Global Financial Crisis (Was: Subprime Meltdown)

[cheesehead]

Originally Posted by ewmayer

Let`s review the facts here: For decades, the U.S. Government has treated the Social Security and Medicare trust funds as giant zero-interest-rate slush funds, "borrowing" tens of billions of dollar a year from each in order to support ever-increasing federal spending and to help paper over gargantuan budget deficits.

Correction 1: the trust funds' money not needed for near-term payouts is invested in U.S. Treasury bonds.

Where else would you have that money invested? Stocks, foreign government bonds, ... what?

Are not U.S. Treasury bonds the most reasonable, logical place to put funds not needed soon?

Correction 2: "zero-interest-rate slush funds" -- No, the trust funds earn the market rates on those U.S. Treasury bonds. Conversely, the government pays the same rates on those bonds as it does to anyone else buying the same bonds.

Correction 3: ""borrowing"" (in quotes) -- Why the quotes? It's a perfectly legal, above-board, sound fiscal practice, and it really is borrowing, with interest and due dates and all.

4. What would you substitute for the current practice in regard to bond-investing by the trust funds? Is the government to ignore those trust funds as potential buyers of its bonds, thus raising bond rates? Shall Social Security just sit on a stack of $100 bills instead of earning interest?

What is your proposed better arrangement for investing trust funds?

The problem is not the bond purchases by the trust funds; it's the dishonest accounting presented to the public since 1968 (President Lyndon Johnson) by merging them with all other government funds in the budget instead of presenting them as separate trust funds should be accounted.

If the government had been honestly reporting the relationships between the trust funds and general funds for the past 40 years, few smart folks such as yourself would now be misled into repeating such nonsense as "the U.S. Government has treated the Social Security and Medicare trust funds as giant zero-interest-rate slush funds". One justification for that false idea that I've heard (and I've heard that idea many times before) was that since the bond interest payments just go from one line to another in the budget and don't affect the bottom-line deficit (or *sigh* occasional surplus), that's just zero-interest transfer.

See, if the reporting were honest, folks could more easily see that bond purchase money goes from trust funds to the general Treasury fund, -- at present, that is -- and that interest payments are going from general Treasury funds into the trust funds, but that in the future we're going to see bond redemptions by the trust funds exceed their bond purchases, and there will be a world of hurt in the Treasury bond department when that principal flow reverses. If this had been honestly reported all along, we'd have better discussions of the mess.

[ewmayer]

Misunderstanding Social Security's Trust Fund

Today, with the overall budget in much worse shape, Social Security's surplus reduces the size of the federal budget deficit, which in turn helps to keep interest rates lower than they would otherwise be.

Call me naive, but that sure sounds like "Government borrowing your money at below-market rates" to me. As an alternative "market rate" scenario, imagine if the Government weren't running a deficit, and used the SS fund to go into the mortgage business - earning [say] 6-7% on the money, rather than lower T-Bill rate. Not that that would ever happen, because the bankers would scream bloody murder.

Also: What percentage of the SS monies reissued as Treasury Bonds has actually been redeemed? What do you think will happen when the bill finally comes due? No, the USGov won't default - they'll just go on another money-printing spree which devalues the dollar and stokes inflation, thus deflating their accumulated debt at - ta dah! - taxpayer expense, in the sense that every $ you get back from the fund is worth less than the $ you paid in, rather than the "original principal plus interest" it should have been worth. Does that seem fair to you?

[cheesehead]

Here we go:

Social Security Online

Agency History

Research Notes & Special Studies by the Historian's Office

Research Note #20

The Social Security Trust Funds and the Federal Budget

http://www.ssa.gov/history/BudgetTreatment.html

I forgot about the nonmarketable Treasury securities, but that doesn't really change my statement of how it works.

[cheesehead]

Originally Posted by ewmayer

Misunderstanding Social Security's Trust Fund

Call me naive, but that sure sounds like "Government borrowing your money at below-market rates" to me.

Okay, you're naive. That article doesn't explain all the factors, thus allowing you to misinterpret it, in your honest-and-well-meaning-but-not-fully-informed naivete. (Where are those accents and umlauts when I need them?)

Re-read my point number 4 above, where I wrote, "Is the government to ignore those trust funds as potential buyers of its bonds, thus raising bond rates?" (because it would limit the potential pool of buyers, the market rates would be higher.)

Then read what I linked to. Note the separation of "The Financing Procedures" from "The Accounting Procedures".

As an alternative "market rate" scenario, imagine if the Government weren't running a deficit, and used the SS fund to go into the mortgage business - earning [say] 6-7% on the money, rather than lower T-Bill rate. Not that that would ever happen, because the bankers would scream bloody murder.

A. You're mixing accounting procedure with financing procedure.

B. It's illegal for the trust fund to invest in anything other than Treasury securities, so your alternative is moot.

Also: What percentage of the SS monies reissued as Treasury Bonds has actually been redeemed?

Again a misunderstanding. The trust fund purchases Treasury bonds. There's no "reissuing". The trust fund redeems Treasury bonds when it needs to (such as at bond maturity date, so it can reinvest in newer bonds), and there is no trouble, hanky-panky, or shenanigans here.

All the bonds are backed by the full faith and credit etc. etc.

What do you think will happen when the bill finally comes due?

Please define exactly which "bill" you mean.

No, the USGov won't default - they'll just go on another money-printing spree which devalues the dollar and stokes inflation, thus deflating their accumulated debt at - ta dah! - taxpayer expense, in the sense that every $ you get back from the fund is worth less than the $ you paid in, rather than the "original principal plus interest" it should have been worth. Does that seem fair to you?

It seems that you continue to mix together ideas in a way that obscures proper understanding. I don't mean that you're deliberately or knowingly doing so, just that your apparent misunderstanding of what goes on prevents you from asking a clear, meaningful question.

- - -

Again, my opinion is that there's nothing wrong with the financial operations. It's the accounting and reporting that aren't right. And I was almost as misled as you until 10 or 15 years ago when I read a clear explanation.

Furthermore, nothing I'm saying here is about the Ponzi-scheme aspect of Social Security. That's a separate dimension of the overall problem. If the Ponzi aspect were removed, that would change the numbers involved in accounting and reporting, but not the financial or accounting procedures. Of course, such a change might help people to decide to make the accounting and reporting more clear, but it's about 70 years too late for that now.

[cheesehead]

From the link Ernst cites:

Today, with the overall budget in much worse shape, Social Security's surplus reduces the size of the federal budget deficit, which in turn helps to keep interest rates lower than they would otherwise be.

If the deficit size were honestly reported, its higher-than-currently-perceived value would encourage potential bondholders to hold out for higher rates than they do in the present situation.

[ewmayer]

Originally Posted by cheesehead

B. It's illegal for the trust fund to invest in anything other than Treasury securities, so your alternative is moot.

If Congress decided to make it legal to use the trust fund in other ways, the alternative would no longer be moot, would it?

Again a misunderstanding. The trust fund purchases Treasury bonds. There's no "reissuing". The trust fund redeems Treasury bonds when it needs to (such as at bond maturity date, so it can reinvest in newer bonds), and there is no trouble, hanky-panky, or shenanigans here.

All the bonds are backed by the full faith and credit etc. etc.

Please define exactly which "bill" you mean.

In my naivete, I consulted Wikipedia, which says as follows:

After the 1977 amendments, the economic assumptions surrounding Social Security projections continued to be overly optimistic as the program moved toward a crisis. In 1982, projections indicated that the Social Security Trust Fund would run out of money by 1983, and there was talk of the system being unable to pay benefits.[14] A commission chaired by Alan Greenspan was created to address the crisis.

Also of concern was the long-term prospect for Social Security because of demographic considerations. Of particular concern was the issue of what would happen when people born during the post-World War II baby boom retired. The commission chaired by Alan Greenspan made several recommendations for addressing the issue. [15] Under the 1983 Amendments to Social Security, signed into law by President Ronald Reagan, a previously enacted increase in the payroll tax rate was accelerated, additional employees were added to the system, the full benefit retirement age was slowly increased, and up to one-half of the value of the Social Security benefit was made potentially taxable income. [16][17]

As a result of these changes, particularly the tax increases, the Social Security system began to generate a large (short run) surplus of funds, intended to cover the added retirement costs of the "boomers." Congress invested these surpluses into special series, non-marketable U.S. government bonds held by the Social Security trust fund. Under the law, the government bonds held by Social Security are backed by the full faith and credit of the U.S. government. Because the government had adopted the unified budgeting since the Johnson administration, this surplus off-sets the total fiscal debt, making it look much smaller. There has been significant disagreement over whether the Social Security trust fund has been saved, or has been used to finance other government programs and other tax cuts. (See the Social Security trust fund article for a more in depth discussion.)

The special series, non-marketable bonds currently held in Social Security Trust Fund are off-balance sheet and are excluded from the U.S. national debt calculation. Unlike traditional bonds, the bonds held in the Fund cannot be sold on the open market. Due to these unique features, some have argued that the bonds held in the trust fund are only "IOUs" that the government has written to itself. The Social Security and Medicare Trustees note:

Since neither the interest paid on the Treasury bonds held in the HI [Hospital Insurance] and OASDI Trust Funds, nor their redemption, provides any net new income to the Treasury, the full amount of the required Treasury payments to these trust funds must be financed by some combination of increased taxation, increased Federal borrowing and debt, or a reduction in other government expenditures. (Status of Social Security and Medicare Programs: A summary of the 2005 annual reports) [18]

This means that these bonds represent a promise to pay the trust fund later, whether by increasing taxes, by cutting benefits, or by borrowing more money. While this is true of all bonds[19], bonds are normally funded by an immediate income from a private source, when the bond is purchased. The bonds placed in the trust fund are placed printed and in the trust, with no external source of money. The Federal government "buys" the bonds from itself.

The above "promise to pay the trust fund later" is the "bill comes due" moment I refer to in my naive way. And to my naive brain, the above still sounds like classic Ponzi finance, with a recursive twist.

Again, my opinion is that there's nothing wrong with the financial operations. It's the accounting and reporting that aren't right. And I was almost as misled as you until 10 or 15 years ago when I read a clear explanation.

Furthermore, nothing I'm saying here is about the Ponzi-scheme aspect of Social Security.

Perhaps I'm conflating your meaning, but "Ponzi finance" and "nothing wrong with the financial operations" are mutually exclusive in my [again-admittedly-naive-about-these-intricate-government-financial-schemes] mind. I always look at fundamentals: If there were truly "nothing wrong with the financial operations", then there would be no solvency worries now, would there? And the money being paid into the fund by people working *today* would be earning a nice rate of interest before getting paid out a few decades hence, rather than getting paid out *today* at an unsustainable rate.

[Prime95]

Originally Posted by cheesehead

If the deficit size were honestly reported, its higher-than-currently-perceived value would encourage potential bondholders to hold out for higher rates than they do in the present situation.

I gotta agree with cheesehead here (except for the statement above). The true scandal is that the U.S. government can report a $200 billion dollar deficit when it is really $200 billion plus the $100 billion social security surplus that was also spent.

I agree with both Ernst and Cheesehead that politicians use of social security is scandalous.

My minor quibble with cheesehead is the statement quoted above. Interest rates are governed by supply and demand. The Social Security Administration's purchasing of t-bills is already increasing t-bill demand and increasing interest rates. If the deficit was honestly reported IMO it would not increase t-bill demand and I would not affect inerest rates.

P.S. Ernst, I've found your thread here quite entertaining and enlightening even though I have a vested interest in hoping you are dead wrong as to the severity.

[ewmayer]

Originally Posted by Prime95

P.S. Ernst, I've found your thread here quite entertaining and enlightening even though I have a vested interest in hoping you are dead wrong as to the severity.

Thank you kindly, George - I've been learning quite a lot in following the economic threads and keeping what has more or less turned into a personal Subprime blog [with user comments, occasionally pointed] updated. It'll be interesting [and perhaps rather painful] to look back on this whole sorry story in years to come. Meanwhile, keep the commentary coming, folks!

[ewmayer]

As previously discussed on the Subprime Mortgage Market Meltdown thread/blog ... time to check in on our favorite contrary market play, the "Do the opposite of what Jim Cramer says":

The Hype: As ever, courtesy of the permabulls [some would say "permabullsh*tters", but we are politer than that around here] at CNBC:

CNBC: Oracle of Profits: CRAMER SAYS - On both March 11th and March 5th, Jim Cramer said he likes Oracle.

The Data: ORCL reports profits of $0.23 per share, well below the consensus analyst estimates. ORCL stock currently down ~10% in after hours trading. It'll be interesting to see if that carries over to tomorrow's open.

[wblipp]

Originally Posted by cheesehead

Correction 1: the trust funds' money not needed for near-term payouts is invested in U.S. Treasury bonds.

Having a Social Security Trust Fund is exactly like not having a Social Security Trust Fund.

Suppose we had no Social Security Trust Fund. When the Boomers retire, there isn't any money to pay them. So the Social Security Administrator goes to Congress and says "I can't pay the bills - we gotta do something" and Congress does some combination of raising taxes and borrowing and printing money to pay off the Social Security obligations.

But we DO have a Social Security Trust Fund. So when the Boomers retire, the Social Security Administrator takes a handful of those special, zero coupon treasury bonds to the Treasurer and says "I'd like to cash these in." Then the Treasurer goes to Congress and says "I can't pay the bills - we gotta do something." And Congress does some combination of raising taxes and borrowing and printing money to pay off bonds from the Social Security obligations.

There isn't any "there" to the trust fund - it's a promise that future generations will pay the social security bills, and it doesn't really matter that the promise is secured by one particular bookkeeping convention or another. The oldest boomers are in their sixties. I imagine everyone will understand this in another decade or so.

[cheesehead]

Originally Posted by Prime95

My minor quibble with cheesehead is the statement quoted above. Interest rates are governed by supply and demand.

... and demand is affected by psychology of the investors.

The Social Security Administration's purchasing of t-bills is already increasing t-bill demand and increasing interest rates.

Increasing over what period of time? SSA's purchasing has been relatively stable for years AFAIK.

If the deficit was honestly reported IMO it would not increase t-bill demand and I would not affect inerest rates.

To clarify: Are you claiming that if bond investors (the ones who didn't already know all this stuff) were told that the true current general fund deficit were actually $300 billion rather than $200 billion that they've been told by the combined budget, it would not make any difference in their demand for U.S. bonds, not make any of them slightly more likely to invest elsewhere, not make any of them harder bargainers when bidding?