Why Social Security Privatization Cannot Be The Solution To Economic Inequality

With the roaring Bull going past ten years now it was only a matter of time before  one once again beheld the siren song of the Social Security privatization nabobs.

Sure enough, a definite snake oil pair (Jeff Yass and Stephen Moore) recently emerged with their misinformational op-ed 'Conquer Inequality With Private Social Security Accounts' (WSJ, July 26, p. A15)

As usual, and ever since this misbegotten idea was first touted by Gee Dumbya Bush, the two current hucksters promise it will relieve or solve all current and possible future financial ills - and there's no doubt their pitch is to the Millennial demographic.  After all, it is this group which has been told over and over that their wages are subject to FICA taxes to help support those "greedy Boomers".  So why not have their own money in their own accounts? Well, plenty of reasons.

The biggest lie is that accepting such a scheme will ensure that "workers will become owners".  Nothing is further from the truth.  You will no more "own" your money than you own your 401 (k), meaning you cannot do whatever the hell you want with it without penalties.  There will inevitably be a Wall Street outfit that controls your funds so you are only under an illusion of ownership.

Just as 401(k)s have misled millions into believing they are really finance mavens and savvy investors, so Messrs. Moore and Yass seek to have you  believe just having a private Social Security account will pave the way to wealth.  As they put it:

"Each individual account (would take 10 % of payroll taxes)  be invested in a low fee index fund of roughly two thirds stocks and one third bonds and would mature at the federal retirement age.   This way every working American  - from the minimum wage waiter to the truck driver to the store manager-  would become a genuine owner building real wealth for himself and his family with each paycheck."

Not so fast there, buckeroos!  First, as the authors of The Great 401k Hoax (Wlliam Wolman and Anne Colamosca) have observed: 401ks were never set up to be investment vehicles, but savings vehicles!  Ditto for Social Security monies.  They were never ever intended to be  paycheck "seed corn" to buy equities or gamble in Maul Street's casino but to supplement pensions in the retirement phase.  Financial specialist Steve Rattner, who I daresay has more educational heft than the two WSJ clowns, has put it best:  "Just as I would not be so kunckleheaded as to perform my own surgeries, I would not be so addled as to believe I can do my own investments. Not unless you are a skilled financial expert or planner:."  And from the annals of most Americans' saving experience and use of money 9 of 10 are not - finance mavens that is. Hence, they have no more business managing their Social Security FICA monies in investments, than they do for 401(k)s.    Certainly not putting money in stocks in any 'index funds" - or more fully managed funds.    Look, you can lose your ass with a bear market just as easily in the first as in the second.

Let's explore this aspect. Investment and finance specialist William J. Bernstein in a MONEY magazine interview in 2012 went through the biggest retirement investing mistakes - most of which violate life cycle investment principles. (MONEY, Sept., 2012, p.  97).  His rule of thumb which thorough research has validated is that the ordinary person needs "20 to 25 times the residual living expenses - the yearly shortfall you have to make up after Social Security and any pension".

So, let's say you do the math and find out on retirement - say at 67 - you will need  $3,500 in monthly living expenses, to pay utility bills, meds, groceries, Medicare supplement premiums, etc.  Then if you know Social Security will pay you $2,000 a month that leaves $1,500 to cover with savings, or safe investments. (Bernstein advises safe assets such as U.S. Treasury Inflation Protected Securities)  12 times that is 12 x   $1,500 = $18,000 per year.  And 20 times that 'magic number' is $360,000.  This is the yearly shortfall to make up  if, say at age 67,  you project the probability of living 20 more years.  The increased (5) factor, e.g. the yearly amt. by 25,  provides a greater safety margin. Hence, the more advisable saving total outside of Social Security is $450,000.

Bernstein is also adamant that the older the worker is the greater the need to pull back from equities.  The reason for that?  The closer you are to retirement, the more difficult it will be to make up the lost earnings - say if you find yourselves in a prolonged bear market, or a major stock crash. Yass and Moore take no account of this in their blather about "owning" private accounts.  The outcome if this is not taken into account?  "There's a significant chance you're going to be eating Alpo when you're 85." according to Bernstein.

WSJ letter writer Don B. Stuart, responding to the cockeyed nonsense of Moore and Yass (p. A14 yesterday) noted a similar concern:

"Is this plan only for those with 40-plus years remaining? What about those with only a decade left?  Their risk may be too high."

Which was exactly Bernstein's point and why the individual person's "life cycle" horizon must be reckoned in, else it's a pile of foolishness.

Do you really think Yass and Moore give a hoot if you're eating Alpo daily at 85? Of course not. They're merely interested in snatching FICA taxes to stuff into the maw of Maul Street to support a stock market investment scheme that has absolutely no assurance of avoiding losses.  Interestingly,  the WSJ authors dodge who will compensate you if a bear market comes along and you lose half of your invested money.   (Let's also bear in mind you'll need a 100 percent gain to get to breakeven after a 50 % loss.)

Letter writer Stuart also points out, reinforcing Steve Rattner's earlier observation about people not doing their own surgery either:

"Yes, wealth is created saving and investing over a long period of time. But this is hard for individuals on their own."

Especially in the stock investment sphere! Speaking for myself, I self-studied finance, stocks, mutual funds and bonds for over five years before investing in Janus Worldwide Fund once we left Barbados and moved to the U.S. in 1992.   This was in a 401(k) provided by the (then) radiotherapy software corporation for which I was a technical writer and regulatory specialist.  The insight provided by education paid off and this Janus fund racked up huge returns for the time I was in it (pulled out in 1996, before leaving the company) and as fate would have it, before the Fund earnings tanked.

The point is not everyone in a 401(k) will have the time or energy to study investment strategy, the ins and outs of mutual funds and their expense ratios, whether 'front loaded' or 'back loaded',  and the nature of P/E ratios. Hence, they won't be able to make an informed decision - as Mr. Bernstein puts it -  "To know when to take the money off the table".

Again, this is why the 401(k) was designed as a savings vehicle, not an investment one, and neither is Social Security.  Imagine, for example, if you're a truck driver at age 45 and could take the WSJ hucksters' advice of diverting your FICA taxes into a private account. What if a bear market or stock crash hits 5 years before you retire?  Think you will escape that Alpo at age 85? Think again.

The value of Social Security is precisely because it provides a stable income stream that will not go down the next month or the one after.  Retirees can make financial decisions precisely because they know what this income flow will be.  Indeed, a second WSJ writer (Robert J. Sartorius, an FCA) also takes issues with the authors noting:

"The 10 percent to which Messrs. Yass and Moore refer is simply not available to be saved and invested because Social Security is currently funded on a 'pay as you go' basis."

The writer adds that in order to make a stable transition to the private accounts scheme invoked by Yass and Moore, would require "an additional federal debt approximating $800 billion per year."

This would be needed "to pay current benefits no longer covered by the 10 percent of payroll being diverted."

Interestingly, this is a critical aspect  - the addition to the deficit - most of the snake oil salesmen ignore.   One therefore wonders if they just expect current retirees in the existing system to just suck salt....or eat Alpo.

In ending, may I also remind people, that  if they DO have 401(k) money in equities they are referred to as "dumb order flow" and "chickens to be plucked" by the Maul Street wizards, quants and casino operators? (Referenced in a WSJ piece from 2010). Like the 'Wizard' in the land of Oz, these folks never want you to see what actually goes on behind their curtains, including the high frequency trading (done by special algorithms) which triggered the "flash crash" of May 6, 2010.

How influential is flash or high frequency trading? According to a The Wall Street Journal   article from 9 years ago: ('Fast Traders Face Off with Big Investors over ‘Gaming’, June 30, 2010, p. C1) it accounted for two-thirds of total stock market volume. All other things being equal, that meant unless one had access to a flash trade system or algorithm himself, he had a 2 in 3 chance of being victimized by flash trade.  That probability is even higher now given the much greater extent to which HFT is used. 

Yass and Moore mention none of this, nada, they only expect the semi-educated and gullible  to take their word that they have the ticket to transcending inequality. 

Don't believe it for a nanosecond!

Maybe It's Time To Dispense With the Trope of "Market Fundamentals".

Jim Paulsen, market expert with the Leuthold Group LLC, believes the turbulence in the market isn't over by a long shot (WSJ, 'Business & Finance', 2/11). Those starting to breathe easier after last week's volatility had better buckle themselves in for more - and also reconsider the somber reality that this market is supported by "fundamentals" - an  ambiguous catchall term designed to baffle with bullshit.

Charlie Farrell – CEO of Northstar Investment Advisors LLC – put the current stock market behavior and its basis in perspective in his recent Denver Post Business column (p. 1K, Feb. 11):

“What makes bull markets so dangerous is they are not supported by fundamental growth, they are supported primarily by investor enthusiasm. When something causes this enthusiasm to wane, as it did last week, markets decline. The important point is that they eventually decline to the fundamental valuation supported by earnings”

And so, in the biggest bull market ever -  lasting from 1980 through 1999 - we saw “70 percent of the price gains from investor enthusiasm”. This set the stage for fifty percent of those gain to be given up in the ensuing bear market. That the current market is overvalued beyond its alleged fundamentals is well known which is why Farrell delivers this advice (ibid.):

“If you need funds any time in the next five years, consider keeping those funds out of the stock market . You can instead do something simple like a savings account, a CD or high quality bonds.”

That advice is not intended to help you get rich but to ensure you don't end up a relative pauper, i.e. dumpster diving after half your disposable income is left in the crapper or having to work 10- 15 more years – eating sardines and fried dandelions each day - to reach a nominal retirement.

A popular trope about the stock market peddled by assorted finance pundits- such as CBS'  favorites Melanie Hobson and Jill Schlesinger – is that you can remain in the market with confidence, 'cause the “fundamentals” are still at work. Don't believe it for a nanosecond. The only “fundamentals” at work in the current Bull (or what I call “bull shit”) market are: ridiculous leverage, and flash trading to game ordinary investors. In the right conditions both have contributed to the volatility we've seen in the past week.

In another Sunday D. Post piece, 'Robots Have Hijacked The Market', p. 1D), Steven Pearlstein informs us:

“Pay no attention to the volatility these financial wizards assure us. It's just a little technical correction. The fundamentals of our otherwise sound economy will soon reassert themselves. The truth is that the market is as irrational and divorced from fundamentals on the way up as it is on the way down. More so today as a result of the high frequency trading strategies of the Wall Street wise guys. What we've watched this week is “herd” behavior on steroids.”

Pearlstein goes on to point out that only “10 percent of trades are made by real live humans”, with 40 percent originating out of index funds or exchange traded funds (ETFs) and the remainder – 50 percent flash trades.

In such a “robot to robot” environment of “circular logic”, he argues, “fundamentals are as irrelevant as the volumes are enormous”. Worse, the multiple trades – often in the millions and lasting microseconds each take only minutes – and are done with borrowed money. This is where the leverage aspect enters.

This is as a result of the Fed's cheap money, low interest policy - which means the same flash trade investors (mainly hedge funds) are emboldened to borrow most of what they need to buy shares. According to Pearlstein:

“the low interest rates allow hedge funds to borrow $4 or $5 for every one they put at their own risk.”

He goes on:

“When prices start to fall rapidly the funds are forced to sell their positions to pay back the banks and brokerage houses, driving down the price even further. Selling begets yet more selling. Investors rushing to cover short positions, or to sell underwater options before they expire run into a similar dynamic.”

Worse, what happens in one asset class can affect all others, as I warned about in an earlier post (Feb. 6th), e.g. with asset classes moving in lockstep setting the stage for a multiplier effect.

Another aspect of flash trading that bears scrutiny concerns the tiny time advantage- called a “latency” - enjoyed by the flash traders. In this latency (see e.g. WSJ:   'CME Defect Aids Speedy Traders', Feb. 13^th, p. B1) a firm receives private confirmation of its trade before it is reported over the public feed. This applies to the CME Group Inc. for which a system defect is “yielding rich profits for ultrafast firms at the expense of ordinary investors.."

Though a CME spokeswoman claimed (ibid.)  it had “dramatically decreased the latency” she also admitted that “private confirmations were still arriving first in some cases”

This ought to be disturbing for anyone plowing money into Maul Street, especially after author Michael Lewis' book “Flash Boys”,  where he exposed the workings of flash trades and how they benefit the flash traders.

In the case of the CME Group latency defect, the typical delays to its public data feed are “measured in microseconds or millionths of a second ….much smaller than they were five years ago” But still (WSJ, ibid.): “the flaw can yield hundreds of millions of dollars in profit a year in profit to flash traders.” This according to Quantlab Financial LLC, an electronic trading firm.

The WSJ piece goes on (p. B2) to note there are various ways to exploit this latency flaw. One concerns so-called “canary orders”, which are small buy or sell orders- say for one or two contracts. In other words not large at all in scale but which nonetheless can be used to detect large trade that can move the market. (Think of the "canary in the coal mine" - when it croaks you know methane gas is around.)

How would this advantage work in practice? The WSJ piece gives this example (ibid.):

“If oil futures can be bought for $60.01 and sold for $60, a trader could place a small order to buy at $60 which would join a queue of similar buy orders at CME. If the trader gets a message saying his or her buy order was filled, that could signal that a large seller is at work and the price is about to tick down to $59.99. The trader could then quickly sell at $60 to take advantage of the expected move.”

So let's get our perspective straight: Here you are faithfully putting money into your 401(k) each month,  expecting to earn a bit for your retirement security, and just microseconds before your fund or funds tank the flash traders learn about it and get to dump the component stocks before you can get to a phone. Fair? No, but that's the only fundamental now at work in this overvalued, over leveraged market.  As WSJ columnist James Mackintosh (Business & Finance) poses the quandary for all investors ('A Historical Tie Breaks, But Trouble Still Lurks', p. B1, Feb. 10):

"The question facing investors is whether they should dismiss the 10 percent drop in the S&P from its  high hit in January, or whether it's indicative of deeper troubles ahead?"

Perhaps the more germane question to ask is: If you are an ordinary, e..g. little guy investor, do you believe the possible trouble ahead is tied to flash traders in large hedge funds betting on volatility, or simply the downstream risk of potential inflation?

My best advice? If you plan to remain in this volatile market and buy "on the dips" like the gurus advise,  just be sure you have enough disposable income to sustain deep losses over time, especially in case of a crash.  Bear in mind that a mutual fund that drops in share price from $20 to $10 has suffered a 50% loss. But for that $10 stock or fund share price to return to $20 it must gain 100%, or double. This may take not just two or three years, but more than TWENTY!