The Stock Market and Solidarity
By
Lancelot Finn (March 10, 2005)
[T]he president's plan would break the bank, and also
break Social Security's intergenerational compact. And it would subject younger
workers to the risk that they'll face retirement with nothing. –
Robert
Reich went to bat for the Social Security program today. I should say first that I salute Reich for
being ready to debate. Argument has been out of fashion on
Overstating the risks
Personal accounts will be comprised of stocks and bonds. Start with stocks. Stocks can be risky, especially in the short run. On a day-to-day basis their ups and downs can be dramatic. The most dramatic of these is Black Tuesday, 1929, when the stock market began a long plunge that would drive share prices down 72%.
And yet, even a fall of that magnitude, which is historically unique, would leave the holders of personal accounts with 28%, which is distinctly different from nothing. Moreover, the fall came after a sharp rise in the 1920s, and was followed by a sharp rise in the late 1930s. Short-term investors got clobbered in 1929, but for long-term investors, this was just an episode in a story that not so bad overall.
Now, a 72% fall in the stock market doesn’t mean that everybody’s shares fall by a uniform 72%. Even in the best of times some companies go bankrupt and the value of their shares falls to zero. If Social Security reform passes, workers who manage personal accounts for several decades of their working lives will probably see a few stocks dwindle to “nothing.” As long as they stay diversified, however, the chances that all their stocks will go to zero at once are minute.
That brings us to the bond part of the portfolio. Sensible, risk-averse investors will keep more of their money in stocks in youth, then shift it into bonds as they approach retirement.
Bonds fluctuate in value too. If interest rates rise, older bonds with lower interest rates lose value. But this does not change the income stream that the investor derives from the bond. If you own corporate bonds and the company goes bankrupt, you do lose the income stream, though you may be compensated when the company’s assets are liquidated. Treasury bonds are considered riskless, so if you want to be on the safe side you could move your money into Treasuries a few years before retirement. But since it’s very rare for a blue-chip firm to suddenly go so bankrupt that even its bondholders lose their shirts, the chances of a diversified bond portfolio becoming worthless (i.e. several such companies going broke at the same time) are negligible in normal economic times.
In all the reform proposals so far, by the way, a welfare-type benefit would be available to those whose personal accounts and private savings were insufficient to keep them out of poverty. So the claim that people risk retiring with “nothing” is a straw man, even if one’s personal account did, by a stroke of miraculous bad luck, fall to zero in the markets. But realistically, no well-diversified portfolio of stocks and bonds is going to leave its owner with “nothing” to retire on, in normal economic times.
With personal accounts, we’re all in it together
When the stock market falls, this usually coincides with recession or depression. A lot of people, not just shareholders, suffer. Workers lose their jobs. Entrepreneurs see their business dwindle, and they may go bankrupt.
Reich
mentions the bear market of 2001-02 as evidence of the dangers of the stock
market, but that bear market would not have hurt the owners of personal
accounts much. Stocks slumped for a
while only after a sustained, spectacular rise in the 1990s. Now they’re paying record dividends again,
giving those lucky enough to own shares pretty nice consolation for their
recent losses. For personal accounts to
be a really bad deal, we’d have to have something worse than the recession of
2001-02. We’d have to have a
depression. Reich starts his article with
an anecdote about how his grandfather lost all his money in the stock market in
’29. Maybe a second Great Depression is
what he’s worried about.
If we were hit by a second Great Depression, with the stock market collapsing and a wave of corporate bankruptcies, some people might actually see their personal accounts lose all their value and fall to zero. They wouldn’t starve, thanks to the welfare benefit, but they would see a sharp reduction in their standard of living. In that case, a lot of people might be better off with the old Social Security system, where their benefit would appear each month regardless of what was happening to the economy.
And that’s what really gets me. Advocates of Social Security reform like to say that “we’re all in it together.” But what they’re really promising is that you can maintain your standard of living even if the rest of the country goes to hell. They’re telling you that even if the stock market crashes and the economy is so shipwrecked that financial investments become uniformly worthless, your benefit will keep getting paid—with taxpayers’ money.
It’s a false promise anyway. If there is a second Great Depression, tax revenues will collapse. Money to pay benefits will become scarce, and will be needed for other things, and politicians would be under tremendous pressure to make cuts in the program. But even if the seniors’ lobby could muscle the federal government into paying generous Social Security benefits during a depression, it would be downright immoral. Accepting a Social Security benefit at such a time would require either a steep rise in the deficit at a time when the nation’s credit was in serious jeopardy; higher taxes that would exacerbate the depression; or cutting spending just when the money was most needed to alleviate extreme poverty.
At
a time like that, there should be shared sacrifice. And personal accounts would make that
happen. Just as some workers lost their
jobs, seniors would lose some of the value in their personal accounts. They’d have to reduce their consumption, like
everyone else. That’s how it should be.