You can easily tell it’s an election year by the constant posturing by politicians, the shameless pandering to the self-interests of anyone who is willing to listen and the total absence of any sound economic considerations or recognition that some tough decisions or even some sacrifices will have to be made. God forbid the circus be disrupted by anything as unpleasant as reality.
Fortunately, there are still those who are willing and, in some cases, obligated to speak candidly and independently. Despite whether you agree with his economic analysis, Alan Greenspan toils outside the political process as chairman of the Federal Reserve and his conclusions are relatively objective. While the Fed may not raise interest rates before the election, Mr. Greenspan is certainly not pulling any punches.
For starters, he announced that Fannie Mae and Freddie Mac, the “government-sponsored entities” that dominate mortgage funding, present a risk to capital markets if they continue to grow unchecked. These entities enjoy a lower cost of raising capital because of their perceived government backing, despite clear language that they are not backed by the full faith and credit of the government. This lower cost of capital is supposed to result in lower borrowing costs for consumers. As it turns out, this cost advantage has instead translated into returns for Fannie’s and Freddie’s shareholders. As their portfolios grow, these entities have created ever more complex hedging strategies that could potentially cause huge losses. At the same time, they have resisted calls for greater oversight and higher capital requirements.
Fannie and Freddie should not be able to enjoy the advantages of their government sponsorship without fulfilling their responsibility to serve the consumer. Likewise, if they want to compete with other private funding sources, they shouldn’t have the lower cost of capital associated with government sponsorship.
The real bomb, though, came in Mr. Greenspan’s comments on Social Security. (He first and foremost stressed the need for government spending discipline, as he usually does, but that notion is easily dismissed by Washington.) He noted that the funding requirements for Social Security could result in higher interest rates and slower economic growth. His solutions include reduced benefits for future retirees and raising the benefits age by some type of indexing to life expectancies. He simply stated what everyone with an elementary understanding of finance knows: Social Security as it is currently structured is unsustainable. Predictably, the presidential candidates strongly denounced these ideas, with John Kerry announcing “Not while I’m president.”
When the retirement age of 65 was implemented, it was actually higher than life expectancy at the time. Since then, of course, life expectancy has increased dramatically, and the number of workers contributing to the system per retiree has dropped from 13 to around 3.5, and it is projected to be only 2 by 2030. Other than adjusting benefits, the only ways to meet the ever-increasing payouts is to significantly increase the amounts going into the system (that’s more taxes, folks) or somehow dramatically increase the investment return of the money in the system (that involves far too much risk). The controversial idea of creating personal accounts with part of the contributions is far from being implemented.
But wait, Dave, you say, weren’t you born in 1957, the highest birth year for the baby boomers, and if benefits are reduced doesn’t that mean that you and your peers will have paid the most into the system for the least proportional benefit? Perhaps, but since I am as motivated by self-interest as the next guy, let’s think about that. Assume the two choices are to leave the system as is (a benefit of $100, with a 25% chance that it will be able to pay those benefits in 20 years) or cut benefits in half and guarantee their payment. Since we are talking about retirement and not a weekly lottery ticket, I would gladly take the $50 sure thing over the 25% chance at $100. (An even worse-case scenario is that taxes are increased in an attempt to keep the system propped up as long as possible, and the inevitable collapse comes before any benefits are available to baby boomers.)
Encouragingly, many baby boomers who are beginning to look toward and actually plan for retirement are not counting on Social Security. They are taking matters into their hands by keeping their financial affairs in order and saving and investing as much as possible. There will always be conscientious workers who just don’t have the means to save enough for retirement, and for them the safety net should be strong. The real wake-up call is for those who have the means to fend for themselves but who choose to live only in the present. There’s nothing inherently wrong with that choice, but I’m not willing to pay for their retirement.