Election Year Spin on Social Security

Bernie Sanders' campaign for the White House has triggered a firestorm of rants, tweets and accusations about Social Security, thrusting the now seventy year old program to center stage in a forum of election year theatre. Sanders' charges, often wrapped in outright inaccuracies, are carefully aimed at a demographic the candidate knows to be voter-ific: aging Baby Boomers. Most, or at least half, of this generation are wholly unprepared for the expenses of retirement, while the other half is, well, just modestly underfunded. Both will be dependent on Social Security in varying degrees, a program that is suffering a mid-life crisis of its own.

The purpose of this post is not to offer my opinions on Social Security, but rather to simply state the facts, as more officially presented to Congress by the Trustees of the Social Security Administration in their 2015 Annual Summary on the Social Security and Medicare Programs. Both the summary and the full report of the Trustees can be easily accessed on the internet or through the link provided in this post.

Sanders' claim of the "myth of Social Security insolvency" is quickly followed by accusations that Republicans plan to "cut benefits" to retirees. Boy, I tell you, it's enough to get a retirees' blood to boil. Then again, maybe that's the point. But in Sanders' attempts to sway public opinion for his electoral purposes, the blatant misstatement of the facts surrounding Social Security actually does far more harm than good for the program and to the millions that depend upon it. 

In an article from earlier this year in the Des Moines Register, entitled "Social Security; Expand it don’t Cut it", the Senator was quoted, 

"Republicans are trying to convince voters that Social Security is in crisis. Let's not kid ourselves: We do have an urgent problem on our hands, but it's not Social Security. Millions of middle-class Americans are facing a retirement crisis as a result of inadequate income and growing wealth inequality. Social Security isn't the problem. It's an essential part of the solution."

While the Senator is correct about the latter part of his comments, he's dead wrong about the former. Social Security is most definitely in crisis, at least according to the Trustees of the Social Security Administration. Perhaps before moving on, we should spend a moment and define who the Trustees actually are and what their role is in all of this. 

By law, there are six Trustees of the Social Security Administration or Trust Fund. These are, the Secretaries of the Treasury, Departments of Labor, Health and Human Services and the Commissioner of Social Security. The two remaining Trustees are public representatives who, along with the aforementioned cabinet members and Commissioner, are all appointed by the President, or in this instance, specifically by President Obama, a Democrat. That being said, it's really not rational to dismiss the comments in the report, or at least not to discount them as a Republican ploy.

Here, then, are direct quotes from the 2015 Trustee report to Congress. Decide for yourself if Social Security insolvency is a myth, as Senator Sanders argues:

“Social Security and Medicare together accounted for 42% of total Federal program expenditures in 2014”

“Both Social Security and Medicare will experience cost growth substantially in excess of GDP through the mid-2030s”

“Social Security’s Disability Insurance Trust Fund now faces an urgent threat of reserve depletion by 2016”

“Beyond DI, Social Security as a whole as well as Medicare cannot sustain projected long-run program costs under currently scheduled financing”

“The Trustees project that the Medicare Trust Fund will be depleted in 2030”

“After 2019, Treasury will redeem trust fund asset reserves until depletion of Social Security Trust Fund reserves in 2034”

Seems fairly straightforward to me that there's an urgent problem with not just Social Security, but Disability Insurance and Medicare. Now why would Bernie Sanders be arguing something altogether different?

For more detail on Social Security and the broader retirement crisis in America, please see my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon, iTunes and Barnes and Noble bookstores. 

Are Stocks Headed Lower?

This is, of course, the question foremost on investors' minds. After all, it's been several years since we've seen a correction to the major averages that stocks have experienced since mid-July. True to form, market swoons of this sort seem to come out of nowhere. Yet as one market sage was quoted, "no one rings a bell at the top". But did we see the market top on July 20, or are we poised to consolidate and move higher?

Visit any financial news website and there are plenty of commentators quick to provide an expert opinion. But of course, no one really knows where markets are headed. We simply try, as best we can, to make informed judgements (or as some have called them, "bets"). 

If you look closely, though, the data have been quietly sending indications of direction. The plunge in oil prices earlier this year seemed to have caught investors (and oil company executives) completely off guard. Oil prices that had hovered in the range of $80-100 per barrel for five years, began a move in the latter part of 2014 that can only be described as a plunge. Now settling in the low 40s, equity investors are considering the implications of these new levels for global industrial demand and GDP.

But there were warning signs of oil's imminent decline that now appear more clearly in hindsight. A robust and vibrant US oil sector, with highflying fracking stocks like Pioneer Natural Resources, EOG and Oasis began to wobble in 2014, but only after their drilling and exploration counterparts that lead production, like Halliburton and Schlumberger, faltered. Prior to this, warning shots were fired by HiCrush and US Silica that make the key raw materials integral to the fracking process. But the real leading indicators we now see were in specialty energy companies like Geospace Technologies that make seismic data analysis tools and provide critical research for drillers and oil exploration companies. Their stock began crashing in late 2013 and should have signaled the "canary in the coal mine" for anyone interested in the direction of oil demand, supply and price.

Oil aside, however, the abysmal levels of a broad range of commodity prices, from copper to steel, has investors questioning global industrial demand. With prices for many of those commodities now believed to have been artificially inflated by China government investment (i.e., building empty cities and bridges to nowhere) everyone is a bit concerned about the veracity of sustainable global demand. Commodity dependent economies like Brazil, South Africa and Australia are unquestionably suffering ill effects, as a result of the reduced demand. These effects are echoing throughout the emerging markets. They are also being felt in the US high yield bond market, where many small energy companies financed their growth and development and now struggle to meet debt service.

With the US and EU economies piddling along, all eyes for now will remain on China. As government mal-investment there subsides, investors are questioning whether there is really internal demand to support consumption or growing global demand to boost exports? The answer, from the most recent data, appears to be a resounding no.

Will China Selling put Upward Pressure on US Treasury Yields?

There's been more than a little attention devoted to this question lately. The concern follows reports that China has been selling portions of its massive US Treasury holdings to support a destabilized Yuan. 

Marketwatch had a nice piece this morning that should dispel much of investors' concerns. This chart from Marketwatch shows net flows of foreign private and official sector purchases of Treasuries. Despite recent selling pressure, private sector purchases appear to be more than offsetting the selling of foreign governments.

Here are some other factors to consider that should equally support US Treasury prices, if not exert downward pressure on bond yields. First, as reported elsewhere, China cannot dump its holdings of UST for fear of price instability and also the question of where to go to reinvest some $1.2 trillion of proceeds. Second, if the world is really trending towards deflation, as is being reported, US Treasury bonds will climb in value. As inflation erodes the value of fixed income securities, deflation produces just the opposite effect. Third, lower US budget deficits (for however long that lasts) will decrease UST new issuance. Fourth, US pension funds are increasingly talking about "de-risking" their investment portfolios, by selling equities and corporate bonds to move into US Treasuries and other safer investments. 

Given these considerations, don't be surprised if near-term the 10-year heads back towards its January 2015 low of 1.68%, particularly if there's a flight to safety trade following a stock decline.

The Public Pension Crisis: Illinois, New Jersey and Puerto Rico

The US protectorate of Puerto Rico has captured headlines for several weeks now following its default on US dollar tax-exempt bonds. The default occurred on August 1, when the Commonwealth paid only $628,000 of a required $58 million payment due bondholders of its Public Facilities Corporation. The consequences of default for the island are severe, as seen most recently when a proposed new $750 million bond issue to fund needed improvements to its water system failed to attract buyers, causing underwriters to pull the sale.

For some time prior to the bond default, concerns with Puerto Rico's credit began to surface with high levels of debt and mounting unfunded liabilities of its employee pensions systems. These unfunded pension liabilities served to magnify the Commonwealth's already hefty public indebtedness. Puerto Rico is now faced with $72 billion of unpaid bonds, plus $33 billion of unfunded pension liability, or $105 billion in total obligations.  For an island with only 3.5 million people, that's $30,000 per capita.

What bond investors are now beginning to realize is that pension liabilities are tantamount to debt. They must be weighed equally in evaluating the level of government debt burden and its capacity to repay its obligations. This concern was highlighted by the outcomes of recent U.S. municipal bankruptcy cases, where public bondholders were paid as little as 12 cents on the dollar, only to see retirement obligations of the local government paid in full. This turn of events has the effect of investors not only recognizing that pension obligations are debt, but debt that may also be a superior obligation, to be paid first in a time of financial crisis.

This has us thinking about some more highly rated municipal credits, like New Jersey and the State of Illinois, and what their true debt burdens might be, considering unfunded pension liabilities. New Jersey, fortunately, fairs a little better than Puerto Rico, with $84 billion of State public debt and $87.6 billion of unfunded pension liabilities, or $171 billion in combined debt overall. Spread over 8.9 million residents, New Jersey total debt per capita is on the order of $19,000.

For Illinois, with $127 billion of bonds outstanding, debt burden is considered "moderate" by the bond rating agencies. But adding $167 billion of unfunded pension liabilities, brings their total amount due to creditors to a whopping $294 billion.  Measured on a per capita basis, this ranks Illinois with 12.8 million people and total debt per capita of $23,000 just behind Puerto Rico. Unlike Puerto Rico, however, residents of many cities (and counties) in Illinois have the added debt and pension burdens of their local governments to contend with, as well. In the case of the City of Chicago, this would add debt per resident of $23,000 to the Illinois state total, or a total debt per capita of $46,000, far greater than that of Puerto Rico.