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Thrift Savings and Government Investing

I've long been pretty sympathetic to the idea that we ought to take some portion of the Social Security Trust Fund money and put it in the stock market. I won't go into the reasons that this could be a good idea, but only note that opponents of this plan tend not to disagree with proponents about the possible benefits. Instead, detractors emphasize the potential downside. As Cato privatization maestro Michael Tanner put it:

On the surface, that approach may have some appeal; in reality it is fraught with peril. It could potentially make the federal government the largest shareholder in American corporations, raising the possibility of government control of American business. In addition, there are serious questions about what types of investment the government would make. Political considerations and "social investing" are likely to influence the government's investment decisions, allowing the government to manipulate economic markets.
The obvious reply to this is that you could write whatever law authorizes government investing to include a clause prohibiting political considerations and social investing in investment decisions and shareholder votes. The counterreply is that sure, the law would start out saying that, but once you've got the federal foot in the door things may change. It seems to me that we should probably dedicate some brain power to thinking up a better institutional solution than that "obvious" one rather than giving up on the whole project. Tanner and co., however, advocate just giving up. I was interested to read on Tim Lee's blog that the guidelines for the federal Thrift Savings Plan are, in fact, very similar to the naive solution to the government investing problem:
Vote all proxies and address all corporate actions in a manner which will result in maximum financial benefits to TSP participants and in accordance with fiduciary responsibilities. Provide the Board with a statement of proxy voting policies and periodic reports explaining any votes that are exceptions to stated policies. Provide updates as policies are revised.
Given that Bush's provide accounts are going to be modeled on TSP, it seems that all the same pitfalls of government investing simply arise anew. Either this kind of solution that TSP already has is going to be adequate to deal with the problems in this case (in which case the government should just invest and spread the risk), or else we're going to need a better solution (in which case we should use that solution to allow the government to directly invest and spread the risk) or else, as privatizers seem to think when they talk about government investing, the problem's not solvable within this sort of structure in which case we should neither privatize nor allow government investing, but just keep financing benefits the same way we do today.

February 3, 2005 | Permalink

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Comments

Of course Tanner proposes giving up. He wants private accounts, not stock market investments. Cato cares far more about getting the money out of the government's hands than it does about the actual pros and cons of investing in the stock market.

A moment's thought provides any number of solutions to the potential problem of the feds intefering with corporate governance. You could simply forbid the government from exercising their proxies. You could have tight regulations on the kind of funds they invest in. You could demand that actual management of the funds be divvied up among the states.

This isn't really that big a problems, and there are plenty of solutions in any case. It's a red herring.

Posted by: Kevin Drum | Feb 3, 2005 12:50:47 PM

Matt,
Were you one of the philosophy grad students who also moonlighted in the math dept, or were you one who dropped out of math after junior year of high school?

Anyway, please explain in detail how more than 49.999% of the population can make money in the stock market. Include in your explanation a discussion of where you think wealth comes from.

Cranky

Posted by: Cranky Observer | Feb 3, 2005 12:54:32 PM

All these proposals to divert federal money into stocks are
complete BS. Long-term stock returns correspond to GDP growth,
and the ability of the government to raise revenue through
taxation (without crippling the economy) also corresponds to
GDP growth. More directly, if the government wants or needs
a slice of equity returns, it can just take it directly by
taxing equity investors.

The *only* reason to deal with these complicated schemes is to
avoid anything that can be framed as a "tax hike". But really,
if government grabs a slice of equity returns by buying stock,
isn't that just about the same thing as grabbing a slice through
taxation ? Apart from all the risks of corruption in having
elected officials control huge investment decisions, and a
substantial change in relative prices of stocks vs bonds (needed
to persuade private investors to sell their stocks to the
government).

When oh when can we move out of all this post-modern politics
and get back to acknowledging that, at least for the purposes
of governance, there is an objective reality ?

Posted by: Richard Cownie | Feb 3, 2005 12:58:38 PM

Red Herrings abound. The reason that Dems have been abusing the hypocrisy charge is that the current crop of Republicans are disingenuous in all talk of policy. Under normal circumstances there are games being played beneath the surface, but both sides have legitimate arguments and goals. Now we have nothing but gamesmanship, or at the very least any partisan advantage trumps any and all policy objectives.

With Cato it is hard to know whether they have deluded themselves enough to think that by repeating the small government mantra that even though they can not come up with a good model of why it might be beneficial, they actually do believe that eventually, down the road, once we reach the small government utopia, we will be in a position to create policies that have a chance of actually having good effects.
Similarly, with Bush it is hard to know how much of this stuff he believes, or if he is just going along with the latest advisor to call their plan a game-changer, but the lack of seriousness that this crop of Republicans has been allowed to get away with will harm policy for a very long time.
PJ O'Rourke's comment, "The Republicans are the party that says government doesn't work and then gets elected and proves it," rings especially true with the Bushies.

Posted by: theCoach | Feb 3, 2005 1:04:49 PM

Cranky,
It would come from better allocation of capital. Of course, the limiting risk in that allocation seriously deludes that potential, and the size of the change, makes previous rules of thumb inoperable.
Personally, I think the money out of a hat scenario of private accounts is very limited, but that by creating an enormous risk pool, the government should, or could, be able to skim a very small amount of the risk premium. After taking into account ou current fiscal picture (Bush's massive deficits), the need to borrow for this make t a non starter until we get the general fund problem under control, and I think the potential gain is likely to be lost in administrative costs, but the potential is there to get a slight improvement in return via better risk pooling and better allocation of capital.
If there were a serious administration in power it might be worth considering.

Posted by: theCoach | Feb 3, 2005 1:12:35 PM

But, in the end, this would be "US borrows from the bond market to invest in the stock market", as we are not running an overall surplus resulting in any investment of the social security trust fund in the stock market (through any means) would need a corresponding increase in borrowing.

Is the arbitrage opportunity so great that this would be worth it?

Posted by: Nicholas Weaver | Feb 3, 2005 1:20:42 PM

Maybe a preferable solution would be to tie social security benefits to price increases rather than wage increases. That will do very little to reduce benefits in the short term, but will significantly reduce the cost of social security in the long-run. We also implement a new program similar to IRAs but with even more generous tax benefits so that virtually everyone would take advantage of it. Maybe we could reduce the personal exemption by $1000 and then allow everyone to invest up to $1000 in an account that would be entirely tax free (instead of just tax deferred). I would think that would be a solution that would be acceptable to just about everyone.

Kevin: Any restrictions on government action that the government puts in place are easily undone. I wouldn't trust anything short of a constitutional amendment to keep the government from using proxy votes for political gain. The possibility of the federal government being an active shareholder is so frightening that it more than counteracts any potential gains from moving into private accounts. Cato is right that government control over the invested funds is an absolutely unacceptable plan and the status quo is preferable.

Cranky: The stock market is not a zero-sum game. Stock value is based on the net present value of future dividend payments and stock buybacks. Investors as a whole make money as long as corporations as profitable. You don't think that all stock market wealth simply comes from trading gains and losses that even out to zero net gain in the long run, do you?

Posted by: Xavier | Feb 3, 2005 1:22:12 PM

> It would come from better allocation of capital.

And the evidence that there is currently a misallocation of capital is what? The dotcom bubble showed that there is plenty of capital for new ideas - and that there is a real shortage of profitable new ideas. The small/medium businesses I work for aren't having any trouble getting reasonably-priced capital for profitable expansions either.

Cranky

Posted by: Cranky Observer | Feb 3, 2005 1:25:22 PM

Read 'The Use of Knowledge in Society.' Decentralized decision-making is *almost* always superior, particularly in info age. TSP can work because it's relatively small.

Posted by: Maestro | Feb 3, 2005 1:27:23 PM

but the potential is there to get a slight improvement in return via better risk pooling and better allocation of capital.
If there were a serious administration in power it might be worth considering.

I have a problem with this kind of thinking, theCoach. What do you mean by "improvement in return?" Do you mean improvement on stock investment return, compared to what it might have been?

Because right now, there is no "return" as the money for SS is not invested. So while investing the money might be able to have a small increase in the amount SS is able to pay retirees (serious emphasis on the might), it would do so by adding all the inherent risk of investment to a system that currently has none. The only risk to the system now is that the US government goes bankrupt, or that crooks like Bush may be elected to head that government.

And I feel pretty certain that, once the risks are factored in, the "small" improvements completely disappear over the long run, and became noticeable decreases in benefit payments to SS.

Which is why SS money does not belong anywhere near the market. And you don't even need to include the (huge and perhaps insurmountable) risk of corruption to show that. Seriously, what do we do for retirees who happen to retire during a serious bust period in the market? They will experience serious declines in their payments (I've seen it happen with stock portfolio retirement plans of coworkers). These bust periods are absolutely guaranteed. Do we just roll the dice, and accept that some people get a seriously reduced payout?

Posted by: Timothy Klein | Feb 3, 2005 1:30:41 PM

opponents of this plan tend not to disagree with proponents about the possible benefits. Instead, detractors emphasize the potential downside

This is a vacuous assertion.

Let's suppose hypothetically that some seemingly bright young person--say he has a degree from Harvard or something like that--tells me he's going to follow in the footsteps of Ashley Revell http://www.cnn.com/2004/SHOWBIZ/TV/04/12/roulette.win/, take his life savings to a roulette table in Las Vegas and put it all on red.

Now, I may not agree with my friend that this is a great idea. But it's absolutely true that you won't find me in disagreement over the possible benefits. It's entirely possible--and fairly likely even--that he will manage to double his money this way.

The only significant difference with stock investing is that the expected return is negative in the case of roulette, and we tend to believe it is positive (relative to guaranteed interest) in the case of stock investing. But in either case, there is volatility.

The big question is what are we going to guarantee to retirees. The amount that we guarantee cannot be subject to fluctuations in stock prices. Even if some people do better than in a defined benefits system, the ones that do worse are probably going to demand that we restore the floor benefits that they believe they were promised. If we know that ahead of time, we really have to keep a certain amount in a safe investment.

There are already all kinds of tax-advantaged ways to enhanced your retirement income with stock investment. I personally think that those who lack the means to participate and thus expect to rely solely on Social Security benefits are already at the floor. If that's the case, then they really should not be putting their benefits in jeopardy.

Posted by: Paul Callahan | Feb 3, 2005 1:37:04 PM

One good reason not to do this is it creates exactly the same transition costs as setting up private accounts. If the rest of the government doesn't borrow from the Trust Fund, it has to borrow from somewhere else.

Another good reason is that it's pointless. As many people have pointed out, the "problem" is that providing for the needs of retirees requires some fraction of the incomes of working people. Government already has the power to claim as much income as it wants from workers by taxing them or selling them government bonds. Incurring major costs now to allow the government to one day sell people private securities as well accomplishes nothing. Rates of return are irrelevant.

Posted by: jw mason | Feb 3, 2005 1:37:49 PM

I was interested to read on Tim Lee's blog that the guidelines for the federal Thrift Savings Plan are, in fact, very similar to the naive solution to the government investing problem:

Huh? This is how virtually all private index funds are run. The have a fiduciary duty to get the best available financial benefits. The TSP was simply hiring a private fund manager to run an S&P 500 fund for the persons who choose to invest their TSP money in the "C" fund. It is simply not comparable to a situation in which the government itself is investing money. One wonders where Matthew comes up with these things...

Posted by: Al | Feb 3, 2005 1:41:04 PM

Do proponents of using stock investments to fund social security actually claim this will grow the economy faster?

If so, I don't understand the mechanism. It seems to me that this kind of automatic investment would--if anything--make the market less efficient than if individual stock investments were made from discretionary income.

If not, then we're not really arguing about whether the resources exist to give future retirees a decent standard of living; rather, libertarian-minded people simply hate the idea of the government taxing the whole economy and redistributing income. Instead they want to set up
this jury-rigged ownership scheme as a substitute. It seems likely to do more or less the same job as the present system, only less reliably, so it's hard for me to grasp what it's good for.

Posted by: Paul Callahan | Feb 3, 2005 1:51:08 PM

It seems likely to do more or less the same job as the present system, only less reliably, so it's hard for me to grasp what it's good for.

Because if anything exists without a capitalist making a profit of it then QED it must be inherently ineffecient. If something exists like SS that flies in the face of John Galt it needs to be removed so it doesn't cause them cognitave dissonance.

Posted by: absynthe | Feb 3, 2005 2:01:17 PM

What is done with the money we put into Social Security now? I am not really sure but I think that the Federal general fund uses it at minimal interest rates, if any. The funds are therefore being used to some political purpose.
So might we be able to do with the money if it were put into the open market? This is where it gets political all over again. Who would control it?

Posted by: Al | Feb 3, 2005 2:01:35 PM

"As many people have pointed out, the "problem" is that providing for the needs of retirees requires some fraction of the incomes of working people. Government already has the power to claim as much income as it wants from workers by taxing them or selling them government bonds. Incurring major costs now to allow the government to one day sell people private securities as well accomplishes nothing. Rates of return are irrelevant."

That's true; Unless the scheme involves a net reduction in government debt/net increase in total productive investments, in those terms it's a wash.

The real problem with having the social security trust fund "invested" in government securities, is that it's disguised the true scale of the national debt, and of the deficit we've been running; When you figure in future obligations, I don't think we've run a ballanced budget since the social security program began.

The truth is, if you really want to "save" social security in some meaningful sense, you'd push a ballanced budget amendment, to reduce the proportion of federal revenues that are just servicing the debt, and which aren't available to pay for actual government programs. And you'd try to increase the private sector savings rate somehow, to boost economic growth.

It's pretty obvious why Bush can'd do the former, but is there a reason [i]Democrats[/i] can't start pitching for a ballanced budget amendment, if only to embarass the President?

Posted by: Brett Bellmore | Feb 3, 2005 2:11:21 PM

T. Klein,
If it sounds like I am advocating for Bush's plan, than I was not very clear.
I think it is reasonable to suggest, but not obvious, that the government could get a risk premium from investing SS surplus money in the stock market, and that the SS recipients would be entirely protected from that risk by pooling it to the US government.
Bush's plan looks nothing like this.

Posted by: theCoach | Feb 3, 2005 2:13:56 PM

"And the evidence that there is currently a misallocation of capital is what? The dotcom bubble showed that there is plenty of capital for new ideas - and that there is a real shortage of profitable new ideas. The small/medium businesses I work for aren't having any trouble getting reasonably-priced capital for profitable expansions either."

Cranky


And the late 1990's also showed (IMHO) that Wall Street can manufacture stock shares to meet any level of demand. If a large, on-going stream of money is diverted into the stock market by the federal government, I'd expect a very large initial increase. After that....

Posted by: Barry | Feb 3, 2005 2:22:33 PM

Brett,
Perhaps a balanced budget ammendment would be a good idea with the current status quo (Bush), but in general it is a bad idea.
With responsible Presidents we would do much better without a balanced budget ammendment (Clinton), and could adjust according to the circumstances.
Infrastructure improvements can be worthwhile expenditures, whereas Bush's Boondoggles have not improved the economy in any meaningful sense.
The issue is good judgement, and the general fund problems can be traced to Reagan, Bush, and Bush II, and back to the bad judgement people showed in supporting them.
It is always interesting to see what causes a libertarian(?) is willing to take away liberty for.

Posted by: theCoach | Feb 3, 2005 2:28:30 PM

Barry,Don't forget the Edward Jones settlement! Always a little more money to be raked off from the suckers.Xavier - I am aware of the theory you are expressing. There are some problems in implementation, as the above link discusses. But the fundamental problem is one of theromodynamics: the output of our economy is what it is. There isn't a magic source called "the stock market" that makes our economy larger by virtue of existing. Pouring more money into the stock market in the absence of any need for new capital will only increase the size of the bezzle.Cranky

Posted by: Cranky Observer | Feb 3, 2005 2:35:28 PM

"With responsible Presidents we would do much better without a balanced budget ammendment (Clinton), and could adjust according to the circumstances.
Infrastructure improvements can be worthwhile expenditures, whereas Bush's Boondoggles have not improved the economy in any meaningful sense.
The issue is good judgement, and the general fund problems can be traced to Reagan, Bush, and Bush II, and back to the bad judgement people showed in supporting them.
It is always interesting to see what causes a libertarian(?) is willing to take away liberty for."

I'm not sure what denial of liberty you're talking about. The only thing I can think of is that a balanced budget amendment contrains a politician's freedom to spend public money without external constraints. I don't think it's terribly difficult to reconcile libertarianism with that constraint.

Posted by: Xavier | Feb 3, 2005 2:48:50 PM

"Infrastructure improvements can be worthwhile expenditures"

"Infrastructure improvements" are a nonsensical justification for the federal government incuring debt. Allow me to explain:

When I built the house I currently live in, I incurred a one time extraordinary expense which substantially exceeded my anual income. Since the house will be of use to me for decades to come, it made sense for me to borrow to pay the expense. Local governments frequently, and state governments on occasion, also find themselves in the situation of needing to buy something long lasting which can't be afforded out of current revenues, and which won't be bought on a regular basis.

The federal government, except in the event of MAJOR wars, or other emergencies of similar scale, does not incure extraordinary one time expenses for infrastructure. It builds highways, for instance, which are long lasting infrastructure, but highways don't cost 1.5 times our annual tax revenues! On the scale of the federal budget, the infrastructure investments the federal government is making are more akin to a homeowner repainting the living room, or buying a couch or kitchen table. The scale of the federal government is large enough, compared to the sorts of infrastructure investments it's making, that they do NOT qualify as extraordinary expenditures.

You and I don't (Well, shouldn't, anyway.) take out long term loans to pay for regular, reoccuring expenses. The federal government DOES. And it does so, not because it makes economic sense to do it, but because expenditures help politicians get elected, and taxes hurt, and the bill comes due when they're retired.

For the federal government, in other words, deficit spending is almost purely just a way of living beyond it's means. And nothing more.

Now, I will grant that any ballanced budget amendment would have to provide for an emergency override, in those few cases, like WWII, where the government really does face sudden expenses that exceed revenues. A supermajority vote, to borrow, perhaps. But on a year to year basis, there simply isn't any good reason to let the federal government borrow money. It's not using it to buy bridges, it's using it to buy VOTES.

Posted by: Brett Bellmore | Feb 3, 2005 3:35:38 PM

Matt:

You may as well argue that The Fed is unduly influenced by politics, yet that seems to work ok. If any government appointed official has too much control over the market it is the Fed.

We can seperate government administrators from political influence to some extent by appointing them to terms longer then the terms of the politicians doing the appointing. Up until recently, appointments to the Supreme Court have been politically neutral (Kennedy and O'Connor) and non-partisan in their decisions.

Posted by: TheJew | Feb 3, 2005 4:00:39 PM

"Up until recently, appointments to the Supreme Court have been politically neutral (Kennedy and O'Connor) and non-partisan in their decisions."

Hey, thanks, I appreciate the laugh. But I don't appreciate having to clean the tea off my monitor and keyboard from the spit-take.

Posted by: Brett Bellmore | Feb 3, 2005 4:13:36 PM

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