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» Social insecurity » Jim Lowell interview

Social insecurity

KAREN GIBBS: There is a debate raging about the solvency of social security. It is the biggest government entitlement program, but also the most universal, most popular and most enduring. President Bush has put reform of the system at the top of his second term agenda, warning: "the system is broken and promises are being made that Social Security cannot keep"… his fix? Allow social security dollars to be invested in the stock market. And supporters have wasted no time launching a public relations campaign.

Critics such as New York Times columnist and Princeton economist Paul Krugman charge the president has created a fake crises and a fake solution. Dick Armey, former House Majority Leader and now chairman of Freedom Works is leading a grassroots movement to completely reform Social Security. He joins us from Dallas.

GIBBS: Paul, are we in a crisis?

PAUL KRUGMAN: No. Probably there's a little bit of a long-run shortfall in Social Security. But you know, when you look at that ad and it says there used to be 16 workers, blah, blah, blah, right now there are three workers for every retiree, and Social Security is running a big surplus. Now 40 years from now, there will be two workers for every retiree. That's not that big an adjustment. And Social Security is running a big surplus now, which means that it's accumulating a trust fund, which is legally binding. It's money that should be repaid. And most estimates say that it's a fairly small shortfall, tiny, way down on the list of our problems, and quite a few economists think the system, if the economy grows as fast over the next half century as it did over the past half century, no problem at all. The system is good forever.

GIBBS: Dick Armey, how does it look from your perspective?

» Pondering privatized Social Security

DICK ARMEY: I think it's been headed for financial disaster at its inception. I frankly have been advocating this change for 40 years privately and for 20 years publicly. The fact of the matter is what the President's suggesting we do is allow people to voluntarily take some of their money that is now savings forced into Social Security, that promises most young people very little if any return, and then put it in private accounts. That, by the way, is pretty much exactly the bill that was initially passed by the Senate in 1936. And if the Senate had had its way, we'd have had the more correct system all these years and we wouldn't be facing this insolvency. And let me also say the day that we do not have current payroll tax receipts that cover current Social Security outlays is the day this government's got a big problem, and that day is coming very soon because the trust fund is a fiction and anybody that doesn't know that today has simply not been paying attention.

GIBBS: Well, when you talk about the trust fund being fiction, isn't it full of IOUs from the United States government?

ARMEY: That's right. This is one pocket of the government saying to the other pocket of the government, "I'm empty, but I owe you this money. And if I get the money to pay you back, I'll have to take it out of your pocket in the first place." It is really bizarre, and if violates, by the way, just about every principle of responsible solvency and investment that under federal law we imposed on every private investment in America. And it's amazing how this government can set such a bad example in doing what it by law forbids everybody else to do.

GIBBS: Paul, what do you think about these government IOUs being worthless?

KRUGMAN: Let me say that on all of these things it's really important to back up and say, you know, whatever you want to say about the future of Social Security -- and I think this crisis stuff is nonsense -- you know, the proposed solution is not we're going to allow people to invest money. It is that the U.S. government is going to borrow lots of money, because you're going to be taking payroll taxes that are being used to pay benefits and you're going to divert them into these private accounts, and we're going to borrow the money. And so this supposed solution is like your financial advisor saying to you, "Well, here's how you prepare for your retirement. Don't save. Just borrow a lot of money, put the money in the stock market. You'll be fine."

This is crazy. This is absurd. There is this moment that this imaginary crisis in 2018 when Social Security is no longer taking in more payroll taxes than it pays out in benefits, I can think of a lot of reasons why we might have a fiscal crisis in 2018 or before. Social Security is not on the list. Right now we've got a huge budget deficit. Right now. Not hypothetically some decades in the future, but right now, because President Bush broke with all historical precedent by cutting taxes while waging a war. We have Medicare expenses which are going to grow by about 2.5 percent of GDP, more than Social Security will ever grow, even when 40 years from now, by 2020, with more than half of that rise because of that horrible Medicare bill that President Bush ran through Congress in 2003.

So to say that we have a problem in Social Security, no, we do have a huge budget problem, which is created by policies that have nothing to do with Social Security. The Social Security system has been run quite responsibly. Last thing to say, let me just say, when Dick says he's been wanting to get rid of this for 40 years, that's the point. Republicans have always wanted to get rid of this thing.

GIBBS: Dick, your response.

ARMEY: Well, let me just say first of all the reason I've wanted to get rid of it was I'm an economist who believes in freedom. And what the President's saying is what a novel idea. Let's let people voluntarily to choose what they would do voluntarily instead of being another generation of people that are compelled by law to participate in a program that they have no confidence in, they don't like, and don't appreciate. And the fact of the matter is all we're saying is even if you say the liquidity problems are there whether you do the right thing or stay with the old wrong thing, how about, Paul, the idea that we should let people be free to choose for themselves how they will define their own retirement security in the future? Don't your children deserve that opportunity more than what the last three generations of Americans have had it because of this compulsory forced savings plan of the federal government?

KRUGMAN: Let's just be clear. I mean Social Security is mostly a program that's run as a pay-as-you-go basis. Primarily most of the money that's collected is a tax that's used to pay benefits. It's retirement security. It's never intended to be the sole source of people's retirement savings, but it's something you can fall back on. It's social insurance. And again, all of these proposals are not saying let's let people invest their own money. They are saying let's let the federal government borrow money, and we're going to hope, it's all got to come from additional borrowing.

This is completely an unfounded idea. And none of the programs, none of the proposals work even in the very long run, unless stocks are for sure, absolutely a better investment than bonds, which is this funny thing, because somebody's selling us the stocks and somebody's buying those government bonds. So I wonder how a former economics professor can believe what you have to to make this program work. You have to believe that you are smarter than the market, that you know that stocks are a great investment, but the market does not.

ARMEY: Let me just say, Paul, I, like you, base all of my confidence about my financial security in my retirement years on my 401(k). And don't tell me that you're any different. You tell me where you put your money. Have you put it in stocks, bonds, in the private capital markets? Or are you willing to be dependent upon Social Security? The fact of the matter is right now the more privileged people have the privilege of the compound earnings of the private capital markets and the less privileged people are forced to put their money into the lowest paying retirement program in the history of the world. Why not let everybody be free to choose just as you're free to choose? And just as I know you're feeling quite confident about your security by virtue of the earnings you've had in the private capital markets throughout all your working life.

GIBBS: Paul, let me ask you that.

KRUGMAN: No, but this is the point. Social Security is not investing people's money badly. It's a program in which people pay taxes and get social insurance. It's not getting a lousy rate of return. There's no free lunch here. I don't know what happened. It's amazing to me that conservatives who believe in the free market now say that it's this enormous free lunch so we can somehow solve this problem they perceive by borrowing money and throwing it into the stock market because there's a money making machine out there that for some reason the private market is not exploiting. And the point is, yeah, I've done really well, and I don't think I'm going to need Social Security. But you know if I should screw up -- I'm getting a little bit old, I'm running out of time to make big mistakes -- but if I should screw up, I'd feel better knowing that there is a program that insures that you do not have lots of poverty among the elderly in the United States.

Social Security is much more than just a way to invest your money. It is a bedrock of the reason why we don't have a lot of misery. And this is not hypothetical. Britain went for a privatization plan back 20 years ago under Margaret Thatcher thinking that they were going to solve the retirement issue forever. And now a big report by the UK Pensions Commission back in October saying we've got a problem here. Lots of people are going to find themselves in deep poverty when they retire because they're not making enough on those private investments. But look, the stock market did great in the past. Mutual funds are supposed to, you know, required to do this disclaimer, past returns are no guarantee of future performance. People have caught on to the fact that stocks were a good thing in the past and the price/earnings ratio is double what it was 50 years ago. So in the future stocks are not going to be that great of an investment.

GIBBS: Dick, what about that? If stocks are so great, how come Social Security itself doesn't invest in the stock market and share the wealth among the beneficiaries?

ARMEY: Well, because federal law requires Social Security to be put into United States Government securities. The argument at the inception of the program back in '36 was this is the safest thing you can do with the people's retirement security. Later on when you had the unified budget from President Johnson, it became clear, particularly to the Democrats, oh yeah, we can milk this for our other additional spending programs.

I think it's a pretty frankly grievous trick to take a 25-, 30-year-old youngster that's working his heart out to take care of this family, force him to put the first 15 percent of all the money he earns into this program under the pretense that he's paying for Grandma's retirement, and then instead be spending the money on such foolish things as AmeriCare or AmeriCorps or the National Endowment for the Arts or any of the other sort of silly, what should I say, indulgings of the federal government's budget. The fact is these youngsters have serious things to do with their life. They don't need to have their savings forced into a program that is subsidizing frivolous government spending programs.

GIBBS: Dick, House Ways and Means Committee Chairman Bill Thomas predicts that partisan warfare over Social Security is going to render his proposal pretty much a dead horse. How do you respond to that?

ARMEY: I think Bill's wrong about that. I think the whole public mood on this subject is so markedly different than what it has been over the years that we're going to be amazed at the amount of grassroots uprising there is in America that says the President's right, now get it done.

KRUGMAN: Let me say what's astonishing to me is the cowardice of the Bush Administration's approach because they're proposing this thing, they're saying we're going to secure the future, but actually we're not going to impose any pain on anyone. It's all going to be borrowed money and we're going to try and rewrite the budget rules so the borrowing doesn't even show in the budget deficit, but we're going to propose something which is going to cut the guaranteed benefits, but you know, none of that's really going to happen for several decades. So we're going to actually leave it to some other future government to actually impose the pain. So this is a fake. This is all propose, you know, claiming to be courageous, claiming to do good stuff, but in fact what we're going to do is we're going to borrow lots of money for an initiative and pretend that it's going to do something in the long run in ways that are totally nonbinding on whoever is running the United States in 2050.

ARMEY: Let me just say it is so inappropriate to talk about the cowardice of the President. Democrats have been beating Republicans over the head to the tune of the third rail since 1964 in Barry Goldwater's election. Any Republican that has the courage to say let's have a serious adult discussion about a very important public policy issue that touches three or four generations is a president that has to be applauded. And, Paul, you ought to appreciate the fact that you now have a Republican president that dares to stand in the face of 40 years of effective mean-spirited Democrat demagoguery on this subject that should have been addressed when Goldwater tried to do it in '64.

» Fixing Social Security

KRUGMAN: I'll just say that the mean-spiritedness and the demagoguery to me seems to be along the other side. Here we have a program that's doing just fine, you know, the problems are a tiny fraction of those associated with the tax cuts, a tiny fraction of those associated with Medicare, Medicaid, and here we are trying to trash the program with scare rhetoric. And it's again, remember that when the Congressional Budget Office scored what appears to be the most likely proposal -- you know, we don't actually have a proposal, that's very weird -- but what we think is going to be the Bush Administration's plan, it says that it will increase the deficit every year from now until 2050. So the good stuff that's supposed to happen is going to happen after the current generation of politicians is long gone.

ARMEY: Well, why don't you join me then in calling for responsible cuts in the rest of the federal budget? If you really believe retirement security for the generations is important, will you join me in cutting out the National Endowment for the Arts, cutting out AmeriCorpsor any number of other programs that have no visible benefit to the American people and are nothing but budgetary indulgences for privileged people in the country?

KRUGMAN: You know that those are pocket change. You know that all that is pocket change.

ARMEY: No…

KRUGMAN: Will you join me in calling for a repeal of tax cuts that were based upon budget forecasts that have turned out to be totally wrong?

ARMEY: No, I will not.

KRUGMAN: Well, there we are, there we are. No sacrifice.

ARMEY: The problem is, there again, let me just say the real level of taxation, as Milton Friedman has pointed out oftentimes, is the level of spending. The fact of the matter is our problem is this government is too big, spends too much of our money, and spends it all too often too frivolously, and most of the people who want to save Social Security as they've known it for the past 40 years will not join in making any of the necessary budget cuts that would even make it possible to do the wrong thing you want to do on Social Security.

GIBBS: Gentlemen, we've barely scratched the surface, and I know we could talk about this for hours. We'd love to have you back, but we're out of time. Dick Armey, Paul Krugman, thank you.

Jim Lowell interview

GEOFF COLVIN: America's favorite way of trying to beat the market is through mutual funds. Nearly 100 million of us own them. Yet incredibly, we usually don't know what we're buying. That's because what really drives a fund's performance is -- duh -- the manager, yet most investors have no clue who is managing their funds. Who's managing yours? Educated investors need to know -- and now, finally, they can. Jim Lowell's new service, called The Rankings Service, doesn't rate mutual funds, it rates mutual fund managers.

Jim, so what is the big concept here? That managers move from fund to fund and you're going to follow them and figure out who the stars are?

JIM LOWELL: Precisely right. Numbers don't lie, and every manager has to post an end of day NAV that lets us see exactly how they're doing relative to their specific market benchmark.

COLVIN: Net asset value. Well, it seems like a great idea, but it seems like an obvious idea. Why hasn't anyone done it before?

LOWELL: Well, that's a very good question, and you'd have to ask that of Morningstar and Lipper to get a better answer than I could give you. But I think part of it is that the fund firms are very happy having people focus on fund performance, so that if a good manager up and leaves, the assets don't leave with them.

COLVIN: Right. And Morningstar and Lipper of course are the big services that rate mutual funds.

LOWELL: Correct. They're using past fund performance, which of course is a terrible way to actually orchestrate any sort of thoughtful way to invest in mutual funds. You need to know the record of the manager so you know literally who you're buying.

COLVIN: Because in some cases of course a great manager can, as you say, up and leave. In other cases, a fund with a terrible record can have a star manager come in, but you wouldn't know that for a long time if you just followed the fund rank.

LOWELL: That's absolutely right, and the fund companies aren't going to tell you, and of course Morningstar and Lipper aren't going to tell you that either. But if you just follow the career records of the managers, you'll be able to tell that day in and day out.

COLVIN: So let's look at who the stars are. Now this is, you research what, 10,000 fund managers?

LOWELL: There are over 11,700 managers in our current database, which I would say is clean for the past 5 1/2 - 6 years. We have close to 5,000 managers. It's pretty much the market. And for fund investors, the managers are the market.

» Jim Lowell: Top 10 managers

COLVIN: Okay. Among that huge universe of fund managers, the top five -- this is from all categories, according to your latest numbers -- number one, Guenter Faschang running the World Funds Eastern European Equity Fund; number two John P. Hussman, the Hussman Strategic Growth Fund; three, the team managing the GMO Emerging Country Debt Fund; four, John Connor -- yes, he was in the Terminator movies -- but this John Connor is running the Third Millennium Russia Fund. And five Carl Wilk of the Gartmore Micro-Cap Fund. Now obviously three of these funds are overseas funds. Isn't there a danger that the ranking could pick out managers who are just lucky enough to be running funds in a hot sector?

LOWELL: It certainly could be a danger, but not with our system. Unlike many publications that you see with their new year predictions for the best funds, they're all gold funds one year, they're all small-cap value funds the next year, this system is designed to, it's a meritocracy specifically designed to elicit which managers have good and poor stock-picking skills. The fact that the more global-oriented, more world-oriented managers are coming to the top of the ranking suggests to me that for the first time in almost a decade the global markets are actually beginning to make an impact.

COLVIN: Now let me see if I've got this right. The way you avoid the danger of having the star managers just happening to be those who are in hot sectors is that you look at the managers' performance relative to the benchmark of that sector.

LOWELL: Correctly right. So one of the things that we don't say is that these are the top-performing managers. They're the top-ranked managers, because our ranking system rewards a manager as much for losing less than their benchmark as it does for gaining ground when the going gets good.

COLVIN: Right. So these are the ones who have outperformed the competition, whatever the competition may have been for them.

LOWELL: Correct.

COLVIN: Okay, now what about the famous managers -- first of all, there's managers here that nobody's ever heard of. I mean I shouldn't say nobody, but most people have never heard of, right? By the same token, there are fund managers who are world famous. Everybody who has ever thought about a mutual fund has heard of these people: Bill Gross, Bill Miller, Mario Gabelli, Bill Nygren. These are famous, these are world famous fund managers. Where do they rank in your ranking?

LOWELL: Well, you're batting 50-50. Bill Gross and Mario Gabelli actually rank fairly poorly. They're fair to slightly below average across multiple funds that they've been managing, whereas Bill Nygren at Oakmark is clearly a strong stock picker.

The one thing you need to know about him is that he delivers his consistently better returns relative to his benchmark with consistently higher volatility than his benchmark, so he might not be as appropriate as Bill Miller for a more growth- and income-oriented investor. Bill Miller, stellar. He ranks in the top quintile, but the last time I looked I think he was number 42 out of about 620 in the group.

COLVIN: Now what about the very largest funds? For example, the biggest, the Fidelity Magellan Fund, been run for awhile now by Bob Stansky. How does he stack up?

LOWELL: Well, unfortunately Bob Stansky has had trailing returns versus his benchmark virtually every year since he's been managing Magellan. Not dramatically less than his benchmark, but enough over time to give him, on our ratings scale of A to F, an F.

COLVIN: Well, that's fairly remarkable. I think most people wouldn't have imagined that.

LOWELL: Well, I think most people still think of Magellan as a growth fund. For those who've matured along with Magellan, maybe they're comfortable with growth and income like returns. But in terms of its benchmark, Stansky has lagged almost five years in a row.

COLVIN: What about the other major funds that viewers are most likely to be familiar with and where their managers stack up?

LOWELL: Well, a passively-managed fund, Vanguard Index 500 Fund, would get basically an F rating in our system, because we pay active managers to outperform the indexes.

COLVIN: Well, and an index fund could be managed by a computer essentially, right?

LOWELL: Absolutely right. But when I look at George Sauter who manages Vanguard Index 500 Fund versus all the other Index 500 fund managers, he looks certainly better than the group. But relative to the active managers in the growth space, large-cap growth space that the Index 500 is a benchmark for, we see literally hundreds of managers who have a consistent record with greater or less risk being able to outperform that benchmark.

COLVIN: Remarkable. Now you mentioned large-cap growth. That is a very popular category of funds. And if I recall properly, the top-ranked manager was Robert Hagstrom? Am I right?

LOWELL: Robert Hagstrom, absolutely.

COLVIN: What's his fund?

LOWELL: He runs several funds. The thing that I look at as opposed to what his fund is or even what his particular individual story is -- I don't talk to these managers -- but what the numbers show us very clearly is that what Hagstrom is doing well, consistently well, over any time period is, with dramatically less risk than his benchmark, delivering outperformance. That is I think a recipe amongst all of our core top-scored managers. They're beating their benchmark time and again with less risk.

COLVIN: Right. And of course Hagstrom runs his funds at Legg Mason and he is a well-known Buffett disciple, and it's paying off. What do the mutual fund companies think of your effort to rate the managers rather than the funds?

LOWELL: I'm sure they'd pay me more not to run this system than to produce it. But I think that on the other hand many fund firms are finally seeing that they can market to their managers' strengths based on a purely quantitative way of displaying what is a tremendous asset for many firms. But we don't license our rankings for profit to those firms.

COLVIN: Jim Lowell, thanks for your insights.

LOWELL: Thank you.

NEXT WEEK: Jackpot Justice