What's Wrong with Social Security and Why it's Important to Gen X and the Millenniums- Part One

The Social Security Administration (SSA) in its 2014 report to Congress, projects the Trust Fund supporting the Social Security System will be insolvent by 2033. The SSA has provided reports like these for many years, with its 2010 report showing a projected date of insolvency of 2040. A 1983 report pointed to a date of 2058. By now, you can see where this is headed.

The Trust fund supporting Social Security is actually referred to as the OASDI fund, and covers both Social Security benefits and also payments under Disability Insurance. With a rapid escalation of disability claims over the past number of years, the disability portion of the Trust Fund is now projected to reach its point of insolvency next year (a date pulled in from 2018 in the 2010 report).

Both programs have seen rapid growth and accelerated outflows since 2008, explained, only in part by demographics and an aging population. Disability has grown dramatically, with roughly ten million people claiming benefits under the program. Its share of the adult population has doubled over the past twenty years, despite advances in medicine and a generally healthier population. Today, the Federal Government spends more on disability payments than on food stamps and welfare combined.

The growth in Social Security claims, as well, can only partially be explained by the aging baby boomer generation. Benefit claims following the financial crisis grew at a rate exceeding forecasts of the Social Security Administration based upon their demographic models. Despite the steep discount to future payments by taking early benefits, this trend has also now been underway for several years.

Many members of Generation X dismiss the whole notion that Social Security will be there for them in their retirement, or that a retirement as most know it, will even be available.  They often fault the baby boomers for the problem, citing over-spending and under-saving as contributing to the retirement crisis. While, in part, this may be true, the problems with Social Security are much more dramatically a problem of mathematics - or demographics, specifically.

In 1940, soon after Social Security began, there were roughly 35 million workers paying into Social Security and only 222,000 beneficiaries (or a ratio of workers to retirees of 159 to one). By 1950, that ratio had fallen to 16 to one, and by 1990, the ratio had declined to three to one. By 2031, it's projected that only two workers will pay into the system for each person collecting benefits.  

All of this, of course, had been forecast by the Social Security Administration many years earlier. But Congress, increasingly focused on their own needs and less and less on the job of actually running the country, largely chose to ignore it. Concerns about an aging population and its impact on Social Security emerged as far back as the early 1980s. Congress then acted to pass HR 1900, the Social Security Amendments of 1983 in an effort to shore up the system. Payroll taxes were raised and benefits, for the first time, became subject to taxation. While they were at it, Congress also thoughtfully moved to add benefit coverage under Social Security to members of Congress, the White House and other executive level appointments. 

But no sooner did surpluses materialize, then Congress found a way to spend the new found cash flow, by borrowing back surpluses of the Social Security Trust Fund, and swapping special issue Treasury Bonds in its place. In fact, this has been the practice for many years. In good years, when Social Security is recording a surplus, the extra cash is borrowed against Treasury bonds. In deficit years, as the Trust has seen for the last several, the shortfall is funded, once again, with Treasury bonds.

It's little wonder then, that the world's largest holder of US Treasury obligations is not China or Japan. It's not even the Federal Reserve. It's the Social Security system. And lest we forget, a Treasury bond is nothing more that a promise to pay from future tax revenue. What that means is that the government will need to raise tax revenue in the future to make good on its promise to pay some $2.8 trillion of obligations to the Social Security system, just for the program to remain on track for insolvency in 2033.

Taper Tantrum Part Deux

Investors may claim to be taking the prospects of a Fed rate increase in stride, but something has clearly triggered the selling of mid to long term Treasury bonds. It was reported yesterday that PIMCO's Total Return Fund, one of the world's largest holders of US Treasuries, unloaded a sizable portion of its stake in Treasuries, lowering their share of the Fund's assets to 8.5% from 23% this past April.

With $107 billion in assets, this would represent selling of roughly $16 billion, hardly enough to move the needle on a $17 trillion market.  En masse, though, with similar moves by other money managers and sovereign investment funds, yields are quickly heading higher. It's unlikely that pension funds and endowments are forming much of the selling, with asset allocation models proscribing certain levels of fixed income allocation. The Fed, while off its campaign of gobbling up a substantial share of new UST issuance, is clearly not a seller either and, in fact, continues to buy each month to replace maturing UST holdings.

Many look to China and Japan, as the largest holders of US Treasury bonds and question their level of buying and selling. The largest holder of US Treasury obligations, however, is actually the Social Security Trust Fund, with roughly $2.8 trillion held (albeit of a special class). Thus, just to meet the targeted date of insolvency of Social Security of 2033, the US Treasury must first raise $2.8 trillion from taxpayers in order to meet the obligation of maturing UST securities. But that's another story.

What's interesting about the recent rise in interest rates is what's happened to the relative value of US Treasury bonds and the sovereign debt of other developed economies. With the UST 10-year trading near 2.50%, its yield represents a whopping 150 basis points over the German BUND, now also rising rapidly in yield. Moreover, UST is trading at higher yields than all EU nations and Japan, save the exception of Portugal, whose bonds yield only slightly higher.

All of this activity, occurs following the first limited bond buying by the ECB begun last March, as part of a 19-month effort to inject $1.2 trillion into the European economy. It's hard to imagine how that plan won't drive yields far lower in months ahead, including those of US Treasuries, now at historic wide spreads to European debt. But in a world where economies are administered by central banks, rather than market based, anomalies like this latest tantrum can and may continue.

NJ Supreme Court Rules on Public Pension Funding

In a surprise move of the New Jersey Supreme Court this morning, the court overruled a lower court decision that required Governor Chris Christie to fully fund deposits to the state pension funds, previously cut by the Governor in his annual budget. Last year, the Governor cut $1.5 billion in funding for pensions from his proposed budget, causing state labor unions to sue for restitution. The unions argued that the Governor was compelled to provide the funding as part of a negotiated settlement with the unions in 2011.

Today's decision reverses the lower court action, with the State Supreme Court ruling that the Debt Limitation Clause of the State Constitution does not recognize or support a multi-year binding commitment to fund public employee pensions, as so argued by the unions and upheld by the lower court. While this ruling may give the state some interim budget relief, it's pension funding obligations remain daunting.

In 2014, the State provided just under $700 million in cash contributions to its employee pension fund. An additional $2.8 billion was spent on employee health care benefits. The total of roughly $3.5 billion represents more than 10% of state budgeted expenses for the year. Despite this significant investment in shoring up its benefit plans, the state will still underfund its statutory annual funding obligations by nearly $3 billion.

To fully fund its requirement, just to keep pace with current accrued pension costs - and with no effort to catch up on prior underfunding - would require $6.5 billion. The state now faces a $90 billion shortfall in its employee benefits funding - $37 billion in pension costs and $53 billion in unfunded health benefits - three times the size of the state budget.

New GAO Study on Underfunded Retirement Savings

The Government Accounting Office just released a new report on retirement security. Their conclusion: most households approaching retirement have very low savings. Just how low, though, is startling. Among households age 55 and older, one-half have no retirement savings at all in 401(K), IRA or similar defined contribution accounts. Similar findings were reported in a 2013 study of the Federal Reserve Bank, along with the fact that for those age 55 and older that do have retirement accounts, the median balance was just $111,000.

The GAO study, however, also found that 29% of respondents had neither funded retirement accounts nor any employer-sponsored defined benefit plan coverage. Of this group, 41% do not own a home, while an additional 24% own a home with some level of mortgage indebtedness outstanding. For this population, social security, with a median benefit of $15,000 per year, may provide their only means of support in the years ahead. The US Census Bureau estimates that there are currently 40 million Americans aged 65 and older, with this population growing by 10,000 each day. By 2030, an estimated 65 million Americans will have reached retirement age. If 29% are projected to live on a median Social Security income of $15,000 per year (and with Social Security by the Social Security Administration's own projections to become insolvent by 2033) America may soon look like a very different place.

As you might have guessed, the data is no better for younger generations. According to a Harris Poll in 2011, an amazing 32% of the members of Generation X, aged 34-45, reported no personal savings whatsoever. In a recent report of Allianz, 84% of Gen X reports that they see traditional retirement as a romantic fantasy of the past (see post below).

What was most interesting about the GAO report was the distribution of retirement savings among households 55-64. While 41% reported no savings and 20% with savings of less than $50,000, it was the distribution of retirement savings of higher level savers that showed some intriguing patterns. While 9% of the group surveyed showed total savings between $250,000 - $500,000, an additional 9% or an equal number as in the prior group, showed total savings of greater than $500,000. Unfortunately, it's only this latter group, or 9% of those surveyed, that will have much chance of funding a comfortable retirement through 401(k), IRA and similar defined contribution savings plans. The full chart is provided below.

Up In Smoke: How the Retirement Crisis Shattered the American Dream NOW Available on Amazon.com

Up in Smoke can now be purchased by following this link to Amazon.com

Generation Worry

Allianz Life Insurance recently reported the results of a study of the views of Generation X toward retirement. What's interesting about their study is that while members of this generation share with Baby Boomers a skeptical and troubled view of their retirement prospects, the percentage so believing is even higher than that of the Baby Boomers. A traditional retirement is now considered a "romantic fantasy of the past", for 84% of those Generation Xers polled by Allianz. More than two-thirds of those surveyed thought that retirement savings targets were "way out of reach" and that they will "never have enough money to retire".

Many young people and even pre-retirees tend to dismiss the grim state of their own retirement funding, believing that they will simply work forever. In fact, expectations of the age of personal retirement are rising, with 37% now indicating they plan to work past age sixty-five, versus just 14% in 1995.  However, while Americans think of age sixty-five as the typical retirement age or that they might work well past this age, in practice, we retire much earlier than this, a full four years earlier on average, with early retirement often brought on by health reasons or layoffs.  

But perhaps of even greater concern for Generation X is that 89% of those polled reported difficulty saving money, while more than half of respondents claimed they "just don't think about putting money away for the future". The most troubling part of the study, however, is that while Gen X is skeptical about their prospects for retirement, 85% also report concerns about the difficulty of keeping a job. Call them Generation Worry.

The truth is, there is still much time for this generation and the millenniums to adjust their lifestyle, spending and savings habits to provide for retirement. While each generation would like to believe this day will never come, as John Lennon so famously said, "Life is what happens when we're busy making other plans". This day will come and with Social Security in desperate shape, corporate pension plans greatly diminished and public employee pension plans suffering startling under-funding, some level of personal planning and public awareness of this issue is well advised.

Our Fixation with Jobs and Employment Data

The most closely watched data point for equity and bond markets continues to be the monthly employment report. Weekly new claims is also closely followed, despite its lack of relevance with the US economy now in its sixth year of expansion. Perhaps markets simply don't know where to look for data. In their suspicion that market gains have been driven largely by Fed policy, stock and bond traders alike have focused on employment as key to the Fed's next move.

The heightened concern clearly has something to do with the lackluster growth in GDP since the recovery officially began in 2009. GDP growth has run plus or minus 2% since 2010, well below its run rate pre financial crisis. Juxtaposed against this backdrop of tepid GDP growth is the anomaly of rapid gains in employment. It doesn’t seem to quite square up. 

Some have pointed to the stubbornly low rate of labor participation and its impact in magnifying the decline in the unemployment rate, pointing to U-6 underemployment, still above 10%, as a more realistic measure of the struggling labor market. But while the quantity of jobs created has had a meaningful impact on lowering the unemployment rate, the quality of job creation may best explain this anomaly.

A report prepared by Global Insight for the US Conference of Mayors found that jobs that had been created over the past five years, on average, paid 23% less than those lost during the 2008-2009 recession. Total wages lost in the move to lower paying jobs were estimated at $93 billion. The same phenomena was observed in the recovery from the 2000-2001 recession, where the annual wage of jobs created in the period following the recession averaged $5,000 or 12% less than those lost in the same sectors in the 2000-2001 recession.

In the 2008-2009 recession, where 8.7 million jobs were lost, the annual wage of jobs lost was $61,637. In the recovery that followed, the average wage of new jobs created averaged $47,171, or $14,500 less than similar jobs held prior to the recession. While the greatest number of jobs were lost in the manufacturing and construction sectors, the highest number of new jobs created were in the relatively low paying industries of food and beverage, health care and social assistance. These workers, though employed, are taking fewer vacations, eating out at restaurants less often and spending less on clothes, health care and other essentials.

If this is in fact what is going on, then the unemployment report, the data release most closely followed by the markets, might be telling us very little about the near term direction of interest rates.

Governor Christie and the Question of Income Inequality

Governor Chris Christie of New Jersey was recently out in front of the media tagging the Federal Reserve and the Obama Administratio with the problem of growing US income inequality. While it is undeniably true that income inequality has widened over the past six years, it's highly unlikely that President Obama supports this trend or that his administration has sought to contribute to it. The case of the Federal Reserve, however, presents an entirely different set of facts.

While the Fed's intentions may have been to drive interest rates lower than any period in US history in an effort to spur borrowing and capital formation, neither of these outcomes have actually occurred. Not by a long shot. But for the Fed to believe that these policies could be continued for seven or more years without creating distortions in the economy, is beyond naive. It borders on irrational. No disrespect to Princeton, but did Bernanke actually teach there?

The Reason Foundation in 2012 found that the Fed's policy of Quantitative Easing was "fundamentally a regressive redistribution program...It is a primary driver of income inequality". Their argument, as true today as when put forward four years ago, is that low interest rates primarily serve the wealthy, thereby driving a greater percentage of income earned in the economy in their direction. We'll explain how, but first some data on what's happened to inequality since the Great Recession.

Global Insight, in a report prepared for the US Conference of Mayors in 2012, found that the share of total income gains over the period 2005 - 2012 captured by the wealthiest 20% of Americans, was in excess of 60%. The lowest 40% received just 5.5% of these gains. The reason for this disparity lies in stock wealth and ownership, a principal beneficiary of Fed policy. According to the Economic Policy Institute, roughly 60% of stock wealth is held by the top 1% of US households. Roughly 80% of stock market gains go to the top 10% of American households.

But stock wealth aside, the savings provided by low mortgage rates, in an environment of tight bank lending standards, has also shifted the benefits of mortgage refinancing to the wealthy, who have the greatest chance of qualifying. Renters, of course, have not benefited at all from lower interest rates, as landlords have not only been unwilling to pass on the benefits of refinancing, but in most markets have raised rents aggressively, as home ownership rates have declined.

Meanwhile, banks, who have been able to borrow at interest rates near zero and have paid less than 1% of interest on consumer deposits for the past six years, have held credit card rates near their all-time high. Data of the Board of Governors of the Federal Reserve in a 2012 report to Congress on trends in bank credit card pricing found that average bank rates had fallen from 14.68% in the period leading up to the recession to just 13.09% by 2011. Borrow at zero, relend at 13%. Nice work if you can get it.

But the Fed is not alone in promoting income inequality. The primary problem with the disappearing middle class is that in an era of outrageous and ever escalating political campaign financing, the middle class is becoming invisible to politicians of both parties. They are neither big pharma, nor organized labor. They are neither oil companies, nor Silicon Valley; not Wall Street, Hollywood or the Trial Lawyers Association. They are invisible, except for purposes of rhetoric. 

Want to solve income inequality in America? Put a couple of hundred million dollars in the hands of an organization lobbying for the benefit of the lower and middle classes in the 2016 elections. Make the middle class matter to Washington.

Up in Smoke to Premier at Book Expo America, Jacob Javitz Center, New York

From the Pottstown Mercury News: the Struggle Between the Governor and Legislature over Public Pensions