September 23, 2004


The Politics of Social Security: Kerry to Use Study to Call Bush Plan a Wall Street Windfall (Jonathan Weisman, September 22, 2004, Washington Post)

President Bush's push to create individual investment accounts in the Social Security system would hand financial services firms a windfall totaling $940 billion over 75 years, according to a University of Chicago study to be released today.

Sen. John F. Kerry plans to use the paper, by economist Austan Goolsbee, as he campaigns in Florida today, hoping to open a new line of attack against Bush. The Democratic presidential nominee is expected to say that Bush's Social Security plan is a sop to Wall Street donors, who are among the Bush campaign's biggest financial backers.

Bush has expressed strong support for allowing workers to divert some of their Social Security taxes to accounts that could be invested in stocks and bonds. But he has never embraced a specific proposal to revamp Social Security, even after his own Social Security Commission presented him with three reform options. Goolsbee, an informal Kerry economic adviser, examined the option that is often cited as the most realistic.

Under that plan, workers could invest as much as 2.5 percent of their earnings -- or about 40 percent of their share of Social Security taxes -- in private accounts, which Goolsbee anticipates would be managed by private investment firms once their balances reach $5,000. He estimated that annual management fees would be 0.8 percent, a conservative figure, he said, considering that management fees across the spectrum of mutual funds average 1.09 percent.

The result: Over 75 years, fees would total $940 billion, more than a quarter of the $3.7 trillion deficit the Social Security system will run over that time period. That would be the largest windfall in U.S. financial history, Goolsbee said, more than eight times the revenue loss that Wall Street suffered during the 2000-02 stock market collapse.

Read and posted this story too quickly last night and completely misunderstood it--thanks Bret & AOG. Mr. Goolsbee seems to have arrived at his numbers by just picking a plan and projecting it unchanged for 75 years, while at the same time assuming an absurdly high fee in private accounts and the cost of maintaining the Social Security accounts to be zero. In actuality the fund options will need to be so limited in any such privatization scheme that management fees will be minimal and there's no reason the government couldn't continue to run the funds if folks so desired (though that seems a bad idea). At any rate, don't you need to subtract the current cost of administering that money within the Social Security system from the cost of managing it in the private sector to arrive at the "windfall" amount? After all, what do I care whether the government charges me .8% to run SS or Fidelity charges me .8% to run the account? And the .8% is a ridiculous figure--to take an example from the private sector,
[The] Vanguard S&P 500 expense ratio is 0.19%, or a quarter of Mr. Goolsbee's low end estimate.

Another problem, Bret and AOG estimated--if I recall correctly--that at the .8% fee the equation assumes an average asset base over the 75 years of about $1.6+ Trillion. But the point of beginning privatization is to end with a privatized system. So in a few years or decades we'd each be putting our entire annual contribution into these accounts and our employers would be putting in their entire contribution. We'd pretty quickly reach a point where $1.6 trillion was going in each year, no? The "windfall" would be far more massive than the paltry figure he's worried about here if they're getting .8% of accounts annually 75 years from now, wouldn't it? More like $800 billion a year?

Posted by Orrin Judd at September 23, 2004 9:16 AM

Mr. Judd;

You meany, I was just about to savage Bret's math! He massively underestimated the growth in assets.

But yes, if there was $100T in assets the fees would be around $800B per year for 0.8% fee rate.
The other thing Goolsbee complete misses is that it's a good deal to pay $1T in fees if the overall performance is more than $1T better. I.e., if my choices are to end with $1T with no fees or $3T and have to pay $1T of it in fees, I'm better off with the latter. Goolsbee ignores the net rate of return (gross return minus fees) which is what one should consider.

You might also note that while gross inflows might hit $1T, there will be torrential outflows to retirees as well. I would expect the net asset base to grow roughly in parallel with the GDP (because ultimately the assets are simply ownership of the GDP). A 2% GDP growth rate gives you a factor of roughly 4.5 over 75 years so I'd expect the final assets to be about that much more than the initial. However, one needs to be careful to distinguish net asset growth from individual rates of return. I'm looking at net assets because that's what determines the fees, not the gross flows in or out nor individual rates of return.

P.S. For this particular set up, each additional percent of GDP growth roughly doubles the net return, so it's 9x for 3%, 18x for 4%, 38 for 5%.

Posted by: Annoying Old Guy at September 23, 2004 11:16 AM

I wondered if I was going (more) crazy last night - I saw the post, went elsewhere, and when I came back, it didn't exist !

This "study" is, with no exaggeration, a kindergarten level analysis.
As "Dr." Goolsbee is a Professor of Economics at the University of Chicago, an institution whose members have claimed 20% of all Nobel economics prizes ever awarded, he must know that, which makes this a straight-up con, a fraud for base political purposes. (Scare quotes because if Goolsbee had performed this poorly in graduate school, he wouldn't have earned his Ph.D.).
Goolsbee makes no adjustments for population growth, demographic shifts, or economic growth, all of which we know will occur.

Really, Austan Goolsbee deserves to be labeled an "economist" about as much as Paul Krugman does, which is to say, not at all. One must demonstrate a basic grasp of economic principles before being honored with the professional title.

The gist of Austan Goolsbee's "study" is that Wall Street will profit from privatized, commercially managed SS accounts, which is similar to noting that the defense industry profited from the decision to go to war in Afghanistan and Iraq.
Like, duh !!

If the problem is that Wall Street will profit, then a simple solution would be to include a basket of bank and brokerage stocks in every SS account, and then everyone can benefit from Wall Street's increased value due to SS money management.

According to the Social Security Board of Trustees, the administrative costs for Old-Age and Survivors' Insurance, (the pension part of SS), amount to around .45% of revenues, or roughly half of what Professor Goolsbee proposes that the private sector would charge.
Not all of that can be eliminated, for the gov't will surely want SS to oversee the management of the private accounts.

Assuming that the maximum contribution to privatized SS accounts stays at 2.5% of earnings, and that there would be 100% participation, I estimate that in 2080, (in constant dollars), there would be roughly $ 23 trillion under management, that inflow to the accounts in 2080 would be $ 750 billion ( $ 100 billion), and that, with a fee of .8%, over seventy-five years Wall Street will have made commissions of $ 6.5 trillion.

So, Goolsbee is only off by about 600%.
Apparently, math isn't his strong suit, either.

Posted by: Michael Herdegen at September 23, 2004 12:04 PM


You hit the nail right on the head !
From 1930 to 2004, in constant dollars, per-capita GNP grew 460%.

Posted by: Michael Herdegen at September 23, 2004 12:15 PM


In my final comment on the previous post I estimated the final assets given growth rates of 10%, 20%, and 100% in order to generate $900 Billion over 75 years. 100% yearly growth is too low? Boy, you are optimistic!

Posted by: Bret at September 23, 2004 1:39 PM


No, I meant that you underestimated how much the assets would grow. A 100% annual growth rate over 75 years would yield an increase by a factor of 37,778,931,862,957,161,709,568 (roughly 40 sextillion). It would not be possible to start with a small enough amount of money to get only $900B in fees from that. If you started with $1, after 75 years the fees would add up to $900B every 100 µs (or every 1/10,000 second) at a fee rate of 0.8%.

Posted by: Annoying Old Guy at September 23, 2004 7:04 PM


Sure, sure, sure, I agree, the larger percentages were hypothetical and pure math and yes, you would have had to have started with some tiny fraction of a penny to end up at $16T after 75 years.

However, you get the same result if the program was funded only a few years ahead (say zero for the first 65 years) and then the assets happened to double every year.

Posted by: Bret at September 23, 2004 8:36 PM