TCS Daily


Fear Not the Risky Scheme

By James D. Miller - November 22, 2004 12:00 AM

Social Security privatization will be one of President Bush's top second term priorities. Below are five means of improving privatization, or at least of making it easier to sell politically:

1. Continually increasing lifespans have burdened government old age benefit programs. I suspect that not even President Bush has the political courage to force an increase in retirement age on everyone. But he could raise the retirement age for those who choose to invest their Social Security taxes in private accounts. Perhaps for every $1000 saved in these accounts the age at which someone can retire would go up by a week. Combining private accounts with an increase in the retirement age would defuse arguments claiming that privatizing Social Security would be too expensive.

2. Opponents of Social Security privatization often claim that it's not prudent to allow future retirees to risk their Social Security nest egg in the highly volatile U.S. stock market. But there's no reason Social Security private accounts would have to be invested in just U.S. stocks.

Diversification decreases risk. Private accounts would be far less risky if their funds were invested in many financial assets besides U.S. stocks such as foreign securities, real estate, and bonds. Defenders of private accounts should come up with some measure of how volatile a truly diverse financial portfolio was over the last 20-30 years and use this measure to argue against critics who merely point to the more volatile U.S. stock market as a reason for opposing privatization.

3. It's very difficult for a homeowner to protect himself against the risk of a drastic drop in the value of his home. Homes are by far the majority of Americans' most valuable asset. A better organized financial system would allow homeowners to hedge against a fall in housing values. But what does this have to do with Social Security privatization?

Social Security private accounts with assets invested in stocks would increase most Americans' financial risk. But if the financial markets could come up with some way of reducing homeowners' housing value risk, many Americans would be more willing to accept an increase of risk in their retirement accounts.

Financial service firms will benefit greatly from Social Security privatization. Consequently, they have some responsibility to reduce the increased financial risk that will accompany privatization. I therefore propose that these firms meet their responsibility by developing financial instruments that will allow homeowners to protect themselves against a drastic decrease in the value of their homes.

4. If workers are allowed to invest their own Social Security funds in the stock market the government should consider forcing them to buy stock market insurance. For example, workers could be forced to buy insurance that guaranteed that they wouldn't lose more than 50% of their investment. Although this insurance would reduce the average rate of return of investments, it would also guarantee that bad investments couldn't leave a retiree completely destitute.

5. If Congress won't approve allowing individuals to invest Social Security taxes in the stock market, workers should at least be able to invest their payroll taxes in treasury bills. Allowing workers to have private Social Security accounts that can be invested only in risk-free government bonds would eliminate the argument made by privatization foes that privatization would create too much risk for future retirees. After creating private risk-free Social Security accounts Bush could push to allow workers to invest some portion of these accounts in riskier assets.

Creating private Social Security accounts of any type would still act as an effective tax cut because workers would see a tangible benefit from paying their Social Security payroll taxes.

James D. Miller writes The Game Theorist column for TCS and is the author of Game Theory at Work.


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