Many of the proponents of privatization point to the success of privatization in Chile and Galveston County.  These people would like to model a new version of Social Security based on the systems in place in these places.  The proponents claim that we will see similar results if we implement the plans here.  And the question that voters should ask is whether that is a reasonable assumption. 

Are the successes of these efforts likely to be repeated in the United States?  For example, it is possible for me to slam-dunk a basketball on the moon, where as it is not possible when I am on earth.  There are differences in the environment.  The voters should ask whether the environmental differences between Chile and/or Galveston County make a reasonable benchmark for the future results of a privatized Social Security system. 

There is a significant difference in timing.  Both Chile and Galveston County started in or near 1981.  So these systems coincided with probably the greatest bull market run in the history of the world.  And if we could go back in time, it would have been a good idea to replace Social Security in 1981 with a privatized system.  That does not mean that it is a good idea to replace Social Security with either system today.  Keep in mind, countries that privatized in the late 90s and early 2000s have not had similar success.  I have never been very good at timing markets, so to me it does not make a lot of sense to use systems which perfectly timed the bull-market as a benchmark.

I am not sure that the systems are that similar.  The Chilean system covers less than 50% of the population, not 96% of the work force as Social Security does.  The Galveston County system covers government workers which provides for longer employment duration than the United States as a whole.  Chile has a very different standard of poverty than America does.  So I am not sure that the success in Chile means much in terms of the United States and Social Security.  I really don't know.

This article may shed some light on the question.  "Social Security Privatization: What the Candidates Can Learn from Central Europe and Latin America" was published by the National Association Of Social Insurance.  I will caution you that the author seems a little biased against the concept of privatization: she sees privatization as "redistribution of wealth toward the wealthy".  That reasoning isn't explained.  The rest of the article is worth your consideration. 

Washington's Idea Is Bad

We oppose guarantees because they encourage unwarranted risk taking.  Guarantees enable workers to invest on unnatural terms.  If the investment wins, I win.  If investment loses, the taxpayer loses.  This will create very lazy investors, who are solely interested in chasing assets that generate a maximum return.  This is the exact mind set which enabled our economy to position itself on a financial apocalypse in 2008.

Washington's Solution Is Worse

Washington expresses its concern by seeking to create oversight boards.  The idea is that an investment board will select safe investments.  Unfortunately, these policy wonks clearly miss the point.  Risk isn’t just in the viability of the business.  Risk is expressed in the price of ANY asset.  If Washington creates a narrow list of approved investment, risk-tolerant money will chase safe investments until they are risky.  When you subsidize risk, you will create risk. 

In short, Washington’s solution is to create risk in our most stable companies.

We are very critical of the idea that workers should be able to invest retirement money in accounts which are guaranteed by the government. 

WASHINGTON DOES NOT UNDERSTAND RISK

Virtually all of these plans create some kind of investment list which is intended to limit the free-risk that workers can take.  This idea tells you how little that Washington understands risk.  This approach doesn't limit risk, it concentrates risk in whatever assets are on the approved list.  learn more

WASHINGTON'S RECORD AT PROMOTING SAFETY AND SOUNDNESS IS AWFUL

Washington's record for monitoring the saftey and soundness of any financial system is awful.  They failed to protect housing.  They failed to protect banking.  What makes anyone think that Washington will be any more successful at protecting worker's retirement.learn more

WHO WILL PROTECT THE SYSTEM FROM WASHINGTON

This approach will increase the footprint that Washington creates in our stock markets.  When Washington creates a list of approved companies, it creates "access".  Access to the approved list will be highly valued.  It is a matter of prestige.  It is a matter of cost of funds.  Access will be worth a LOT OF MONEY.  To give you some prospective, the S&P 500 is a similar list which drives investment decisions.  Access to this list can be worth hundreds of millions of dollars.  It is difficult to imagine how Washington plans to protect retirees from political influence because every district will have a company that wants "access" to cheap-funds.

We generally oppose any privatized solution which guarantees the investment returns of a retirement account.  If workers want to invest their retirement money in lottery tickets, it is up to them and they must accept the consequences.   This isn't cruel.  It is necessary to protect the rest of us from fools armed with other people's money.

Guarantees encourage unwarranted risk taking.  Guarantees enable workers to invest on unnatural terms.  If the investment wins, I win.  If investment loses, the taxpayer loses.  This is the exact mindset which enabled our economy to position itself on a financial apocalypse. 

Washington expresses its concern by seeking to create oversight boards.  These policy wonks who have never bought or sold a stock completely miss the point of risk.  Risk isn’t just in the viability of the business.  It is expressed in the price of ANY asset.  If Washington creates a narrow list of approved investment, risk-tolerant money will chase safe investments until they are risky.  When you subsidize risk, you will create risk.  In short, Washington’s solution is to create risk in our most stable companies.

On a very good day, this idea is simply foolish.  It strays into the realm of dangerous because Washington, which clearly does not understand risk, wants to be in the position to manage risk on our behalf.  They want to create an investment list of suitable investment to ensure the safety and soundness of the system.  

 Fair enough.  How successful has Washington been in protecting the safety and soundness of any system.  Let’s look at banking.  The government was surprised by the dangers of 35 to 1 leverage in the banking industry.  Washington described “derivatives” as useful tools held in the hands of well-capitalized sophisticated investors.   Half were, and the other half was in the hands of AIG.  Over a period of a few months, these investments wiped out Bear Stearns, Lehman Brothers, and AIG costing the tax payers hundreds of billions of dollars. 

Let’s look at housing.  In 2006, Washington said that the strength of housing prices reflected a strong economy.  Washington didn't just misgauge the housing market.  It suggested that the housing market was fine despite being a levels of overvaluation that occurs about every 1,000 years.  And you want to allow government to define how you can invest your retirement funds?

We see serious flaws in the McCotter plan, and that perception is shaped by the past.  In our lifetime, we have seen the government increase the size of failed government programs many times.  We haven’t seen a government program fixed by increasing its size and scope. 

The McCotter’s plan does both to Social Security.  McCotter’s plan will increase the size of benefits that the system pays.  The increase is so generous that the Chief Actuary of Social Security assumed that 100% of the eligible workers would take an irrevocable deal.  So the jump in benefits has to be clearly visible to all workers.

Specially, this plan will expand the Social Security benefits package to include ownership rights.  Here is a right that doesn’t exist today; “In case of death, and (remaining amounts) will be distributed to designated beneficiaries or to the participant’s estate.”  Ownership rights are wonderful – but expensive. 

The McCotter plan also increases the scope of Social Security.  The goal of Social Security is to help seniors avoid abject poverty.  It is suppose to augment personal savings.  McCotter's plan will increase the scope of the system to be a wealth accumulation vehicle.  That isn't a bad thing by itself, but there are already many tools to accomplish this goal.  So we are retooling Social Security with something that we already have running at a fraction of the cost.

More benefits always does well at the polls.  The problem is that someone has to pay for these benefits.  In the case of McCotter’s plan, it is the general taxpayer who will absorb these costs.  So the 50 year-old who has paid for his parent’s retirement through Social Security, and will now be asked to contribute to his children’s retirement through income taxes.

None of the privatization pieces that we have read talk about "Adverse Selection", and it should be a signficant concern to supporters of this concept.  What happens if the only people to leave the Social Security system are contributors. 

"Adverse Selection" is picking customers that you don't want.  It happens at banks for example who offer no-fee checking.  The majority of the people who reply to these invitations are low-balance, high activity account on which the bank loses money.  This is why you see a "minimum balance" in conjunction with the free offer.

In terms of Social Security, adverse selection is picking high-wage earners and people with shorter life spans.  This people are net contributors to Social Security.  They will exit the system, but there is no incentive in the system to get people who drain the system to leave.  According to the SSA, there are groups of individuals who make 9% real rates of return.  It is unlikely that they will match that level of return in the private sector.  So many of those people will stay in the system. 

Here is the bottom line: if Social Security is an unstable failure with all of the people participating, how will it survive once the contributors leave?