Social Security, Ponzi Schemes, and a Little Optimism

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Texas governor and Republican presidential candidate Rick Perry isn't shy on Social Security.

"It is a Ponzi scheme to tell our kids that are 25 or 30 years old today, 'You're paying into a program that's going to be there,'" he said last week. "Anybody that's for the status quo with Social Security today is involved with a monstrous lie to our kids, and it's not right. You cannot keep the status quo in place and call it anything other than a Ponzi scheme."

Them's fightin' words. But are they accurate?

I'm the umpteenth person to pick apart Perry's Ponzi comments. Most so far have concluded either yes, he's absolutely right, or no, he's utterly wrong. I don't think it's that simple. There are elements of both hard truth and hyperbole to his statement.

Perry is completely right that, based on the status quo, Social Security can't pay all of its promised benefits. "A monstrous lie," in his words.

But this isn't a secret, and I don't know anyone who has argued otherwise. There's no reason to. The numbers are in the open for all to see: Social Security paid out more benefits than it took in from payroll taxes last year for the first time since 1983. It made up for the gap though interest on Treasury bonds held in the Social Security trust fund -- something it can continue doing through 2022. Then, trust fund assets will go into net liquidation, covering benefits through 2036. After that, payroll taxes will cover 75% of promised benefits through at least 2085.

Those are the numbers. But what is a Ponzi scheme? Lately, the term has become a synonym for anything in the financial world that you're unhappy with. But it does have a specific definition. First, existing investors are paid with money raised from new investors. Second, the number of new investors has to increase geometrically to pay old investors. Finally, it has to be a scheme to defraud that will fall apart when the curtain is raised.  

Social Security really only fits one of those -- one group receives benefits from cash raised by another group.

But that alone doesn't make it a Ponzi scheme. It's how all insurance companies work. When I pay my car-insurance premium, the money goes to pay for someone else's accident. Someday down the road I'll be in an accident, and the money to pay for my repairs will come from someone else's premium. Does this make GEICO a Ponzi scheme?

Of course not. But the reason some think Social Security is Ponzi-like while approving of GEICO is that GEICO isn't forecasting to hit a breaking point in 2036 where it can pay out only 75% of claims, as Social Security is. Instead of calling it a Ponzi scheme, calling Social Security a poorly managed insurance company run by terrible actuaries may be more accurate.

Private pensions may be a better comparison. The majority of private pensions work well and are sustainable. Others, as the histories of General Motors (NYS: GM) , United Airlines (NAS: UAUA) , and YRC Worldwide (NAS: YRCW) have shown, do not and are not. But this doesn't mean they're Ponzi schemes, lies, or frauds. Some things just aren't managed as well as others.

The good news is that there are relatively easy fixes to get Social Security's head on straight. Perry notes that the program is doomed based on the status quo. He's right. But shifting that status quo to a sustainable path isn't nearly as difficult as some might think.

Every few years, the Congressional Budget Office issues proposals on how to put Social Security back on track. One solution is so simple that most would hardly notice a change.

Currently, initial Social Security benefits are determined with a calculation that considers how much you earned in the past adjusted for real wage growth. They call it wage indexing.

If Social Security switched to price indexing -- a process where initial benefits are calculated by adjusting past wages only for inflation, not real wage growth -- the Social Security trust fund would never become exhausted. Ever. The program becomes permanently viable.

Importantly, this would fix Social Security without the political venom of raising taxes. It would, of course, mean that future benefits would be incrementally lower than are currently promised, but this is inevitable without raising taxes.

It's a reasonable fix. It's even reason for optimism. By no means is it a Madoff.

At the time this article was published Texas governor and Republican presidential candidate Rick Perry isn't shy on Social Security."It is a Ponzi scheme to tell our kids that are 25 or 30 years old today, 'You're paying into a program that's going to be there,'" he said last week. "Anybody that's for the status quo with Social Security today is involved with a monstrous lie to our kids, and it's not right. You cannot keep the status quo in place and call it anything other than a Ponzi scheme."Them's fightin' words. But are they accurate?I'm the umpteenth person to pick apart Perry's Ponzi comments. Most so far have concluded either yes, he's absolutely right, or no, he's utterly wrong. I don't think it's that simple. There are elements of both hard truth and hyperbole to his statement.Perry is completely right that, based on the status quo, Social Security can't pay all of its promised benefits. "A monstrous lie," in his words.But this isn't a secret, and I don't know anyone who has argued otherwise. There's no reason to. The numbers are in the open for all to see: Social Security paid out more benefits than it took in from payroll taxes last year for the first time since 1983. It made up for the gap though interest on Treasury bonds held in the Social Security trust fund -- something it can continue doing through 2022. Then, trust fund assets will go into net liquidation, covering benefits through 2036. After that, payroll taxes will cover 75% of promised benefits through at least 2085.Those are the numbers. But what is a Ponzi scheme? Lately, the term has become a synonym for anything in the financial world that you're unhappy with. But it does have a specific definition. First, existing investors are paid with money raised from new investors. Second, the number of new investors has to increase geometrically to pay old investors. Finally, it has to be a scheme to defraud that will fall apart when the curtain is raised.  Social Security really only fits one of those -- one group receives benefits from cash raised by another group.But that alone doesn't make it a Ponzi scheme. It's how all insurance companies work. When I pay my car-insurance premium, the money goes to pay for someone else's accident. Someday down the road I'll be in an accident, and the money to pay for my repairs will come from someone else's premium. Does this make GEICO a Ponzi scheme?Of course not. But the reason some think Social Security is Ponzi-like while approving of GEICO is that GEICO isn't forecasting to hit a breaking point in 2036 where it can pay out only 75% of claims, as Social Security is. Instead of calling it a Ponzi scheme, calling Social Security a poorly managed insurance company run by terrible actuaries may be more accurate.Private pensions may be a better comparison. The majority of private pensions work well and are sustainable. Others, as the histories of General Motors (NYS: GM) , United Airlines (NAS: UAUA) , and YRC Worldwide (NAS: YRCW) have shown, do not and are not. But this doesn't mean they're Ponzi schemes, lies, or frauds. Some things just aren't managed as well as others.The good news is that there are relatively easy fixes to get Social Security's head on straight. Perry notes that the program is doomed based on the status quo. He's right. But shifting that status quo to a sustainable path isn't nearly as difficult as some might think.Every few years, the Congressional Budget Office issues proposals on how to put Social Security back on track. One solution is so simple that most would hardly notice a change.Currently, initial Social Security benefits are determined with a calculation that considers how much you earned in the past adjusted for real wage growth. They call it wage indexing.If Social Security switched to price indexing -- a process where initial benefits are calculated by adjusting past wages only for inflation, not real wage growth -- the Social Security trust fund would never become exhausted. Ever. The program becomes permanently viable.Importantly, this would fix Social Security without the political venom of raising taxes. It would, of course, mean that future benefits would be incrementally lower than are currently promised, but this is inevitable without raising taxes.It's a reasonable fix. It's even reason for optimism. By no means is it a Madoff.Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by @TMFHousel. Motley Fool newsletter services have recommended buying shares of General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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