Baseball Crank
Covering the Front and Back Pages of the Newspaper
February 9, 2005
POLITICS: Finance 101 - You Fail!

Matt Yglesias demonstrates what he doesn't understand about finance:

A lot of people, including George W. Bush himself, seem unduly impressed by the fact that the trust fund does not consist of a "a pile of money being accumulated somewhere." . . . Here in the United States . . . nobody accumulates literal piles of money. Instead they buy stocks, bonds, and other financial instruments. The Social Security Trust Fund is, like most of Bush's money, invested in bonds issued by the U.S. government.

It seems to have become fashionable in the precincts of the contemporary right to start noting that these are "just IOUs," which is to say a promise that the money will be paid. The fact that all bonds are just IOUs, however, highlights the importance of making good on them. . . Our ability to borrow money at a reasonable price . . . is dependent on the perception by investors and foreign governments that Congress won't do this, even though it could.

Changing the law so as to no longer honor the commitment made by Ronald Reagan and the congressional leadership in 1983 would be a dangerous indication that today's president and Congress don't take such commitments seriously. That would be a poor signal to send at the exact same time the president asks the central banks of China and Japan to loan him a few trillion more dollars to cover the costs of the transition. After all, if bonds are "just IOUs," who's going to pay perfectly good yen for them?

(Emphasis added). Look, there are perfectly good arguments to be made about Social Security, but this ain't one of them. Let's say you can invest in two companies. Both are identical except that, for a third of their assets, they hold a portfolio of corporate bonds. Company A holds corporate bonds issued by, say, General Motors. Company B holds corporate bonds issued by . . . Company B. Wouldn't you be just a bit skeptical about the value of Company B's investment? Don't you think Company B would get into some trouble with its investors if it just said "a third of our assets are invested in corporate bonds" and didn't bother to disclose that they were buying their own bonds? There is a very big difference between buying bonds issued by somebody else and buying bonds you issued yourself.

Now, all of us make mistakes, and I'm certainly no expert on all the economic issues here - there's a reason I haven't delved too deeply into the Social Security debate - but if Yglesias can't grasp that simple distinction, he really should not be writing about this issue.

MORE: He's at it again here. Yglesias' point is that foreign holders of Treasury bonds will panic and fear a default by the U.S. if we don't repay the Social Security Trust Fund's theoretical holdings of Treasuries. But that's nonsense, and anybody who believes that wouldn't last a day as a bond trader, because the anticipated dramatic narrowing of risk-premium spreads between other bonds and Treasuries just wouldn't materialize. Holders of Treasuries know full well that nothing done to rearrange the U.S. government's internal accounting for what it "owes" itself (they're really IOMEs, not IOUs) will make it more likely that we would decide to default on bonds held by a non-federal-government holder, any more than the bank that holds my mortgage cares whether I keep a New Year's Resolution to put more of my money into my 401(k). You can argue over whether Bush's plan would improve or harm the federal government's overall long-term fiscal outlook (we'll leave that one for another day), but there's nothing here that remotely suggests the likelihood of a general default on Treasury bonds.

Posted by Baseball Crank at 9:28 PM | Politics 2005 | Comments (11) | TrackBack (0)

If we don't repay, there will millions of ticked off retirees, who vote. Within two years there will be a new Congress that does repay -- even by raising taxes.

Posted by: RobertJ at February 10, 2005 2:44 PM

I think your underestimating the gravity of what BushCo is floating here. The trust fund isn't fille with "IOMe's". That's my money the government has - not theirs. And they've been getting even more of it for the trust fund since 1983.

We have the Constitution to protect us from our government. The trust fund is exactly what it is and BushCo faces a Constitutional obligation to pay it back. To even suggest that the US Government would not is treasonous.

Posted by: eRobin at February 10, 2005 3:08 PM

Yes, it's your money, and mine. It all is, every penny in the federal government's pockets. That's not the point. The point is, the existence of a "trust fund" consisting of money the government owes itself is an accounting fiction that wouldn't stand up to elementary scrutiny in the private sector. You can't count something as an asset if the money you get by selling it comes out of your own pocket.

RobertJ - It will be years before the Bush plan would reduce any retiree's guaranteed benefit. By that point, people will have private account balances to offset the decline in the guaranteed, defined-benefit payment. What Bush is proposing will stand or fall on whether that tradeoff is one that makes sense to voters. Certainly, no retiree's check will be cut off between now and 2006; that's just a lie.

"Treasonous" to suggest rearranging the federal government's fiscal obligations? That's a new one. Go report me to the FBI.

Posted by: The Crank at February 10, 2005 3:26 PM

It'll be a cold day in hell before the congress allows those bonds issued by the trust fund to federal agencies to go into default. They'd all be voted out the next election cycle, not doubt about it.

Posted by: Drew at February 10, 2005 6:53 PM

...comparing a private firm to the federal government is about as honest as a deficit hawk comparing the federal deficit to a college student with $20,000 in credit card debt. The very idea that these debt insturments issued by the trust fund won't be paid is completely obsurd.

Posted by: Drew at February 10, 2005 6:58 PM

Your point seems to be that Treasury bonds held by the SSA are worthless because the SSA is a branch of the government.

Perhaps you could tell that to Alan Greenspan who had the idea of building up the trust fund in the first place and persuaded everyone that payroll taxes should be increased to pay for it.

Posted by: Thomas Dent at February 10, 2005 7:38 PM

federal debt includes unfunded liabilities. the benefits owed to future beneficiaries are an unfunded liability. Greenspan perpretated a hoax by raising payroll taxes to fund a 'trust fund'. The trust fund would be funded if it contained something other than promises from one part of the government to another. When revenues from the payroll tax start to exceed payouts, some tax will have to be raised or some other spending will have to be cut in order to pay to beneficiaries what has been promised to them. What is going to result from the current debate is probably a combination of (1) reduce the liability by cutting benefits, (2) increase revenues by increasing the payroll tax, and (3) invest part of current and future excess revenues in assets other than government debt. Step (3) should have the affect of increasing revenue because of higher returns; but it does not reduce the liability for promises made. Anybody who thinks that lenders do not take unfunded liabilities into account is crazy. If the US cuts benefits it is not repudiating the bonds in the trust fund, it is reducing its liability. This happens all the time. I worked for a state that once had one pension for everybody. Over the years as the state spent more than it took in, it assigned younger workers to less and less generous pension systems in order to reduce future liability. This was done time and time again by votes of the legislature ratifying agreements betweens unions and the state administration.

Posted by: jim linnane at February 11, 2005 6:37 AM

I'm a long way from convinced by Yglesias's argument that we are about to "default" on the "trust fund."

As I understand it, Bush is probably going to use the "trust fund" (which is essentially a promise to use general funds to pay for however many billion $ in benefits) to pay benefits to current and upcoming retirees in place of the benefits that would have been covered by the private account money. If you really believe in the trust fund, there shouldn't be anything wrong with that.

Posted by: J Mann at February 11, 2005 4:38 PM

What's been demonstrated here is that Yglesias' grasp of the situation is the same as Greenspan's as far as the reality of the Trust Fund goes. So Greenspan flunks Finance 101 as well?

Or, if you say Greenspan perpetuated a giant hoax -- with what motive?

What's wrong with the 'Bush Plan' such as it is, is that the bonds in the Trust Fund, real or illusory, are designated to be used to pay benefits after 2018 with the majority of the burden coming some years after that. If you use them *sooner* for 'current and upcoming retirees' you're left with even less when the crunch comes. As admitted by administration sources, the plan would move the date of payback or 'insolvency' *forwards* from 2018 to 2012. Hence the large proposed cuts for those not currently about to retire.

If you think that the Fund is illusory, consider this alternative argument: people (mainly middle-class) paid more payroll taxes during the late 80s and 90s under the belief that this would enable them to have full benefits when they retired. The increase in taxes should have helped wipe out the deficit both short-term and long-term, so that when the time came to pay benefits after 2018 the general fund was in a sufficiently good state.

Now, after tax cuts (going disproportionately to the top 2%) and Iraq the general fund is running huge deficits as far as the eye can see, when according to the plan it should be nearly balanced or in surplus due to transfers from SSA to the general fund.

If there is a predicted crisis in paying Social Security after 2018 it is entirely due to the failure to pass balanced budgets. Apropos of which Bush has never vetoed a single spending bill.

Posted by: Thomas Dent at February 12, 2005 2:16 PM

If they're "just bonds," like any other bonds, then great: Put my slice in an account with my name on it and let me sell 'em for another asset should I so choose. Because I can do that with real bonds. That I, um, own.

That we can't do that and still call it a "unified Federal budget" exposes the sham that currently exists.

If the government "doesn't repay" because the liquid assets aren't there, and the economy is at a point on the Laffer Curve where "simply raising taxes" won't raise revenues, period, let alone cover the nut, then it's Enron. Except that respirators start getting unplugged.

Posted by: S.B. Terwiliger at February 13, 2005 5:08 PM

When in doubt, go to the source. The President explains Soc. Sec. reform in his own words, "Because the-all which is on the table begins to address the big cost drivers...There's a series of parts of the formula that are being considered. And when you couple those-changing those with personal accounts, the idea is to get what has been promised more likely to be-or closer to what has been promised." Clearly a man with a plan.

Posted by: jim at February 16, 2005 12:07 PM
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