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Argument: Privatized social security accounts vulnerable to downturns

Issue Report: Privatizing social security

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Greg Anrig and Bernard Wasow. “Twelve reasons why privatizing social security is a bad idea.” The Century Foundation: “REASON #6: WHAT YOU GET WILL DEPEND ON WHETHER YOU RETIRE WHEN THE MARKET IS UP OR DOWN. In the twentieth century, when stocks generally grew significantly, there were three twenty-year periods over which the market either declined or did not rise. The volatility of investment markets means that it matters a great deal whether you retire during an upswing or downturn. For example, a worker who invested his or her retirement fund in a stock portfolio that matched the Standard & Poor’s 500 index and cashed out upon retirement in March 2000 would have a nest egg almost a third larger than someone who retired just a year later using exactly the same investment strategy because the stock market plunged over those twelve months.

Gary Burtless of the Brookings Institution demonstrated how much timing matters under privatization by examining what would have happened to workers with forty-year careers who retired in each year from 1911 until 2002.12 Following Burtless’s method, Figure 2 assumes that each worker put 7 percent of his or her earnings in the stock market every year (reinvesting dividends) and earned the actual historical return, year by year. It shows the wide variation in the retirement income workers would have received. Clearly, some workers would do much better than others based simply on when they happened to retire—which would be a major change from today’s system.”

Eliot Spitzer. “Can we finally kill this terrible idea?” Slate. February 4th, 2009: “President Bush and all who support privatization began with the proposition that private accounts invested in an array of stocks and bonds would outperform the current formula based on wages earned and overall wage appreciation. Well, let’s go to the videotape, as they say. Since Jan. 1, 2005, the year President Bush proposed the idea, the Dow Jones industrial average has dropped from 10,783 to around 8,000, a drop of more than 25 percent. OK, we are in a trough after a steep period of appreciation. Fine. Since Jan. 1, 2000, the Dow has dropped from 11,497 to 8,000, a drop of more than 30 percent. So what would this have meant to an average recipient of Social Security?

Let’s try to quantify this, albeit roughly. Under the current system, a couple earning a household income of $100,000-$150,000 per year would get slightly more than $3,000 every month in Social Security benefits. And their benefits would be inflation-adjusted every year. Suppose the couple were to invest for retirement in the private markets. With an income of that size, the couple would be able to save about $500,000. As Allan Sloan calculated in Fortune, a couple retiring at age 66 at the end of 2007, having accumulated $500,000 in a private savings account, would have been able to purchase an annuity delivering $3,000 per month until the death of the longest living of the two. In other words, that couple would get an annuity worth about the same amount as their Social Security benefits. A couple retiring at the end of 2008, by contrast, would have been able to purchase an annuity delivering only $2,000 per month—a 33 percent loss.

In other words, if Social Security were in private accounts, the payout you’d receive would be more correlated to the timing of your retirement than to anything else. With a privatized system, those retiring in 2007 would have been reasonably pleased—though they still wouldn’t have made a windfall compared with normal Social Security benefits—while those retiring now would be devastated, receiving vastly smaller retirement payments.

If insurance against catastrophic economic loss and deprivation in one’s retirement years is the underlying purpose of Social Security, we cannot permit the dramatic cyclical nature of market returns to place at risk a substantial portion of people’s retirement accounts. The very purpose of the Social Security system is to have a guaranteed return, not one subject to the risk of a volatile market. Indeed, it is inconceivable that we would tolerate retirees descending into poverty after a cataclysmic market collapse such as what we have just seen. Suppose we had privatized Social Security before the recent declines: In order to prevent mass poverty among the elderly, we would have been obligated to re-create traditional Social Security to redress the failure of the privatized system.”