Plum Crazy

The main structure would be to retain a government-mandated percentage of salary deduction and matching employer funds, but have it flow into an IRA that is controlled by the individual. It is certainly the simplest method of privatizing Social Security. It is also certainly the second least likely to be adopted method (the first being the one where there is no government mandate at all). This idea causes nearly as much of the great “What if” fear as my ideal method causes.

“What if there is a market crash that wipes out people’s retirement savings?”

That is the great “What if” that any method of privatizing Social Security needs to address to have any chance of being adopted. Unfortunately any means to address it cause us to compromise even further with the idea of big government. We must decide which form of big government we are most willing to live with, understanding that not making such a compromise will leave us in the worse position of having to retain the status quo of a completely government-run retirement savings scheme and the resultant sub-optimal returns.

The first compromise would put us in the position of accepting a form of welfare. Government aid would be provided to people on a means-tested basis. This would ensure that no elderly are left starving, which should go some way to assuage public concerns. It also allows you to completely dismantle the existing Social Security bureaucracy and leverage off the existing welfare system bureaucracy.

The second compromise would put us in the position of accepting government restrictions on the types of investment vehicles one could maintain in the IRA. No naked options. No derivatives of any other sort. Those two are probably easy enough swallowed, since it is doubtful that the investment houses would let most people use their relatively meager retirement savings on naked options or other derivatives anyway. You have to have a pretty fat portfolio before they’ll let you invest in those instruments.

You could, however, go even further with the restrictions, since most people are uncomfortable with the idea of unfettered freedom to invest in any equity instrument. “Look at the dot.com failures,” they’ll tell you. “Look at a bunch of companies with no sustainable business models that people were regularly warned not to invest heavily in by the Fed chairman,” I reply, but to no avail. Unfortunately most people are simply unwilling to accept the consequences of freedom. They either want the safety net provided by government assistance or someone to tell them what to do. If the compromise we accept is someone to tell them what to do, their ability to invest in equity instruments must be curtailed also. You place limits on the percentages of their portfolio they can invest in equity, allowing them mostly to invest in market-indexed mutual funds and fixed income. You can even vary these percentages based on age, meaning that a younger person with a longer time horizon can invest in more equity, and an older person can invest mostly in fixed income. These are sound strategies that individuals should be following anyway. If you are close to retirement, you ought not to be placing assets you will need to live on in risky instruments. Unfortunately, the whole concept of risk is one many people only grasp when they’re reaping the upside potential.

Such a mechanism would allow you to dismantle the existing Social Security bureaucracy. You might have to keep on a few advisors to make determinations as to the restrictions, but that would be far smaller than the massive structure currently in place. The downside is that you are restricting people’s decisions. You are accepting a soft ceiling on returns in exchange for the comfort of a soft floor.

The last option is to retain a government-run system on an opt-in basis. Those who want the government to invest their retirement savings for them and accept a sub-optimal return can do so, those who do not can choose to invest their retirement savings as they see fit. If you opt out, you agree to no government assistance later. The infrastructure to run such a system would be completely funded out of the taxes of those who opt in. In some ways, this is the system I like most. It provides people with choice. It does retain a huge bureaucracy, but at least the users will pay for it. My main fear is that when there is a critical mass of people who don’t have sufficient retirement savings, the retained bureaucracy will do what bureaucracies are wont to do – increase its power by lobbying to have all retirement savings run through it, and we’ll be right back where we are today.

None of the proposed solutions are ideal. All require a compromise with big government. I do feel, though, that accepting some form of compromise will improve the system we currently have. The only question becomes what form of compromise. Ultimately, I believe that is up to the public to decide. I only wish the government would make public some options (and the ones I laid out are surely not the only ones) and give us the chance to decide. Let there be some public debate. However, I fear they are too in love with their own power and imagined brilliance to do so. They will leave it all up to themselves; firmly believing they know better than we do. And we will let them.