I'm No Chicken Little

I wrote a piece on the 2009 results that were published by the SSTF. Some of my assumption and many of my conclusions have come under criticism. Mr. Bruce Webb, a well-respected fellow, suggested that I was “peddling crap”. He went on to suggest that I was in collusion with two leading economists, Mr. Briggs and Mr. Hassett of the American Enterprise Institute (AEI). There is no truth to that. Right or wrong I have come to my observations on the Fund on my own. I have written a total of 11 pieces (out of 180) on the SSTF in the past year. They have all been published outside of my blog. I am not that new to this debate.


Dale Coberly (another well respected guy) at Angry Bear did a piece that discussed all of this. Mr. Coberly took me to task on my views. Argued with my analysis. Disagreed with all of my conclusions. Fair enough. I think that is what blogs are for.

I have never met Coberly or Webb. I am not sure why they took the approach they did. The Angry Bear site has a link to Webb’s blog on the banner. So they speak as one voice. One says that I am colluding with people from AEI (in my view he lost any respect he might deserve with that silly assertion) the other approaches this with a tone and style that makes me think of a sandbox.Their piece and my thoughts:


The Sky Is Falling Before Schedule. Again.
by Dale Coberly

Bruce Krasting tells us The sky is falling the sky is falling Social Security has run out of money 30 years before it was supposed to happen. The words here are mine, the tone is his:

BK-I never said anything of the sort. As you say, you make up words. Why do you feel it is necessary to do that? I did say the following and I stand by it:

"I think that the recession of 08 and 09 and the anticipated high unemployment (low employment) in 2010 has crippled the Fund. Nothing short of a major overhaul can turn it around at this point. The damage has been too great."

BK-Yes, a major overhaul is necessary in my opinion. From the SS Trustee’s 2009 report to Congress,


“Under current law, the cost of Social Security will soon begin to increase faster than the program’s income….. . Based on the Trustees’ best estimate, program cost will exceed tax revenues starting in 2016.”


FICA and SECA taxes were less than benefits paid for the first time in history in 2009. That is a significant milestone. Mr. Webb points to adjustments to this basic ratio including tax on benefits and RR expenses and overhead. His calculation was for this to result in a surplus of $8b. Fair enough. By that calculation the Fund covered expenses 1.012X. The ratio I point to is .9924X. These are rounding errors. The break even point has been functionally achieved. It will be exceeded in 2010. The Trustees predicted that this would happen in 2016. In will come six years earlier. You see no sense of urgency in that?

He tells us the Trust Fund has a surplus of 2 and a half trillion dollars. That's 2,500 billion. Yet he is convinced that a 5 billion cash shortfall this year "has crippled the Fund." Other things being equal (they are not), that 5 billion shortfall would take 500 years to deplete the Fund. The Fund will run out of money long before that for other reasons... but those other reasons were understood and planned for a long time ago.

BK: Yes, if you divide 2.5 trillion by 5 billion you get 500. But we both know that is an irrelevant calculation. You think that math adds to this debate?

Krasting may be alluding to those other reasons when he argues with Bruce Webb that the small cash deficit this year will keep on growing, but he doesn't really say so. The deficit might keep growing or it might not. The recession could end, and then cash flow would go positive again, at least for a while.

BK: Yes the recession will end. It already has. But we have 10% unemployment and few prospects for job creation. If we started getting increases in NFP of 700k per month, I might back off. But we are still losing jobs. I think that net of census hiring we will lose jobs for the full year. I am not alone in that view of employment. What is your outlook for jobs creation? Are you looking for 10mm net new hires this year? If not, you might want to consider the implications to the Fund.

The other reasons the Trust Fund will eventually "run out of money" (almost) will still be with us. Fortunately, they don't matter either. Social Security will not be "broke." The Trust Fund was designed to "run out of money" (almost). When it does, Social Security will return to pay as you go (almost) at perhaps a slightly higher tax rate to pay for the longer life span of the generation paying the tax.

He claims that there was a negative COLA. There wasn't. He seems to think the difference between the December and January total outlays represents a "decline in monthly checks." It doesn't.

BK: This is a valid criticism. It would have been more correct if I had said:

“The December to January benefits number fell by $475mm ($6b annualized). The first time ever absence of a COLA adjust may have contributed to this unusual phenomenon. In the past decade there has not been any years where this has occurred. The percentage change in the past few years were 06/07 = + 2%, 07/08 = + 1%, 08/09 = + 5% and 09/10 = -1%. A big swing in direction for 2010."


I look for numbers that change from a ‘predictable’ direction. When that happens there is often consequences. Sometimes those consequences create opportunities to make and lose money. That is why I watch for them. Coberly and Webb have unique knowledge of the workings/numbers of the Fund. They could turn that into an opportunity to make a buck. They should try it. It is rewarding in many ways. But I doubt that they see the forest for the trees.


He seems to think that a 100 billion dollar surplus is a deficit because it's not a 190 billion surplus. Time to run in circles, scream and shout, because we only came out a 100 billion ahead this year instead of the 190 billion we predicted before the recession. The whole point of the Trust Fund is to bridge cash shortfalls due to things like recessions. What Krasting is screaming about is the Trust Fund doing what it was designed to do. See, you build up surpluses when times are good, and you spend them down when times are bad.

BK: That was not a little rain shower we just went through. That was the storm of the century. Yes we have eaten into the surplus. In 2010 we may start to ‘live off the interest’. And this ship is far from being turned around.


Yes, I do think a miss of 45% on a basic measure of the Fund’s performance is material. If a public company missed by 45% on the bottom line we would take the stock out back and shoot it.

He seems alarmed that Social Security is not able to lend money to the Treasury. This is like your forty year old son getting mad at you because you can't afford to "lend" him a hundred bucks this week like he expected because he has gotten so used to getting it. The purpose of Social Security is to provide benefit checks to the people who pay the payroll taxes. The purpose of Social Security is NOT to support Congress' deficit spending.

BK: You have me right on this point. I am alarmed. While I agree that this is not an issue for the SSTF, it most certainly is an issue for the entire fixed income market. In prior years the SSTF acquired Treasury IOU’s for as much as 50% of the total deficit. In a few years the Fund will be a seller versus a buyer. Do you really think that is not a significant development?

So because Social Security has reached the long planned for point where the surpluses have to be called upon to do the job they were designed to do, Krasting wants to call a "deficit commission" and steal the benefits from the people who have paid for them. And subject them to "means testing," i.e. "welfare," which Social Security was specifically designed not to be.

BK: The fund has proposed either a 2% increase in payroll taxes or a 13% cut in benefits (or some combination). The 2% solution proposed by the Fund would increase payroll taxes by $115 billion annually. That number would rise each year thereafter. Please point me to the economist, Senator or Congressperson who would sign up for that. I think the voters in the States that they are from would be anxious to hear about that. You have my email. Send me the list and I will publish it.



The Trustees said that ‘creative thinking’ would be required. I don’t see you two putting anything new on this table. There are 160mm people paying into the system, there are 55 million getting benefits. That is two thirds of the population and most of the adults. Not one of them would support an increase in their taxes and/or a decrease in benefits. What I offer is politically doable. The alternatives will create a debate that will make health care and tea parties look like small beer.


A question. You have two choices, which do you choose?


1) You reduce the check to Bill Gates’s and a widow from Alabama’s by 20%.
2) You eliminate Bill’s check entirely and keep the widow with her old benefits.


Would your really go for #1? If so, I suggest you ask Bill (or me). We would disagree with you. #1 is not the ‘right thing to do’.


Mr. Coberly has already answered this question. He stated yesterday, “Bill Gates will get his check” He is correct, under the current law Mr. Gates will get money he does not need or want. But if it becomes necessary to cut benefits, Mr. Gates will have his benefits reduced by the same percent as the widow. In 2010 the mindset of the people is not in agreement with this thinking.

It also needs to be pointed out that Social Security has nothing to do with the deficit. Not the current debt nor any future deficit. Social Security was carefully designed to be paid for by the people expecting the benefits. It is not paid for by general revenues, taxes on the rich, or government borrowing.

BK: I want to focus on the statement that, ‘SS has nothing to do with current debt.’ This is correct. But things are happening now that affect who owns the debt. On a month to month basis a small portion of the debt has been shifting back and forth between that held by the public and that which is intergovernment. I want to demonstrate a troubling trend that I see. Some data.



The monthly shortfalls are reversed at the end of the quarter (except Q 3) and we see the annual surplus number. There is no YoY negative shift in the Public vs. Government holdings. (It continues to be positive)


However, for the months of Feb., May, July, August, Sept., Oct., and Nov. the SSTF did reverse repo transactions with Treasury to provide the liquidity to cover the monthly shortfall. The offset is that for that month the Treasury has to increase it’s sales of Treasury bills to the public to generate the cash to cover the deficit. In 2009 those shortfalls had three affects. 

1) It reduced the amount of investable funds and therefore the ability of the Fund to earn income and,
2) It cost the Fund +/-$125mm in interest to fund the monthly shortfalls. 
3) It caused the Treasury to issue additional short term debt in the public market. Some of that additional debt extended beyond one quarter.



I acknowledge that these monthly amounts are negligible in the scheme of things. But now you have to acknowledge something. In 2008 there were 3 deficit months. In 2009 there were 7 deficit months and the sum of those was $24.2b. As historians of the Fund’s performance you will confirm that these negative cash flow months have not been seen in the Fund’s numbers over the past twenty years. A troubling development if it were to sustain itself. I believe that it will.


Now consider the 4th Q 2009 surplus of only $13.6 b. Compare that with the surplus in 2008 of $52.3 b. A YoY decline of 75%. I believe there is a very real possibility that the 4th Q 2010 number will be a full quarter deficit number based on the trend from 08 to 09 and the assumption that there will no meaningful additions to the number of contributors. I expect the 3rd Q to repeat the 09 performance.



You would say of this development, should it happen, that it is no big deal and of no lasting significance. From the perspective of the Fund you might be right. But you have to look ‘outside the box’. There will be a market consequence to this. And that is what my readers and I care about. Should the 4th Q 2010 prove to be a net negative you will get this headline in the Wall Street Journal:


Treasury Forced to Sell More Debt to Public as SSTF Turns Negative for Second Half 0f '10
Bond market spooked, yields rise. Gold rallies, stocks and the dollar down.


You may be experts on the Fund. But I know a thing or two about markets. A six month deficit for the Fund is not “priced in”. Unless something is done (or we get extraordinarily lucky and create 8mm new jobs) this development will take place in the next two years. When it does it is not going to go over well at all.

Finally, let us suppose that Krasting were right (he is not) and that we have depleted the Trust Fund. Would this be a catastrophe? Would Social Security be "broke." Would we see a crippling burden on the young?No. Social Security would return to pay as you go... as it was always intended to be.

BK: I never said the Trust Fund was depleted. I said that it needs a fix ASAP. You say I am wrong about something I never said. Do you think making these false claims supports your position? There are a lot of smart folks who read this stuff, they will see through this fog you are trying to create.

It would continue to pay benefits out of current payroll taxes.Because of the size of the baby boom, the missing Trust Fund income would have to be replaced by a small tax raise. That raise would be on the order of one percent of payroll for each the employee and the employer, probably phased in over ten years. This was going to happen anyway... starting in about 2026...because the next generation is going to be living longer than the last. All an immediate collapse of the trust fund (not going to happen unless Congress steals it) would do would be to advance the date of the first one tenth of one percent tax increase.

Krasting does not understand what he is talking about, but he is getting encouragement from people who do. They know he is wrong, but they are happy to let him do the "sky is falling" screaming for them. It accomplishes their purposes, which is to panic the people into letting them cripple Social Security.

BK: Okay. I don’t know what I am talking about and Mr. Webb and Mr. Coberly, are the experts. Mr. Webb has stated his views, “nothing needs to be done, maybe a tweak in twenty years”. I think he is way off on that call.


We shall see who is right or wrong. I say that SS is at a nexus. I say we should address the issue before it gets to a point where the fix is more than we can bear. They suggest that we should just sit back and assume that this is all going to work out fine. Sorry to disappoint you. You can’t put your head in the sand and hope this goes away. It will not.


In their posts yesterday Mr. Webb/Coberly went out of their way to establish that they were in fact the experts on this. The word Hubris came to mind when I read:


I am an expert on this part of Social Security. Bruce is an expert on a part of it that is larger than but not entirely overlapping my part. There are a few other experts around. But in general you cannot trust people who bill themselves as "non partisan experts."
Dale Coberly





Note:
On November 20, 2007 I was on the FOX “Scoreboard” show with David Asman. On that show I said, “Fannie and Freddie will go bankrupt. The stockholders will be wiped out, the bondholders will all be spared”. I took a lot of criticism for saying that. All the ‘experts’ were saying it could not happen and guys like me were lunatics. Less than a year later I was proven correct. I did well with that call.

SS is no Fannie or Freddie. There will be no explosion. But the ins and outs of SS are equivalent to 13% of GDP. Anything that affects SS will have an impact on the real economy one-way or the other. When that happens there will be both risk and reward. My guess is that this is about nine months off from become an issue that starts to move markets. If anything, it will be less.

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