Bernie made off with the $$$ but is Social Security the biggest scam of all?

The popular host of CNBC’s Mad Money Jim Cramer said on his Dec. 17 show. “To everybody in the press, who’s calling Bernie Madoff’s alleged $50 billion scam the ‘largest Ponzi scheme ever,’ I say give me a break,” According to Jim, the biggest Ponzi scheme in history is being run by the federal government, it’s called Social Security.

In 1935, President Roosevelt introduced a controversial "social insurance". The idea was to relieve the devastating financial blow that the Great Depression had dealt so many older Americans leaving them in poverty. As part of his New Deal, Social Security provided benefits to retirees and the unemployed, financed by taxes on current worker's wages.

Critics of Social Security often draw parallels between it and a Ponzi scheme, because the people who make payments today will receive benefits later from payments made by others in the future. Economist, Walter Williams once said, "Social Security is unsustainable because it is not meeting the first order condition of a Ponzi scheme, namely expanding the pool of suckers." In fact one of the biggest challenges Social Security faces over the long haul is that the pool of recipients is growing faster than the pool of contributors.

According to the 2007 Social Security trustees report, Social Security is projected to bring in $827 billion in income for 2008 and payout $617 billion in costs, leaving it with $2.4 trillion in assets by the end of the year. However, costs are outpacing income and some predict the fund will be insolvent – as soon as 2016 if the amount of Social Security assets held in US Treasury bonds are discounted. Others predict that the program will be insolvent by 2042.

The Social Security Administration describes itself as providing a “pay as you go social insurance program” and defends itself against the "Ponzi scheme" comparisons with the following statement:

“There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go insurance programs, in that, in both money from later participants goes to pay for the benefits of earlier participants. But that is where the similarity ends. A pay-as-you-go system can be visualized as a simple pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end. As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever. There is no unsustainable progression driving the mechanism of a pay-as-you-go pension system, and so it is not a pyramid or Ponzi scheme. If the demographics of the population were stable, then a pay-as-you-go system would not have demographically-driven financing ups and downs, and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes or any other fraudulent form of financing; it is simply the nature of pay-as-you-go systems.”

So if you read their statement closely they do admit that the base scheme for success requires either a perfectly balanced flow through the “theoretical pipeline” or there needs to be very careful money management to ensure that the excess funds are earning interest to offset the demographic highs and lows.

This is where the current system will fall apart. The aging of the US population combined with an increased average lifespan will provide the perfect storm for Social Security. The number of people projected to draw Social Security will increase from the current 39MM to 47MM by 2015, to 64MM by 2025 and a whopping 89MM by 2050 according to recent census data. As a percent of the population that represents a shift from 13% of the population collecting benefits to 20% receiving them.

Of course this was not supposed to be a problem. A Presidential Commission headed by Alan Greenspan recommended in 1982 that payroll taxes be increased in order to begin pre-funding the retirement of the Baby Boomers through a trust fund. Rather than saving the surpluses to prepare for the massive demographic shift as was planned. Greenspan allowed Congress to borrow the funds for other government programs and to make the federal deficit appear smaller. The surplus funds were replaced with government I.O.U’s which now represent an unfunded liability for taxpayers.

Since 1983, $647 billion has been borrowed from Social Security's trust fund to lower the size of the annual budget deficit. Money borrowed from the trust fund will have to be paid back through tax increases or benefit cuts once the Boomers start collecting their Social Security benefits.
While the Social Security system is running annual surpluses today, it will need to start tapping into the reserves around 2012 to meet its‘ benefit obligations.

While it may not be a Ponzi scheme by the purest definition, to all the taxpaying citizens who have been forced to pay into this system our entire work lives the final outcome may feel the same. Just like Madoff’s victims who thought they were building a safety net for their golden years, those of us who contributed each pay period to Social Security thought we had something we could count on when we retired. We may not have thought it would be enough but we all expected to get a fair return. Now it looks like we will be lucky to get anything and we will all have to work longer to get it.