U.S. workers and pays out retirees more than they contributed while they were working. Your FICA taxes don't go into some special savings account. First, the proceeds pay that years benefits then the rest gets spent by the Federal government. The Social Security trust gets a government note (an IOU) for the difference. It's as if all the workers paying FICA are lending the government money until they retire. What rate of return do we get? In good times, politicians of both stripes kicked around the idea of throwing some of it in the stock market but thankfully it's just stayed in plain vanilla government bonds. You would think that today's retirees, as a group, would be getting paid out what they collectively put in plus the appreciation from investing in government debt. That's not the case. Not even close. The first benefactor of Social Security paid in $24 over 3 years. She lived to be 100 and collected nearly $23,000; kind of like winning the lottery. The problem is not everyone can win the lottery. If they say it's possible it's a Ponzi scheme. Haven't we learned that we can't promise to pay out more than we take in? Isn't that one of the reasons we're so screwed? That's what we're doing with Social Security. We promise retirees a monthly benefit based on what they made while they were contributing. It's calculated by considering the average wage while they worked and inflation and has two brackets that makes it progressive. Sounds pretty reasonable but each retiree, on average, gets the equivalent of a $55,000 check on their 65th birthday. That adds up quick. This whole time we should have promised them what they put in plus interest. I'm not saying the benefits can't be paid out progressively, i.e. the lower earners get a larger share than the higher earners, just that we can't pay more than is there. Just ask Bernie Madoff, you can't keep paying the old investors a phantom return with the new investors money. You can only pay out real profits. Here's a link to a spreadsheet with raw data and the current benefits and the calculation rules to get them compared with what their payments are worth today. This doesn't even address the myriad exceptions that in every case increase benefits. Enough talk about fairness and preserving the economy for our children. The facts are retirees did not pay in as much as they're taking out and that can't continue indefinitely no matter what the AARP says.

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