The Truth About Social Security's Dirty Little Secret

Richard Robinson's picture

Friday, May 5, 2017 - 2:30pm

by Richard Robinson

"Sometimes I wonder whether the world is being run by smart people who are putting us on or by imbeciles who really mean it."

The above is a quote by Laurence J. Peter, the man who formulated the Peter Principle. For the uninitiated, the Peter Principle states that an employee is promoted based on their performance in their current position -- not on their ability to do the new job.

This means the employee will continue to receive promotions until they get a job they can't do.  Once they reach this level, they have gone as far as they can in that organization. Peter called this level their "level of incompetence."

Unfortunately, once an employee reaches his level of incompetence, the organization begins to suffer. And by default, the customers of that organization are harmed by the incompetent person's inability to do their job.

What The Peter Principle Looks Like In Reality
The Wall Street Journal has been taking comments in an online debate over the idea of investing the Social Security trust fund in stocks. The idea is that the Social Security trust fund has about $2.9 trillion in assets that, if invested in the stock market, would increase the fund's annual returns.

The basis of the online poll is a research paper by the Center for Retirement Research at Boston College. One of the paper's co-authors, Boston College economist Alicia Munnell, is a proponent of using the trust's funds to purchase stocks.

Of course, she believes that using the funds to buy stocks would delay (or possibly eliminate) the "day of reckoning" to which Social Security is fast approaching.

What is the day of reckoning?

According to the Social Security trustees, the fund will exhaust its reserves by 2033, a mere 16 years from now. Once this happens, Social Security recipients will see a 25% decrease in benefit payments -- leaving the elderly with very few options.

But is she correct, or is this an example of the Peter Principle in action?

I think it's the latter. Here's why…

Investing A Nonexistent Balance
The Social Security trust fund doesn't physically exist. It's nothing more than a financial record of the money the government has collected in FICA taxes since its inception.

Let's look at a simplified example. Assume the government collects $1 billion in FICA taxes in 2017. That's real money from real wages going to the Social Security trust. Once the trust receives the money, they document the $1 billion on its books. But that's the last the trust will ever see of that money.

By law, the money must be turned over to the U.S. Treasury, where it becomes general revenues of the government. And no, that money is NOT earmarked for Social Security. The money is used for ANY purpose the government desires.

Now, in exchange for the cash, the Treasury gives the trust fund an equal number of government bonds -- in this case, $1 billion. These bonds are "non-marketable," which means they can only be sold back to the U.S. government.

The bonds carry an interest rate, but interest is never paid to the trust. Instead, the Treasury issues a second bond to the trust fund for the "accrued" (phantom) interest. Again, no actual money is transferred. In other words, the trust holds nothing more than the accumulated promises of cash at a later date.

This begs the question…

When Alicia Munnell says the trust fund assets should be invested in stocks, what money is she talking about? The money in the trust doesn't actually exist.

Now, maybe she means the government should "print" it. But that risks an inflationary wildfire and a stock market crash that would make the 2008 crisis look like a picnic. Of course, the government could go to the bond markets to borrow the money, but there are serious problems here, too.

The national debt is currently near $20 trillion. At current rates, that $20 trillion grows to more than $35 trillion in 2035, excluding any additional deficit spending between now and 2035. If rates return to their historic average of 6.3%, the national debt grows to more than $90 trillion by 2035.

If you add professor Munnell's additional borrowing, those levels grow significantly -- putting the entire U.S. economy in peril.

The truth is there is no politically acceptable answer to Social Security's problems. Most politicians are walking examples of the Peter Principle in action. Most don't fully understand how the system works, but even if they did, they wouldn't have the guts to tell the American people the truth anyway.

What You Can Do About This
To be clear, Social Security won't go entirely bankrupt. True, the government could end Social Security, but in all likelihood the government will continue receiving FICA taxes that can account for 75% of promised benefits.

But that means we have to do more to prepare for a future where Social Security is a smaller part of retirement income. And it starts with providing yourself (and your family) the tools to become great investors.

For those who are interested, this is where my StreetAuthority's Nathan Slaughter and his premium newsletter, High-Yield Investing come in. Nathan and his research team are acutely aware of the problems that retirees (and future retirees) face in the United States -- such as the looming "day of reckoning" for Social Security.

That's why Nathan offers thoroughly-researched investment picks to his subscribers in his newsletter twice a month. We're talking about safe high-yielding stocks, bond funds, convertibles, closed-end funds -- you name it. If it offers a safe, high yield and can help supplement your income during retirement, you'll find it in High-Yield Investing.

Bottom line, Social Security isn't in great shape. And the hopes of fixing it don't look promising. We'll be offering more research and commentary on this topic in the coming months, but in the meantime, if you'd like to learn more about Nathan's newsletter, you can go here.

does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.