Marginal Utility

by Tom Bozzo

A big part of the Social Security "reform"ers' pitch to the public — especially in the flavor dispensed by right-wing think tanks — was fundamentally an appeal to greed: why settle for the measly return on Social Security tax payments when you could have the bounty of the Markets instead?

Well, of course 2000-02 happened, and enough of the bloom was off that rose that the '03-'04 partial recovery didn't do much to make lots of people roll the dice over what they'd be eating in old age.

Brad DeLong, meanwhile, reacts with some enthusiasm to plans that would bring additional revenue into the system in the form of funding for private accounts:

[P]rivate accounts as an add-on would be a fine thing for Social Security. Americans need to save more, both individually and collectively... The poorer half of Americans have no long position in the stock market. Given that the S&P currently carries a real [return] of 6%, that is a scandal and an outrage.

It's not totally obvious to me why you couldn't make some hay with the existing types of private retirement accounts — which are fairly widely held even among the poorer half (*). Otherwise, the situation actually is even more of an outrage than DeLong suggests. While about half of households in the second quartile of the wealth distribution (i.e., the richer half of the poorer half) have some sort of retirement account, the 2004 Survey of Consumer Finances shows that you have to reach into the top 25% to see anything resembling significant account balances, and well into the top 10% to find amounts of money that could do more than modestly supplement one's Social Security check (**).

But this worries me:

My ex-student Konstantin Magin has long argued that the projected equity premium makes policies to boost investments by Americans in the stock market a winner, and has recently pointed out to me that the magnitude of long-run mean-reversion implied by current estimates of return predictability makes long-run passive investments in the stock market the closest to a sure thing of anything except running your own online poker site.

Now, I'm no finance guy, as may become obvious. But you call these returns "predictable" or "mean-reverting"?!

(Click to see a larger version.)

A question might be, reverting to what? The S&P rather underperformed that 6% for calendar year 2005 (~1.5% after inflation), and even getting in the ballpark (~4.3% above CPI inflation, which was 4.2% over the 12 months ending in May) over the year through the end of May is a matter of timing that emphasizes the moderately upbeat end of last year. Right now, we're on track for 2006 to be another lackluster year, as indicated by the returns of these Vanguard funds (add a couple points to the YTD returns for the stock funds, depending on the longevity of this afternoon's market euphoria over the latest FOMC statement):

Fund	1-Year Return (through 5/31/06)	YTD Return (through 6/28/06)
500 Index	8.49%	0.69%
Extended Market Index	17.22%	1.56%
Total Bond Market Index	-0.59%	-1.45%
Total Int'l Stock Index	29.75%	4.34%
Total Stock Market Index	10.44%	0.92%

So much for unrealized market gains making up for the low savings rate. House price appreciation has likewise slowed sharply; the latest reading for Madison-area sales showed the year-over-year change in the median price to be well below inflation. Heck, even if you happened to have placed timely bets in some hot sectors, the brakes seem to be on the gravy train (at least until the next major hurricane takes aim at the Gulf Coast hydrocarbon operations):

Fund	1-Year Return (through 5/31/06)	YTD Return (through 6/28/06)
Energy Fund	47.09%	12.21%
Pacific Stock Index	34.79%	-1.59%
Precious Metals and Mining	82.78%	19.95%

So, yeah, by all means let's bring more money to the table. The catch, back to DeLong:

Now it is possible to make Social Security private accounts a bad deal for everyone. And it is surely the case that the Bush White House's track record is such that only an idiot would sign on to any proposal designed and implemented by the Bush White House.

Damn straight. But then:

But if we were offered a slightly different pomegranate. If, say, we were offered a pomegranate that consisted of: (a) contribution increases, (b) well-designed, low-fee private accounts, (c) Treasury Secretary-to-be Paulson with the baton to make the detailed decisions and set the tradeoffs, (d) advised by an Assistant Secretary for Social Security Reform named Jagadeesh Gokhale, who (e) promised to retain enough social insurance in the system to preserve a substantial defined benefit component--then yes, I would eat that pomegranate. And I would advise Mark Thoma to eat it too. [link added]

Whuh?!? Is there really that much difference between the Bush White House and a marriage of the Cato Institute and the Bush Treasury Department (political division)? I can get on board with the Platonic ideals of (a) and (b), but what evidence at all is there that you can do more than wipe your bum with (e) given (c) and (d)? None that I can see.

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(*) It's just that typical account balances for those in the lower half lucky enough to have them are insignificant.

(**) Dig at more James Lileks wankery to come.