Big news in pensions today: Silverdex, a major US-based conglomerate with fingers in just about every economic pie, from mining to solar cells, turns out to have been stuffing its main pension fund full of… it’s own corporate bonds. For decades. It’s still not clear how this happened without anyone noticing, but essentially the pensions that current workers have been counting on for thirty years turn out to be backed by nothing more solid than the company’s promise to pay. Amazingly, when confronted by reporters about this behavior, a representative declared that this was a big fuss over nothing.
“It is perfectly legal to invest a pension fund in corporate bonds. That is what we have done. These bonds are backed by the full faith and credit of Silverdex, and it is defamatory to suggest that they will not be paid.”
Silverdex is still pretty profitable after all these years, but “defamatory” seems absurd; obviously, it’s quite conceivable that the firm will run out of money, and the workers will be left with no jobs, no pensions, and no retirement. Though no charges have yet been filed, a congressional hearing is scheduled for next week, and observers expect high-level resignations from the Pension Benefit Guaranty Corp, which regulates pensions, to follow.
I don’t really know how to say this, but sorry, I lied a little bit. I’m not talking about a private company at all, because of course, if a private company did this, it would be completely and totally illegal. Regulators would have shut this down decades ago and probably at least a few lower-level executives would have spent a little time in the pokey. Instead this is, of course, a description of how the United States Social Security “trust fund” works.
I translated it into the private sector in order to make a point about the absurdity of arguments over the trust fund. Now that the debt ceiling negotiations have come down to entitlement cuts, apparently we are back to arguing about whether the social security trust fund is “real”:
First things first: Social Security is funded via a payroll tax on all income up to $110,000. You pay 6.2 percent and your employer pays 6.2 percent. These numbers were set by the Social Security Reform Act of 1983, and for the next three decades payroll taxes provided more money than was needed to pay out benefits to retirees.
Now, suppose this surplus had been invested in corporate bonds. What exactly would that mean? It means that workers would be giving money to corporations, who would turn around and spend it. In return, the Social Security trust fund would receive bonds that represent promises to repay the money later out of the company’s cash flow. In effect, it gives workers a claim on the cash flows of the company at a later date in time. When that time comes, the company would have to pay up, which would make it less profitable. If the company was already unprofitable, it would make their deficit even worse.
If that’s what had happened, there would be no confusion about the trust fund. Everyone agrees that corporate bonds are real things, and that the corporations who sell them have an obligation to pay them back, even though it means less money for shareholder dividends.
Now let’s change a few words in this story. What actually happened is that the Social Security surplus was invested in treasury bonds. What does that mean? It means that workers gave money to the federal government, which turned around and spent it. In return, the Social Security trust fund received bonds that represented promises to repay the money later out of the federal government’s income tax receipts. In effect, it gave workers a claim on the income tax receipts of the government at a later date in time. When that time came, the federal government would have to pay up, which would make it less profitable. If the government was already running a deficit, it would make the deficit even worse.
I’m not sure why we spend so much time on a rather silly semantic argument. Is Santa Claus “real”? What about Falstaff or Mickey Mouse? True love and patriotism? The future and the past? They do not occupy physical space, and yet we are naming something that exists in our minds, that has real properties by common understanding. It is in that sense that any accounting standard exists, and in that sense, the Social Security Trust Fund is as real as next week.
And yet, this does matter, because people who vehemently proclaim that the Trust Fund is real usually pair this trivial semantic observation with a bunch of really misleading claims about the deficit, or various legal and moral entitlements, which supposedly proceed from the reality of the trust fund.
Let’s consider this analogy to corporate bonds more carefully, because reasoning by analogy from a US government trust fund stuffed full of US corporate bonds to a US government trust fund stuffed full of US government bonds is really popular. But if these two cases are actually parallel in the way that is implied, then a third case would also be parallel: a US corporate pension fund stuffed full of the bonds of that corporation. Call it the Silverdex Scenario.
Such a pension fund would, of course, be illegal. And for good reason: we recognize that it is not, in fact, a pension fund. It’s a promise by the corporation to pay its workers at some later date, not a funded pension plan. The company can call this anything they want—trust fund, pension plan, Ponzi scheme—but whatever we call it, we’d recognize it for what it is: a meaningless accounting fiction that does not in anyway enhance the security of worker retirements. And if, say, Verizon tried to fund its pension plan this way, liberals would hit the roof. Because we recognize that a pension fund full of third-party securities is not, in fact, very much like a pension fund full of securities issued by the same entity—corporate or government—that owes you the pension.
That’s not to say that liberals would believe that a pension fund thus funded is somehow a free pass for a company to stiff its workers. I think we’d all agree that as long as they are solvent, even a company that set up this lunatic pension plan is obliged to pay out what they’ve promised.
But they’re not obliged because they put some “bonds” in the “trust fund” and made a bunch of complicated entries on the balance sheet about all the “interest” they were paying to the “trust fund” before “lending” it back to the company. They’re obliged because they wrote a contract that said they would pay the workers pensions. If the value of the “bonds” in the kitty fell to zero, their obligation to the workers would not decrease by a single dollar.
Conversely, increasing the face value of the “bonds” to $5 trillion dollars would not make the workers one iota better off. It doesn’t give them any greater claim on the company’s funds than they had before.
All of which is to say that this “trust fund” doesn’t bring anything to the party; if the company can pay, they will, and if they can’t, the workers get bupkis. Which is why the government has very sensibly forbidden companies from funding their pension plans this way. Funding corporate pensions with company bonds leaves retirees with nothing but a claim on the future sales of that corporation, which is to say, exactly what they had before you implemented the “trust fund”. And funding social security with special, non-tradeable US bonds leaves beneficiaries with no more than the claim they already had on future tax revenues.
We force companies to put their pension funds in the bonds of other companies and governments, rather than their own, because it gives the workers an asset that will be worth something even if the company goes bust. Funding a pension plan this way means that workers are diversified: they get their paycheck from one company, their retirement savings from another. At least in theory, I mean; in practice, most pension funds are underfunded (and government funds worst of all). But at least the workers have some independent asset if their company goes bankrupt.
If the SSA stops writing checks, it will be because the US government is out of money. And if that happens, good luck waving those bonds in the air.
In fact, hypothetical Silverdex workers are better off than Americans with Social Security accounts in one key respect: they actually have a legal right to get paid. Not because there are “bonds” in their “trust fund” but because the company made a legally binding contract to pay them. If Silverdex tries to stiff them, a judge will seize money and hand it over to the pensioners; if the company goes bankrupt, the pensioners are probably going to be near the head of the line of unsecured creditors.
Trust fund afficionadoes imply that this is somehow also true of Social Security beneficiaries, but it’s not. This has been black-letter law for fifty years, ever since the Supreme Court ruled in Flemming v. Nestor that the government can take away your benefits any time it wants to. You have no legal rights to your Social Security benefits; you enjoy them at the pleasure of the US Congress.
The special-purpose bonds in the Social Security “trust fund” do not change this fundamental reality. Those bonds are owed to the Social Security Administration, not to individual beneficiaries, and you are not a shareholder of the Social Security administration. Since Flemming v. Nestor, you’re not even a creditor of the Social Security Administration. You’re just someone that they may or may not write a check to occasionally, as directed by Congress. Unlike a private company, Congress can decide at any time to cut benefits, and a judge will simply sigh and suggest you start hunting for sales on Fancy Feast.
To be sure, I do not think that it is likely that Congress will suddenly decide to massively slash benefits. But it’s not like the bonds in the trust fund are a mighty wall between us innocent taxpayers and the entitlement-gutting hordes of the United States House of Representatives. Social Security is going to keep cutting checks because doing otherwise would be really unpopular. It would be just as unpopular, and unlikely, if there were no trust fund. Like I said before, the bonds and the trust fund are not bringing anything to the party.
Nor do they confer any particular moral obligation, above and beyond the fact that we’ve promised, implicitly or explicitly, that we’ll help pay for retirement. (No, really: before you bring it up, it is not true that we set up the “trust fund” so that Baby Boomers could pre-fund their retirements, or as some sort of intergenerational swap deal where workers paid more tax earlier, and rich people were supposed to repay them later. According to the folks who were actually there, that’s a myth, and the current structure of the US social security finances is mostly an artifact of the hasty compromise that the Greenspan Commission slapped together at the last minute.)
So while liberals are right that it’s “real” in the sense that there is something that is called, by general agreement, “the Social Security trust fund”, conservatives are also right that it’s “not real”—unreal in the sense that it is not, as the other side keeps implying, anything like the usual kind of trust fund which has assets in it entitling you to get paid by someone else. The trust fund exists, but it’s about as useful as a chocolate teapot. It doesn’t make retirees more likely to get paid. It does not make it easier for the government to pay them. You can’t even cut it into pieces and use it for s'mores.