If Social Security Is A Ponzi Scheme, Where Is The Money?

Updated on

In the discussion of Social Security, little is more unproductive and contentious than the assertion that Social Security is a Ponzi scheme. It marks the point where the discussion stops and the fight begins.

Is Social Security a Ponzi scheme? That entirely depends upon your meaning of the phrase.

Get The Timeless Reading eBook in PDF

Get the entire 10-part series on Timeless Reading in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

If you use the term loosely to describe current investors relying on more future investors, it is. But there are many of these arrangements around if you define the word so broadly. On the other hand, some over-qualify the term to a point where nothing qualifies.

Let's look at the two people most frequently associated with the concept of a Ponzi scheme: Charles Ponzi for whom the ploy is named and Bernie Madoff, now serving a 150-year sentence for investment fraud.

Who Were Charles Ponzi and Bernie Madoff?

Ponzi sold investors on a complicated investment idea that was guaranteed to make them large returns over a short period of time. Instead, he paid early "investors" with the money eagerly supplied by those who came later — pocketing millions for himself. His ruse lasted only a few months, collapsing under the weight of its own absurdity.

Madoff sold investors on the simple idea of safety, promising stable returns over long periods of time. In reality, he followed Ponzi's example of paying early investors with the money from later investors — pocketing billions for himself. Madoff's scheme lasted decades, and only collapsed amid a black-swan financial crisis during which spooked investors actually wanted to hold their own money.

What Do They Have In Common?

The one thing that these men have in common is that they personally benefited from the transaction. In every dollar invested, there was a substantial probability that a portion of it would wind up in the pocket of the operator. They have little else in common to bind them together in minds of Americans.

Would Social Security Have Made Madoff Proud?

The answer is no. It would have made him angry, period. While there are widely accepted rumors that the government has profited from Social Security, there is no actual evidence of it.

Today, the Social Security Trust Fund holds about $2.8 trillion. That reserve sounds like a lot of profit pocketed by the government until you break it down by source. Most of the sum comes from interest, which is a cost to the government for borrowing money from the program. Since inception, the program has collected about $1.9 trillion in interest and interest on interest. Separately, the government has paid subsidies of more than $600 billion to the system from the General Fund. Thus, virtually everything in the trust fund actually represents a cost to the government.

So What Happened To The Trillions?

Virtually all of the money ever contributed by workers (nearly 99%) has been spent on beneficiaries. Since inception, the program has collected $14.8 trillion in payroll taxes, and has distributed about $14.5 trillion in payments.. In total, the excess contribution borrowed by the government is not enough even to pay for the subsidies that have been made to the system. As a result, the government has lost nearly half a trillion dollars on the program.

Is Social Security Collecting A Fair Return?

Maybe the government benefited from access to the cash. Specifically, some economists argue that the excess cash that accumulated over years enabled the government to borrow at lower rates. In theory, it is possible because Social Security has created an undisputable supply of cash locked into government securities.

On the other hand, the math tends to discount the size of the savings. The interest rate earned on bonds held by Social Security is based on the yield of longer-term maturities traded in the public markets. That rate is applied to whatever cash is available in June of the year. Provided the long end of the yield curve is higher than the short-end, the government isn't making a killing on the program.

Did Early "Investors" Make Money?

Yes, they did. Typically, we hear about Ida May Fuller, the first beneficiary of the program who collected nearly $23,000 over the course of her lifetime against a contribution totaling less than $25.

The lesser-known fact is that she lived nearly triple the time in retirement as an average retiree of that era. Moreover, she had the good fortune to live through a series of expansions to the program via Congressional mandate, which accounted for the vast majority of her returns. As a consequence, it is exceedingly difficult to determine where the pork barrel politics ends and the Ponzi scheme starts.

To illustrate the distinction, the first farmer to receive agriculture subsidies enjoyed tremendous economic gains. Does that make agriculture subsidies a Ponzi scheme?

What Is In A Word?

The label "Ponzi scheme" isn't contributing to an informed discussion about Social Security or its financial challenges. It is a pejorative meant to scuttle the debate. The label offers no solution, and generates a bottomless rabbit hole of pointless bickering.

Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.

Article by Brenton Smith, Money Tips

Leave a Comment