30 January
by John Vomastic

 

The Perils of Privatization

President Bush wants to set aside funds for individual accounts for younger workers. The amount set aside would be invested in the stock market or other securities and managed by financial services firms. But to fund the private accounts, a large amount of money (an estimated $2 trillion for the first 10 years) must be borrowed.

Suppose funding of private accounts is approved for people from age 20 to 45. The amount needed is $2 trillion for the years 2005-2015. But what happens in the period from 2015-2025 and beyond? Those future retirees are now 30-55. An additional $2 trillion would be needed, plus additional money for the new workers ages 20 to 30 (another $.5 trillion to $1 trillion). The same logic also applies to the years 2025-2035. The original $2 trillion estimate would balloon to about $8 trillion before any savings have been realized.

Can you find a reputable stock broker (who doesn't have a political agenda), who would recommend that you borrow money (when you are already deeply in debt) and then take that borrowed money and invest it in the stock market? I would wonder, whether such a person was more interested in his brokerage commissions on the trades than my financial security. But that is precisely what Bush is recommending and guess, who the main beneficiary would be - Wall Street. Investing in stocks with part of your SAVINGS (emphasis on savings) is a sound financial decision for the long term. Even buying stocks on margin could be okay, if adequate reserves are maintained should a margin call occur. But borrowing money, to invest in stocks, I don't think so.

I worked in the aerospace industry in the 1990s. After the Cold War, there was considerable down-sizing and consolidation, and many employees were offered early retirement. Because of incentives, some of those employees had invested heavily in stock of the parent company. But the value of the stock fluctuated, in some years by more than 50 percent. The lump-sum payout (and the lifetime annuity) for retirees was considerably less than other times. Think of the market in the last ten years. The only thing certain about the market is that it will fluctuate, and that is not a good thing when picking a retirement date.

Managing private accounts has associated costs. If a management fee of one percent of the total assets in the account is deducted each year, a 30-percent reduction in assets over the life of the account could result.

Bush has also stated that individual accounts could be passed on to one's heirs. In 1940, the life expectancy of Americans was 64 years. If you were born in 1940, you would turn 65 this year. Many Americans born in 1940 made significant contributions from their wages, but did not live long enough to draw benefits. These contributions were not returned to the individual's heirs, but remained in the system. If the money in private accounts is passed on to one's heirs, this could result in a serious drain on overall assets from the Social Security system.

Bush has stated Social Security is in crisis and immediate action is necessary. But before actions are taken in haste, it would be prudent to examine the details of privatization. You may find more than one devil lurking there.

 

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