Staking Social Security

Look closely at the current proposals to privatize Social Security, and you might detect a slight resemblance to the classic Ponzi scheme.

Charles Ponzi found a way to get rich quick in 1920. He convinced Bostonians that his Securities Exchange Co. was making enormous profits on international postal exchange coupons by taking advantage of differences in rates of exchange. When investors asked for details, he replied, "My secret ... that is what I do not tell." No one pressed him - after all, he was actually paying 50 percent interest after 90 days. People were desperate to give him money.

But there were no profits. Interest was paid from new money coming in. This worked so long as new investors were added and the old ones continued to pay. The scheme collapsed when the cat got out of the bag. After accumulating $10 million in a matter of months, Mr. Ponzi was jailed for larceny.

Like Ponzi, the would-be privatizers of Social Security, mostly financial houses, are peddling the idea of a fast buck, although it's modified to fit the law.

One way their approach differs from Ponzi's is that they promote capital gains, not interest. Stock prices appreciate with corporate earnings, but also with the amount of money pouring in. A large and continuous flow propels prices upward, and any slowing or stopping represents danger. Finding new sources is a must.

The individual investment accounts the privatizers propose for Social Security are their main tool. They lobbied successfully for the IRA in 1974, the 401(k) plan in 1978, and now seek a large hike in contribution limits. They are aggressively campaigning to convert state-defined benefit plans (which offer a known benefit at retirement) into individual account plans, which would leave retirees at the mercy of securities markets. Moreover, when a state's defined benefit plan is privatized, stock voting power is greatly fragmented, another plus for the privatizers.

Social Security is the privatizers' holy grail, with annual income at $500 billion and rising. The privatizers have pursued Social Security for more than 20 years. Average families, they say, can expect to retire with $1 million dollars or more, and low-income families with at least half a million; they can "choose a privately invested system structured for average unsophisticated investors." Workers will benefit from new jobs and expanded opportunity coming from the great sums that will pour into the private market. Privatization will give workers more control of their money.

A big roadblock has been the public's great esteem for Social Security, due to its doing what it was set up to do: keep beneficiaries financially whole upon retirement or death. Undaunted, the privatizers embarked on a massive campaign to blacken Social Security's good name by declaring its imminent bankruptcy, calling it a Ponzi scheme, ironically, and making the public unnecessarily anxious.

The privatizers, seeing vast profit potential, have given more than $60 million in "campaign contributions." Many congressmen have submitted privatization proposals. Gov. George W. Bush asks that $80 billion or so of Social Security's $500 billion be privatized, which would mount up to $1 trillion in 10 years and $3 trillion in 20 years.

A negative effect of so much money going into stocks is an artificial ballooning of stock prices. When price is divorced from real value, it can become wildly unstable. Market crashes will likely take place more often and become a cause for constant concern.

There is the danger, too, of a supply-side debacle. Excessive capital may lead to overproduction, production cuts, lost jobs, and shrunken purchasing power. Such a cycle led to the Depression and Southeast Asia's economic collapse.

Privatization won't lead its practitioners to jail; they are not fraudulently offering, as Ponzi did, unusual interest rates when there is no profit and new money is being used to pay the interest. In their zeal to corner cash flows, they strongly imply the opportunity to receive the long-term yield of 7 percent.

But the privatizers have been remiss in not pointing out the potentially harmful impact of huge sums coming on the market. If they were required to issue a prospectus to the public, and they omitted such information, there might be grounds for prosecution. Nor is there an obligation to explain - although it is the right thing to do, especially with Social Security at stake. Unfortunately, the lure of extreme wealth and corporate and political power is too great.

David Langer, a consulting actuary, is chairman of David Langer Co. in New York.

(c) Copyright 2000. The Christian Science Publishing Society