The Confident Investor

This isn’t a political blog and I don’t want to talk politics here very often. Like many Americans though, I have been watching the various political debates in the hopes of understanding the issues better and making an informed voting decision.

One of the comments that has come up lately is the privatization of Social Security. Evidently, Mr. Romney and Mr. Ryan supported this idea when it was proposed by President Bush several years ago. Mr. Obama and Mr. Biden are currently pointing out how terrible life would be if we had pursued such a measure.

I don’t follow the logic. Let’s assume that this privatization wouldn’t have taken place until 5 years ago (1 year left in the Bush administration). It is nearly impossible to understand a program that was never enacted so I am going to make some broad assumptions.

1. My first assumption is that the federal government would never transition all of the FICA taxes to the private accounts since the government needs this money to pay its current bills.
2. My second assumption is that a significant portion of the investment would be bonds and not in stocks. Having more money chasing bonds would lower the costs of operating the government. Also, since the “stock market” is too big of a monstrosity to gauge  let’s just focus on the S&P 500. It is reasonable that a portion of the privatized investments would be targeted to that group of companies.
3. My third assumption is that only younger workers would be able to contribute in this manner as they can withstand short-term decreases in the market. These younger workers would keep their money in the fund for 15-20 years before retiring.

The S&P 500 has increased in value about 50% in the last 4 years (it was about 940 on 10/17/2008). I do not believe the the Social Security bank account has increased in value that same amount. It seems that this level of increase would be a good thing for retirees. Granted, that first year of the 5 year window, the index didn’t do as well. Since FICA would have been invested at least quarterly, Social Security funds would be significantly ahead as the growth increased over the last 4 years.

Image is from Google Finance 

The criticism assumes that the investment of that much capital wouldn’t have affected the stock market itself. I don’t believe that this is true. Let’s do some simple math that doesn’t truly take into consideration any other affects this influx of capital would have on the market.

The S&P 500 companies average P/E for the group is 16.62 and we know that the total market capitalization of the group is 12,880,727,000,000. The earnings for the group would probably not increase significantly with more capital invested in those same companies. We can assume that the market capitalization would increase by the amount of capital invested by the FICA contribution.

For arguments sake, lets say that the law would allow 20% of the FICA contribution to be invested equally in the S&P 500 companies. I realize that this is a bit naive but lets stick with that assumption for now. We can be reasonably confident that the government would never have allowed 100% of the contribution to be privatized (see assumptions above) and 20% seems like a reasonable guess for a law that was never enacted. The following table taken from data supplied by the Social Security Administration shows the FICA tax generated about $3,256B in revenue to the US federal government in the previous 4 years and the first months of this last year.

Therefore, the price that was paid for the S&P 500 (market capitalization) would be increased by $651,000,000,000 and would now be $13,531,727,500,000.

If earnings in that group are the same as today, this means that the average P/E would be 17.46. This is an increase of about 5% over today’s P/E of 16.62.

Eventually this would reach steady state. Workers would start to pull money out of the market as they approached retirement or were in retirement. The natural increase would be about 1% for the average length of time workers would leave money in the account so approximately 20% assuming a 20 year average contribution. However, different from the current status of the accounts, it is possible that this money could be left to heirs where now social security is lost to the federal government. As more wealth was generated by this privatization, the need for ‘traditional’ social security would ease for workers thus allowing it to be more useful for the disadvantaged, very poor, or disabled.

It is reasonable to assume that this model is far too simplistic. It is likely that other investors (non-SSA based) would feel the S&P 500 stocks were over-priced at these levels and would move some of their investment dollars to non-S&P500 companies. This spill-over effect would also raise the price of those stocks. Basically, the influx of FICA money into the system would cause an inflation of stock prices and investment vehicles. This inflation would be beneficial for many companies as they try to raise capital to grow business – there would be more money available in the system to grow business.

If you believe that the stock market is an instrument for companies to find capital to drive their business (as I believe) then you would assume that this much money chasing equities would make a fantastic boon to business. More companies would have access to capital and more companies would be able to go public to accelerate their growth. More companies that can grow fast means more workers need to be hired.

While most efforts by the government to stimulate the economy and stimulate jobs fail miserably, the privatization of Social Security would likely have been one technique that would have accelerated growth of the US economy like no other vehicle. It also satisfied the Libertarians in all of us as it is not the government doing this work but simply US workers using their cash to save for their retirement.

I realize the issue is far more complicated than I have described. I understand better than most that any investment is fraught with risk. However, US workers driving the growth of the economy by helping US employers seems like a good thing.

Not only would US workers have more financial security if their FICA tax was invested for them rather than the current system but the market would be much larger and it would be an economic boon to companies that look for capital.

So, why is Mr. Obama and Mr. Biden saying that Mr. Romney and Mr. Ryan are wrong for supporting this in the past?