Can the derivatives market save social security?

Question

My understanding of economics is that there are different investment possibilities for cash, versus a derivative based investment.

I think that funds from social security are either used to pay out current benefits, or to pay back treasury bonds.

If Social Security had more flexibility than a HSA, where higher risk investments could be pursued, perhaps there is a way to enhance or extend SS.

Question

• Is there any study that would maintain the current paycheck deduction, with various outcomes that could extend (or enhance) Social Security?

• Is there anything incorrect about my assumptions?

Answer 1

There are a number of problems with what you propose.

First, unlike an HSA and an IRA, Social Security is not a pool of money that individuals have access to. The money is managed by the government. Therefore they have strict legal requirements on what actions they can take.

Second, derivative markers are much more risky than the current fiscal profile of the Social Security fund. Yes that means Social Security can have huge gains, but that also means Social Security can have huge losses. Social Security is supposed to last over your entire life. How would you feel if after 50 years of contributions the Social Security fund lost half its value because of a bad trade?

In general Social Security knows all the numbers it needs to survive: how many people are contributing, what the total contributions are, how many people are going to retire and when, how many people are retired, etc. Its a lot of big and complicated numbers, but you can put it all together to get a reasonably accurate estimate of the required growth rate to sustain Social Security. Why risk more than you have to?

Another less obvious problem is liquidity. Even though social security has been cut a lot, its still HUGE. Its going to be hard to put all that money into a type of financial security just because there may not be that many people selling. And if the Social Security fund decides its a good time to sell its derivatives it may have trouble to sell them all for the opposite reason - there just may not be enough people buying (this is what lead to the Lehman collapse in 2008). You could offset this by working in many different types of derivatives, but now your operational expenses balloon as well as your risk metrics.

So short story, Social Security going into the derivatives market would be theoretically possible, but realistically impossible.

Answer 2

There is zero chance of the federal government investing the Social Security trust fund in derivatives. Both parties would be opposed to this. Democrats want it to be financed directly where taxes go in and benefits come out. Republicans want individuals to do the investing.

There used to be a tiny chance that the Republicans would allow people to take over the responsibility of investing their personal share of the trust fund. This was heavily demonized by Democrats as "privatizing Social Security" and was part of the run up to the 2006 midterms, which Republicans lost. It is extremely unlikely that Republicans would try again. Particularly as Donald Trump ran on a platform of not touching Social Security or Medicare in any way.

It's also worth noting that in many ways, it's too late. The original proposal was to divert some of the surplus to these private accounts. But there's no significant surplus anymore. In some years, Social Security runs a deficit. What was barely fiscally possible in 2005 wouldn't work in 2017.

It's extremely unlikely that they'd allow any of these accounts to invest in derivatives. The actual proposals would have allowed investments in stocks.

Derivatives work best when traded by people with some stake in the derivative. Either they produce the underlying product and want to hedge against price decreases or they consume the product and want to hedge against price increases. Social Security investors typically do neither of those things. They would be taking a lot more risk for not so much more profit. And because most individuals don't spend every waking moment monitoring the news and markets, it's easy for individuals to lose a lot of money with derivatives. I wouldn't pick them for anything related to retirement.

Answer 3

There's a major problem with your idea: you have to have something to invest.

Social Security sits atop a theoretical $2.6T dollar trust. But the trust is a numbers game. A real trust has money in it. The Social Security trust has invested 100% of that money... in the US Government. Here's what the SSA website has to say

Money flowing into the trust funds is invested in U. S. Government securities. Because the government spends this borrowed cash, some people see the trust fund assets as an accumulation of securities that the government will be unable to make good on in the future. Without legislation to restore long-range solvency of the trust funds, redemption of long-term securities prior to maturity would be necessary.

Far from being "worthless IOUs," the investments held by the trust funds are backed by the full faith and credit of the U. S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government.

Now everything they said is true. The Federal government will always pay its debts (even if it has to print money to do so). But it's also a clever deception. When you buy government securities, that money goes into the Treasury, which then uses it to pay government debts. In other words, the money has been spent. What's happening is that Congress is now having to use general tax revenues to repay this debt to itself. Consider what happened in 2011, when the debt ceiling was a constant fight (emphasis mine)

Here’s how President Barack Obama answered CBS’s Scott Pelley’s question about whether he could guarantee that Social Security checks would go out on August 3, the day after the government is supposed to reach its debt limit: “I cannot guarantee that those checks [he included veterans and the disabled, in addition to Social Security] go out on August 3rd if we haven't resolved this issue. Because there may simply not be the money in the coffers to do it.”

Social Security status-quo defenders have assured us for the past 25 years that Social Security is fully funded—for the next 25 years, or 2036. So if there are real assets in the Social Security Trust Fund—$2.6 trillion allegedly—then how could failure to reach a debt-ceiling agreement possibly threaten seniors’ Social Security checks?

The answer is that the federal government has borrowed all of that trust fund money and spent it, exactly as Krauthammer asserted. And the only way the trust fund can get some cash to pay Social Security benefits is if the federal government draws it from general revenues or borrows the money—which, of course, it can’t do because of the debt ceiling.

So you can't invest what doesn't exist. Or, technically, you can't invest what the government has already "invested" in itself.