REFORMING SOCIAL SECURITY JANUARY 13, 1997 TRANSCRIPT

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Last week a bipartisan commission offered three alternatives for redesigning the Social Security system so it will be able to cover the retirement needs of Baby Boomers. The plans were quite different, but they had one dramatic new element in common. All three anticipated investing some Social Security reserves in the stock market. Margaret Warner leads a debate on the merits of that idea following a background report by Paul Solman of WGBH Boston.

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A RealAudio version of this NewsHour segment is available. January 13, 1997 WGBH's Paul Solman reports on the various proposals to fix Social Security. July 16, 1996 Ross Perot describes the Social Security issue as he sees it in a NewsMaker interview.

MARGARET WARNER: Now to our discussion. Theda Skocpol is a sociology professor at Harvard University who has written about the history of American social policy. Mickey Levy is chief financial economist at NationsBanc Capital Markets, a Wall Street investment firm. Estelle James is an economist at the World Bank who advises other countries on designing and reforming their national retirement system. And Henry Aaron, also an economist, is senior fellow of economic studies at the Brookings Institution in Washington. Welcome, all of you. Mickey Levy, starting with you, let's look at the broad question before we get into individual components, as we've just seen, there are so many different options. Should at least a portion of Social Security taxes be taken out of government bonds and put into the stock market? You think so. Why?

MICKEY LEVY, NationsBanc Capital Marks: (New York) Well, quite simply, the rate of return historically on treasury bonds is extraordinarily low. The rate of return on stocks is much, much higher and compounded it would provide significant benefits. If you pick any twenty or forty year period over which a person works, there's never been a whole period when stocks have been negative. The riskiness or the perceived riskiness is much lower than most people perceive.

MARGARET WARNER: And the bipartisan commission estimated that the rate of return on government bonds for the next 75 years would be 2.3 percent after inflation, and they pegged the market at 7 percent plus inflation. Do you think that's realistic, or does that sound high? That would be about 11 percent return essentially after inflation.

MICKEY LEVY: Their research is based on historical data. One can never guarantee that rate of return going forward. Yet, if you simply take a conservative outlook for long run economic growth and growth in profits, then you can expect investment in the stock market risk adjusted and inflation adjusted to far exceed rates of return on treasury bonds.

MARGARET WARNER: All right. Theda Skocpol, you are opposed to this idea. Why?

THEDA SKOCPOL, Harvard University: (Boston) I'm not opposed to cautiously experimenting with investing a portion of the trust fund in stocks, as long as we do it collectively. But I think we have to use our common sense here. Every time we see an ad for a mutual trust fund on Wall Street, we always hear how good the performance has been in the past, and then there's a little disclaimer that says we can't promise it'll turn out this well in the future. So before we bet the farm or even 40 percent of the farm on the stock market, we should probably keep in mind that Wall Street could be in a situation where stocks are going up very slowly or even going down sharply. And we need to be careful how much of our Social Security savings as a nation would bet on that gamble.

MARGARET WARNER: Henry Aaron, where do you come down on this?

HENRY AARON, Brookings Institution: Well, I substantially agree with what Theda just said. The one thing we do know about investment in the stock market is that if individuals do it, they're going to experience highly variable rates of return. Some are going to make a lot of money, and some are going to actually lose money. They won't make anything at all. Administrative costs for many investors, particularly small investors, will eat up a large share of the returns they might otherwise earn. And that's why I think the point that Theda made about the importance of doing this together as a group, rather than exposing individual investors to the viscidities of the market, is absolutely central. There is a lot to be said for reasons that Mr. Levy put forward for doing--for having an investment in the stock market. And there are a lot of reasons, as Prof. Skocpol said, for doing it jointly.

MARGARET WARNER: Estelle James, what's been--there are some other countries that have experimented with this. What's the track record of those? Give us a little sense of that.

ESTELLE JAMES, World Bank: Yes. The study we did at the World Bank, as you know, was, was an international study, and it was primarily looked at the experience of other countries, not the experience of the United States. We found a number of countries had invested pension reserves under public management, and we looked at those results compared with the results of countries where there were large, privately managed pension fund sectors. We found that in general the publicly managed pension funds did not fare well. We looked at the experience of the 1980's.

MARGARET WARNER: And by publicly managed, you're talking about the kind of thing that Mr. Aaron and--

ESTELLE JAMES: That's right.

MARGARET WARNER: --Theda Skocpol were talking about.

ESTELLE JAMES: Centrally managed funds. We found many of them earned negative rates of return in real terms after adjusting for inflation. In some countries the, the returns were positive, but they were low. On the other hand, privately managed pension funds fared much better. And the basic reason is that the publicly managed funds tended to be dominated by political objectives. It was very difficult to separate out the economic and the political objectives. The privately managed funds, on the other hand, were more likely to seek the highest rate of return. And this is not only good for the pension fund, it's also best for the economy if the high returns signify high productivity of capital.

MARGARET WARNER: How do you respond to that, Mr. Aaron?

HENRY AARON: I think Ms. James is raising a very important point, which is the question of whether it is possible as a practical matter to manage the investment of Social Security reserves in private securities, without exposing the private economic to political control. But this is not a question we need to guess about. The answer is in, and the answer is we're doing it already. The federal employees retirement system is managed in precisely that fashion, and people are able to choose among broad index funds that are managed with very low fees. The Federal Reserve system, the Air Force, the Tennessee Valley Authority all have pension funds, a part of which is invested in private securities. And there's another point. Three quarters of a century ago or more we entrusted to a government established entity responsibility for managing something the political sensitivity of which is vastly greater, I think, than the management of these funds. We entrusted the Federal Reserve system with authority to run monetary policy. But the Federal Reserve doesn't interfere with investment plans of individual companies, or even individual banks. You'd make sure we have a safe banking establishment. It controls the amount of money growth there is in the economy. We insulate it from the kinds of political pressures that I think correctly trouble Ms. James but I don't think would be need trouble us as a practical matter if we design this institution correctly.

MARGARET WARNER: Mickey Levy, where do you come down on this question of whether it should be simply a matter of the government diversifying its portfolio versus really giving individuals a lot of responsibility for making their own investment decisions?

MICKEY LEVY: I think individuals should be given a choice, individuals always do better with more options, and you do run into the problem of, of politics playing a role. Politicians love to invest politically in socially correct, and that reduces their rates of return. Quite simply, when we talk about betting the farm on the stock market, that's not the right approach. That's not even the right angle to take on it. Quite simply, the stock market and stock valuations are a reflection of what's going on in America with the rate of growth, with the rate of profit growth, and interest rates. So, in fact, a diversified portfolio would definitely want to be invested in the stock market in the long run, in particular over invested relative to bonds with riskiness perceived to be less than what it used to be. Now, I think it'd be very wise to give individuals choice. The Social Security Administration could set up a program whereby individuals could through any number of funds invest and invest in ways that they choose to be conservative or invest in ways where they know they're taking risk. I've seen numerous examples in countries where this has worked. Certainly you're going to have certain individuals outperforming and certain individuals under-performing. But the fact of the matter is for decades now we've known there is a major problem with Social Security, not just in the funding but many of its distortive effects in this low rate of return to current retirees and current workers, and it's about time we moved to, to a transition to a program that will work for the long.

MARGARET WARNER: All right. Theda--let me let Theda Skocpol in on this because you were endorsing essentially the position that also Henry Aaron outlined. What problems do you see with giving the individual more control or some responsibility for their own investments?

THEDA SKOCPOL: Well, Social Security is the most successful and beloved shared security program that we have in American. It's worked so well for so many Americans over decades because we're in it together, we're all contributing to work in payroll taxes, and in return, all of us working together are guaranteeing a decent benefit in retirement to our parents and grandparents and to ourselves when we get there, as we all hope we will. The guarantee is especially rock solid for people who make less income or moderate incomes in their working lives; that is, the middle class people and the working people of this country. If we move to a system of radical individual attempts, we say to everybody it's up to you to sit down there and figure out which of many different funds you're going to invest in, and you can take the really risky or you can take a very moderate approach to this and you're own for a significant part of your retirement, according to how things turn out for you--if you're lucky, or you're smart, or you have time to pay attention to the stock market. Then we're going to have a situation in which many people who have worked hard all their lives for a modest income end up really on the short end of the stick.

MARGARET WARNER: And are you saying that that is going to destroy or undermine political support for the program?

THEDA SKOCPOL: Oh, it would definitely create a situation in which some people, especially those who made higher incomes, would say we like it be on our own. After all, they don't face as much risk if things don't work out, and people who have relied on Social Security as a shared program would be left in possibly a tighter and tighter situation with less money for their retirement than they could count on if we all stayed in it together. I think we should all stay in it together.

MARGARET WARNER: What's your answer on that political risk issue?

ESTELLE JAMES: Well, I would like to just comment--

MARGARET WARNER: I'm sorry. I'm going to let Ms. James respond to the point you made.

ESTELLE JAMES: I'd like to first comment, one reason why Social Security has been so popular in the past is it is a pay-as-you-go program, and in a pay-as-you-go program, the first twenty or thirty years of people who retire earn a very high rate of return, so it is bound to be a popular program in the first twenty or thirty years. In the next twenty or thirty years, people will be earning a very low, possibly even negative rate of return, and Social Security will be much less popular. Its base of support will be undermined when that happens. The report of the Social Security Advisory Committee, in fact, showed that everyone and, in particular, middle and high income groups, middle and low income groups would fare better in a program that had a larger funded component.

MARGARET WARNER: Henry Aaron, where do you see the political risk greatest?

HENRY AARON: Well, I'd like to back away from this a little bit and just stand back. If we were in a different situation, talking about educational policy in the United States today, we might well be talking about the terrible problem that exists because our high schools are turning out tens of millions of graduates, even our colleges, of people who are not very literate and who are not very numerate. What is being proposed here is that these people who are--do not have the sophistication that Mr. Levy does or that he sells to his clients or would sell to people under a privatized system, these people will be turned loose in financial markets at the mercy, I would suggest, of people who may be more interested in making high commissions than in earning high returns. They will--some of them--invest unduly conservatively and earn lower returns than the stock market could, in fact, yield if we do so in a safe way jointly through the Social Security system. And I think it's important to keep in mind that what I am talking about and I think what the group on the Advisory Council is talking about is not a political investment of these funds. It's an investment in a broad index of private securities.

MARGARET WARNER: And you're talking here about where the government would make the investments and everyone would share--

HENRY AARON: The government would hire a private manager, so that the manager would be doing it, and the government wouldn't be making the decisions directly. And if that's done, what he said about individuals earning higher rates of return is not correct because broad index funds consistently out perform actively managed mutual funds on the stock market. In the last two years, somewhere between 75 and 85 percent of mutual funds performed less well than the passively managed index funds which are the kind that I'm talking about, and I believe the advisory council was talking about having Social Security invest in.

MARGARET WARNER: All right. Mickey Levy, respond to that.

MICKEY LEVY: Well, I find this amusing that the country of Chile has a privatized system with segregated accounts. Is the American public less sophisticated than the average Chilean? You can invest in an index fund now. In terms of Wall Street taking advantage of individuals, the simple point is there are several thousand equity managers now. The Social Security Administration could set up a wide menu for people so that with the large choice there would be enough Wall Street firms and banks, et cetera, et cetera, chasing after people that commissions would not be high.

HENRY AARON: Let me just suggest two names that rebut this view. Keating and Citron. Mr. Keating was the manager of the savings & loan association that bilked his depositors allegedly out of large sums of money. Mr. Citron is the investor who managed to bring Orange County into bankruptcy. I'm not suggesting that these are typical investors. I am simply suggesting that investors of this kind will be out there competing with honest professionals like Mr. Levy and most investors are like the sophisticated people in Orange County, are not going to be able to tell the difference.

MARGARET WARNER: Go ahead, Ms. Skocpol.

THEDA SKOCPOL: I think we have to keep in mind that Social Security today is not in a big crisis. And it's not unpopular. Let's imagine that I'm Mrs. Social Security and I'm in my late 50's, and I go see the doctor and the doctor says look, you're getting old now, and you may be getting sick from time to time; you need to take some vitamins and maybe eat a little less and exercise a little more so that you don't end up in a miserable old age and a burden on your family. It wouldn't make sense for me to take that kind of advice, which is where we really are, and that's the kind of advice that the Ball group, the majority group that wanted to do a cautious investment program, a shared investment program, are advocating. It wouldn't make sense for me to take that kind of advice and then go home and say, oh, my goodness, things could be terrible in 15 years if I don't undergo radical surgery and replace one of my lungs so that I--

MARGARET WARNER: All right.

THEDA SKOCPOL: --ward off the possibility of falling ill. And I think that's what we're being asked to consider.

MARGARET WARNER: And I'm being asked to do radical surgery here and end this, but thank you all very much.

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