To describe American Social Security as such a scheme wouldn’t be much of a stretch. For a system with so many complicated facets, advanced accounting and half-truths, there is one absolute fact: Social Security is not taking in enough money to write all the retirement checks it is obligated to write over the next couple of decades.

So last week, President Obama’s Bipartisan Deficit Commission set out to begin unwinding the scheme. Their proposal, like most things from Washington, was ambiguous at times and difficult to understand. Some suggestions included “creating a new bendpoint,” “reducing replacement factors,” and “phasing into a higher taxable maximum.” But stripped down to the essentials, the plan has some merit. Here are the basics:

• The retirement age will go up to 68 by 2050 and 69 by 2075

• The government will make “hardship exemptions” for people 62 or over who are physically unable to work

• There will also be a minimum SS benefit for those making very little income

• The rich will likely be eligible for fewer benefits while having to contribute slightly higher FICA taxes.

• Cost of living adjustments will be gradually reduced by using a different measure of inflation (Chained CPI)

How does a government back its way out of an accidental Ponzi? Well, something like this proposal. In abstract terms, the Social Security system either has to pay out less, take in more, or both. That means lower benefit payments and/or higher taxes.

And to the credit of the Commission, this proposal would work just fine. Everything about it is built to please both Democrats and Republicans – or rather, to displease both Democrats and Republicans. For starters, the commission is co-chaired by a member of each party, lest the whole thing be billed as a scheme to usurp power by the “liberal elite,” the “radical right” or some other political affiliation that actually makes most people nauseous.

Then there’s the mechanics of the proposal. To appeal to the left, there are several provisions aimed at the underprivileged and disadvantaged. In essence, no one who REALLY needs a retirement insurance plan will be hung out to dry. Those dastardly “top earners,” on the other hand, will have to pay more. And the left’s precious “middle class America” will be just Goldilocks…tucked in that warm sweetspot of relatively few benefit cuts and minimal tax increases.

For the right, the whole plan should appeal to the true blue Republicans (are there any?) that value fiscal responsibility above all. Allegedly, for every $1 of higher taxes in this plan, there’s $3 in spending cuts. Of course, hiking taxes sounds like nails on a chalkboard to that crowd, especially during a recession. But the plan also proposes to cut individual tax rates to a maximum 23%, which would counteract the higher FICA taxes that would help pull Social Security out of the red.

So, what we’ve got here is a fair, bipartisan proposal. It’s flawed, of course, like any other first attempt. But is it that insufferable? Apparently so:

• “This proposal is simply unacceptable,” lame duck Speaker Nancy Pelosi said flatly, and in the same breath insisted we “do what is right for our children and grandchildren’s economic security.”

• “We’re not talking about cuts in Social Security,” blackballed Jim DeMint, supposedly one of the biggest Republican debt and deficit hawks. He promised to somehow fix this mess “without cutting any benefits to seniors or veterans.”

• “Especially in these tough economic times, it is unconscionable to be proposing cuts to the critical economic lifelines for working people, Social Security and Medicare,” said AFL-CIO President Richard Trumka. “The very people who want to slash Social Security and Medicare spent this week clamoring for more unpaid Bush tax cuts for millionaires.”

• “Deficit Reduction Plan Draws Scorn From Left and Right” headlines the liberal New York Times, noting that “Republicans face intense pressure from their conservative base and the Tea Party movement to reject any deal that includes tax increases.”

• “Commission Offers Controversial Solutions to Axe Deficit” reports conservatives at FOXNews

• Even the Independents hate it! The Commission’s proposal is “extremely disappointing and something that should be vigorously opposed by the American people,” said Vermont’s Bernie Sanders, the House’s only official Independent.

Dear reader, bad-mouthing the Commission’s proposal on fixing Social Security might be the most bipartisan effort in the history of Washington DC. Alan Simpson, the Republican Co-Chair of the Commission, half joked on Thursday, “We’re entering the witness protection program.”

Simpson and his Commission colleagues forgot they were in the business of politics. And politics, of course, is the business of being re-elected. It doesn’t matter if none of the changes proposed would be felt for years, and that not a single current Social Security beneficiary would be affected. What does matter is that Nancy Pelosi, Jim DeMint, Bernie Sanders and all their brood can hear the 2012 campaign ads already… “Pelosi voted to CUT your Social Security benefits”… “Jim DeMint abandoned his Republican roots and voted to RAISE your Social Security taxes,” and on and on.

By even hinting at messing with Social Security, no matter Republican or Democrat, any politician is ruffling the feathers of the greatest golden goose of them all: seniors. Is there any demographic as coveted and important to election results as the grey hairs? No, there isn’t. Seniors, much thanks to the entitlement programs their generation built, have plenty of time and wherewithal to shuffle over to the polls and vote down any candidate with the political fortitude to cut benefits…whether the threat to their actual retirement is real or just perceived.

Thus, the Deficit Commission’s proposal is dead on arrival, shot down by the most bipartisan hunting party assembled in years – all of whom are acting on behalf of a constituency that claims it cares for future generations, but has historically voted to save its own skin. Entitlement reform? It’ll have to wait.

“Democrat or Republican, Elephant or Donkey, nothing much ever seems to change,” famous bond investor Bill Gross wrote in his monthly letter to investors earlier this month. “Each party has shown it can add hundreds of billions of dollars to the national debt with little to show for it, or move our military from one country to the next chasing phantoms instead of focusing on more serious problems back home. This isn’t a choice between chocolate and vanilla folks, it’s all rocky road: a few marshmallows to get you excited before the election, but with a lot of nuts to ruin the aftermath.”

With that in mind, nuts to you Republicrats, and you too, Bernie Sanders… and to anyone else who wants to reduce the deficit without making a single sacrifice. Interestingly, one of the only Washingtonians making sense last week was President Obama. “If we are concerned about debt and deficits,” he said, “then we’re going to have to take actions that are difficult and we’re going to have to tell the truth to the American people.’’

Well, you know the truth. Ready to take action?

Good luck,

Ian Mathias
for The Daily Reckoning

Fixing Social Security… Some Other Day originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

100 years ago, back in 1910, Zeppelins were all the rage. After patenting his design at the turn of the century, Count Ferdinand von Zeppelin had successfully made his rigid airship the one and only legitimate form of flying transportation. True, in 1910 there were some country boys named the Wright Brothers tinkering with terribly unstable gliders and propeller flying machines. But the Zeppelin was the standard. You see, it just made so much more sense at the time…make a big cylinder out of the thinnest metal possible, fill it with cow intestines then fill those intestines with light, flammable gas; power the thing with a fire-breathing engine to float thousands of feet above ground… What’s not to love?

While the Wrights toiled on their design, Zeppelins ruled. The world’s first airline, DELAG, flew Zeppelins exclusively. Zeppelins had conducted commercial cargo and passenger flights long before Americans risked their lives or merchandise with airplanes as we know them today. Zeppelins were a hit with the German military too, while in 1913 the American Army deemed the Wright model C “dynamically unsuited for flying.” They had this nasty way of nose-diving and killing everyone on board, the Army said, and soon after discontinued its business with the Wright Company.

So imagine this: You’re an investor, alive and well in 1910. You have to chose to lend to one of these companies money for the next 100 years… Do you write Count Ferdinand a century bond, or do you loan the money to the Wright Brothers?

The Wrights, as you know, had the right idea, even though the opposite seemed true at the time. Had you lent them money 100 years ago, there’s a chance you’d get it back today, plus interest. Their company became the largest aircraft manufacturer in the world by the end of World War II and is now known as Curtiss-Wright, a publically traded component manufacturer with a $1.4 billion market cap.

Count Ferdinand and his Zeppelin, however, slowly floated into an antiquated reality until the Zeppelin industry – quite literally – crashed and burned into New Jersey in 1937. Your best shot at getting your 100-year Zeppelin bond cashed today would be mugging the crew of the Goodyear Blimp.

The moral of the story: The vast majority of people, your editor included, don’t know squat about what the world will be like 100 years from now. We can guess, but little more. And in the “game” of investing, guessing is a scary thought. Better to know for sure, or as close to sure as you can get.

Yet, the 100-year bond is now officially back in vogue. The last three months have seen the trifecta of century bond offerings:

• A stalwart American company: Norfolk Southern, arguably the oldest railroad operation in the US, raised $250 million in August when it sold bonds to investors due in 2110.
• A powerful multinational bank: AAA-rated Rabobank raised $350 million a month later selling 100-year bonds of their own.
• A struggling sovereign state: Mexico borrowed $1 billion in early October, which most of its lenders won’t see until this time in 2110.

Here’s the best part: For the privilege of borrowing “investor” capital into the next century, not one of these issuers paid over 6%.

This is the latest chapter in the most powerful trend in investing at the moment: the hunt for yield. Investors are so hungry for high-yielding, stable return they are willing to take outlandish risks…like buying a 100-year bond from a government that has suffered two major currency crises and one sovereign default during the last 30 years.

Why? As with most financial bubbles, ask the Fed.

Having pushed interest rates to 0%, the Federal Reserve has made the cost of borrowing money around the world its cheapest…ever? Microsoft recently sold a wave of three-year bonds at a stunningly low 0.8% yield. Under such low-rate circumstances, companies can raise cash for almost nothing. Investors, meanwhile, are left gnawing on meatless bones… If you can finance your retirement on 0.8% annual returns, please tell us your secret.

So the average investor has to choose between a savings account that yields 1%, bonds that might yield even less and a stock market that just suffered its biggest collapse since the Great Depression.

This explains most investment trends of 2010. Appetite for yield is why the S&P Dividend Aristocrats index is outperforming the S&P 3-to-1 this year. It’s why, according to Dealogic, US companies have sold a record $168.5 billion in high-yield bonds so far in 2010. And it’s why investors are willing to entertain the idea of letting railroads, banks and struggling states borrow their hard-earned dollars for a hundred freakin’ years.

But the same way there are two sides to every story, not all century bond buyers are foolhardy investors. In fact there’s a good chance that, should deflation worsen in the US, 100-year bond owners will be able to sell their bonds on the secondary market for a premium.

Here’s one example: Norfolk Southern Railroad has issued 100-year bonds before. As of this writing, it would cost an investor $1,110 to buy a $1,000 century bond Norfolk Southern issued in 2005. That premium to par value is a sign of investor demand…the same way stock investors pay insane earnings multiples for “hot” companies like Google. Even though overpaying for that Norfolk Southern bond will cut it’s yield from 6% to an effective rate of 5.3%, investors can’t find better yield elsewhere…or they’re betting they can sell those bonds to a greater fool down the road.

In bond trading parlance, income investors are getting pushed “out on the curve.” Rates for US Treasuries and short term, investment-grade corporate debt are so dismal that anyone seeking meaningful income (like over 5%) has to take on an unusual amount of risk. Either they must take on default risk by lending to sketchy companies teetering on bankruptcy. Or they must expose themselves to interest-rate risk by lending for obscenely long periods…like 100 years.

Maybe, 100 years from now, a railway from West Virginia to New York (or the coal that it’s carrying) will be as useful as the Hindenburg. What will become of those Norfolk Southern 100 year bonds then? Geesh, will the Fed even be around in 2110? It wasn’t in 1910. If the dollar makes it to 2110, it’ll be one of the longest lasting currencies in the history of the world… What will those bonds be worth if they have to be redeemed in Ameros? Or yuan?

These are all questions Norfolk Southern century bond buyers are willing to dismiss…for a measly 5.9%.

As Eric Fry and Bill Bonner have reckoned in these pages before, we may be witnessing a sort of “peak debt” in the investment world. Earlier we mentioned that remarkable bond issue from Microsoft. It’s worth adding, the company currently pays a 2.6% dividend. So if you were forced to buy its debt or its equity, which would you choose…three years of 0.8% and no chance of capital appreciation, or three years of 2.6% dividends and a stake in future earnings?

We’d sooner take our chances with a solid yield and an uncertain future than a bond coupon that inflation will certainly consume. We don’t exactly crave a stake in the company that brought you the Zune, but with bonds at 0.8%…what’s the point?

There is money to be made in bond trading, like always. But for investors looking for stable returns and substantial yields, corporate debt – or any debt for that matter – ain’t what it used to be. Unlike years past, corporate equity is now the source of the best income risk/reward ratios.

To repeat: income investors, for the time being, are better off being owners than lenders.

Regards,

Ian Mathias
for The Daily Reckoning

The Really, Really Long Bond originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

We weren’t kidding, dear reader… There’s only so much reckonin’ we can do in one day. Last week we chronicled a turning point for retirement in America: On September 30, the Social Security Trust Fund will officially begin paying out more than it’s taking in. Now, you – and many others who wrote in – provide an inadvertent introduction to our final question in this Social Security Series: What, exactly, is in that fund?

The quick answer is this, as we noted Saturday. “With $2.6 trillion left in the Social Security war chest, there is no immediate threat to the status quo.”

The Social Security Trust Fund is, in fact, worth roughly $2.6 trillion. The status quo is safe at the moment. But as you hinted, there isn’t a single US dollar in that fund…and anyone who thinks the money they’ve been sending the government to pay for retirement is neatly stacked in a giant vault – some super-sized swimming pool of money – has the wrong idea.

Indeed, your government-sponsored retirement fund has all been spent already. Didn’t you get your receipt?

The World’s Biggest Bond Investor – You

You, loyal taxpayer – not the Chinese – are the biggest US Treasury Bond investor in the world. The entire balance of the Social Security Fund, all $2.6 trillion of it, has been borrowed by the US government. Upon receipt of your payroll taxes (those are the ones that fund Social Security) the Treasury instantly converts them to special issue Treasury bonds. In simpler terms, money is taken out of the Social Security “vault” and replaced with an IOU.

That’s not necessarily bad. Many sovereign states purchase debt from other nations, government owned companies or private institutions, and for good reason. If that money is not needed right away, the interest on the bond will help guard the fund against inflation. Those bonds might even make some extra money.

But such an investment doesn’t work when a debt-burdened government borrows money from itself. While the American Social Security scheme is not quite as simple as taking money out of one pocket and putting it in another, it’s darn close.

“Since 1983, the money from all payroll taxpayers has been building up the Social Security surplus, swelling the trust fund,” the LA Times’ Michael Hiltzik neatly explained in August. “What’s happened to the money? It’s been borrowed by the federal government and spent on federal programs – housing, stimulus, war and a big income tax cut for the richest Americans, enacted under President George W. Bush in 2001.”

The government is not using your payroll taxes to build retirement nest eggs or to insure the elderly and disabled. Rather, the SSTF is used to sustain government itself. Not a dollar is set aside for you…just debt. Given the current state of US affairs – $13 trillion in public debt, weak economic growth and a $1.3 trillion budget deficit for 2010 – this is not the kind of sovereign debt most investors want to own.

We should note, this is no conspiracy theory. On the SSTF website, the Trustees offer to-the-month spreadsheets of fund holdings, each and every one revealing nothing inside but US Treasury bonds. President Bush himself laid it out quite simply back in 2005:

Some in our country think that Social Security is a trust fund – in other words, there’s a pile of money being accumulated. That’s just simply not true. The money – payroll taxes going into the Social Security are spent. They’re spent on benefits and they’re spent on government programs. There is no trust.

There is No Trust… So Why Trust Social Security?

This bookkeeping scheme known as the Social Security Trust Fund is not the biggest issue in America for one reason: US Treasuries are currently as good as cash. In fact, since they pay a paltry yield and are accepted everywhere, they might even be better than dollars.

But in a real, utilitarian sense, T-Bonds in the SSTF are way, way worse than cash. They are a liability, not an asset. The SSTF can exchange them for dollars, but those dollars must come from the very government that’s on the other side of the exchange. As President Clinton’s Office of Management and Budget once explained:

Balances are available to finance future benefit payments and other Trust Fund expenditures – but only in a bookkeeping sense…. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

This is a similar situation to what China has called its “nuclear option.” As the largest foreign holder of US Treasuries, China could cripple the US by cashing out its bond holdings. The Treasury would be forced to either redeem the bonds or default, both of which would send American interest rates through the roof…maybe even destroy our economy altogether.

The SSTF isn’t that different, except China holds “just” $846 billion in US bonds, about a third of what’s owed to the Social Security Trust Fund.

So add up the American fiscal condition as we know it, dear reader, and tell us what you get:

76 million Baby Boomers about to retire
+ Life expectancies increasing
+ A Social Security Administration that’s now paying out more than it’s taking in
+ The Social Security Trust Fund holding nothing but $2.6 trillion in US debt
+ A national debt over $13 trillion
+ The worst US economy since the Great Depression
+ Unemployment near generational highs
+ Stagnant wages for over a decade
+ Average personal savings rate of 6% of disposable income
+ Minimal interest rates on those savings
+ Home prices (most people’s largest investment) down 20% from their peak
+ Stock indexes (and most private retirement funds) down 25% from their peak
+ Rising energy and healthcare costs

The sum of these parts, among other things, equals a lousy retirement landscape in America. Like so many other economic matters these days, it’s hard to picture a worse scenario for retirees since the Great Depression.

It Could Be Worse

One cliché has been working overtime lately: The night is always darkest before dawn. No one really knows how long this “night” will last in America. It’s running about 20 years strong in Japan, an economy eerily similar to our own. But just the same, most people felt like nothing could possibly go wrong in early 1999… and by September 11, 2001, just about everything had. Maybe now, as most of us are choking in the dark smog of this economy, a breath of fresh air might blow our way. Who knows?

But to bank on that is a bad move. If America doesn’t return to booming prosperity, the Treasury and Social Security Trustees will have to do something to keep the program alive. In the past, that’s meant raising payroll taxes and reducing benefits. Not only will the government have to accommodate Social Security operating at a deficit, but they’ll have to deal with all these bonds… the trillions owed to the American public and trillions more to foreign investors. Either income or sales taxes will have to rise dramatically, or the Fed will have to print money. Both “solutions” would seriously impact American purchasing power, particularly retired Americans living on a fixed income.

Even the rich ought to devise a retirement Plan B. The richest 1% of US population now accounts for 24% of the country’s income, the highest ratio since just before the 1929 market crash. Most of the other 99% is understandably bitter about that, and especially given the tendencies of the current administration, we expect the rich to get soaked good and hard over the next few decades. As we’ve forecast before, expect a Social Security means test in the near future and a hike in the SS taxable wage base even sooner.

Thus, all economic classes in America could feel the sting of imminent Social Security reform. Those that need it will likely receive fewer benefits, and those wealthy enough to retire on their own will likely be forced to pitch in for those that can’t. Meanwhile, all government welfare programs will likely be reduced, as one day – who knows when – Uncle Sam will have to start paying back money borrowed from the Social Security Trust Fund.

Your choice is to wait for that day and see what happens…or start preparing for it now.

Good luck,

Ian Mathias
for The Daily Reckoning

What’s Really in the Social Security Trust Fund? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

–Former US Comptroller General David Walker, July 2010.

If David Walker – who was essentially the US government’s accountant from 1998-2008 – can make jokes like that about Social Security, we’re in trouble. Indeed, as we noted in our essay “The End of Social Security as We Know It”, the Social Security Trust recently began paying out more than it is taking in. Over the next 75 years, the Fund will require an additional $5.4 trillion to pay for scheduled benefits.

Given the deplorable fiscal condition of the Social Security Trust Fund, some forward-looking Americans are asking, “Why can’t I just opt out?” Even middle-aged members of the Baby Boom generation are wondering if there will be any Social Security left for them when the time comes…and if they wouldn’t be better off abandoning the government’s mandatory retirement plan.

So can you opt out? In a word, yes.

How Do You Feel About a Horse and Buggy?

It’s true; you can opt out of Social Security…if you belong to a fiercely independent religious culture like the Amish.

Back in 1954, when the Social Security Administration first began taxing and covering “agricultural workers,” the Amish took issue with Social Security’s forced participation. The program, also known as Federal Old Age, Disability and Survivors Insurance, is a pretty brash affront to the Amish credo. Not only are the Amish famous for “taking care of their own,” but the whole concept of insurance goes against their faith. As people extremely serious about God’s plan, they don’t take kindly to a government-mandated hedge against His prerogative.

So in the late ’50s, the Amish started their resistance to Social Security. Naturally, they were quiet and reasonable about it. Some put money into a bank account and insisted the government place a lien on it. At least that way, some Amish thought, they weren’t voluntarily paying into the program. Others signed a petition and sent it to Capitol Hill. But, naturally, the IRS paid no attention. The IRS kept insisting that FICA taxes be remunerated…until eventually many Amish just stopped paying.

The whole conflict came to its climax in 1961 when the IRS went after one of these “delinquents,” Valentine Byler. Long story short, he owed over $300 in back Social Security taxes, so the IRS repo’ed three of his six horses. No kidding. (At one point in this fiasco, Reader’s Digest reported a judge berating the government’s representatives, “Don’t you have anything better to do than to take a peaceful man off his farm and drag him into court?” Apparently not.)

To the Amish’s credit, they kept resisting the FICA tax, insisting that it violated their 1st Amendment right to practice religion free of government interference. Byler’s story, as you can imagine, was a real hit with the media and within a few years the IRS caved under public pressure. In 1965, the government passed a law that allowed US citizens to opt out of Social Security.

Of course, only a small minority of Americans can legally stop paying Social Security taxes and strike their beneficiary status. In order to qualify for the IRS’s exemption, you must:

• Convince them you are part of a religion that is “conscientiously opposed to accepting benefits of any private or public insurance that makes payments in the event of death, disability, old age or retirement.”
• Have a ranking official of this religion authorize that you are a true believer
• Prove that your religion has been established – and continually opposing insurance – since at least 1950.

So unless you are Amish, Mennonite, Anabaptist or part of another very small religious sect, odds are you’re stuck paying (and receiving) Social Security for the foreseeable future. Still, we won’t fault you for trying: Look around for Form 4029…you’ll have to file with the IRS if you seek Social Security exemption. Be careful what you wish for…exemption might be the swan song for your life, auto and health insurance, too.

Learn from the Amish

Even though your opt-out chances are slim to none, there’s plenty to learn from the Amish battle against Social Security.

1) This story should serve as a reminder of what the whole program really is: insurance. When FDR first introduced Social Security in 1935, he said it would “give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.” It was never intended to be a program in which nearly everyone paid in and nearly everyone expected to be fully paid out…even though that is what it has become today.

We suspect that kind of insurance language will return. The rich – who are so exceptionally unpopular these days – might soon be reminded they are not “average” and that Social Security was not designed to supplement their fat 401(k)s. (Whether that is in any way ethical, or even what qualifies you as “rich” in America, is a debate for another Daily Reckoning.) At the least, expect this cash-strapped government to raise the wage base for the Social Security tax or institute a benefits means test in the near future.

2) The framework of Social Security is flexible. There are plenty of people alive in America today who were around before this program even existed. Those same people saw it amended and reformed many times in the ’30s, ’40s and ’50s. Exceptions have been made along the way. And in 1983, under the Greenspan Commission, the government gave Social Security yet another dramatic reform.

Thus, there is no reason to think Social Security can’t be amended again, for better or for worse. Maybe the government, like it did in the ’80s, will change the rules and hike taxes, raise the retirement age and reduce benefits. Or if you are as persistent as the Amish, perhaps you can influence legislation in your favor. (Your odds increase dramatically if you own or control a large multinational corporation.)

3) Most importantly, like the Amish, expect a self-sufficient retirement. “The best revenge is living well,” the saying goes. Thus the best way to survive the plight of the Social Security Trust Fund is to not need it in the first place. Take a page from the Amish playbook and minimize your taxes…contribute the most you can to your company’s tax-deferred 401(k) plan. Better still, enroll in a self-directed 401(k), where you can invest in stable, dividend-yielding companies that might compound your returns. A few of those companies might even have a dividend reinvestment plan (DRIP) where you can use those quarterly payments to reinvest in the underlying stock… That’s a double serving of perfectly legal tax evasion.

There’s something to be said for the Amish way of taking care of your own, too. Their lifelong financial planning doesn’t just revolve around their individual net worth, and neither should yours. If there’s money to spare, set up some tax-deferred accounts for family members. Not only could it empower them, but depending on your situation, you might be able to alleviate your own tax burden at the same time. They’ll thank you 10-20 years from now, when David Walker’s joke isn’t quite so funny.

Regards,

Ian Mathias
for The Daily Reckoning

Opt Out of Social Security originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Back in March, the Congressional Budget Office (CBO) admitted that most Social Security funding projections were way off, and that sometime in 2010 the program would begin paying out more than it’s taking in. In August, the Social Security Board of Trustees said much of the same, that they too were drastically revising previous solvency projections. Just a year ago, both agencies forecast that the Social Security Trust Fund would stay out of the red until 2016. This year, they said 2010… As in, it’s probably already happened.

According to this year’s FICA/SECA tax receipts and benefit payouts, there’s reason to believe the SS fund dipped into deficit as early as February 2010. But since there’s no “official” government mandated date for when Social Security officially entered the red (we wonder if either agency actually knows) the end of the fiscal year will have to do, for now.

Though there will be some debate over when SS started losing money in 2010, there will be no such discussion in 2011, or the year after, or the year after that…or maybe ever again. Despite 2009 projections completely to the contrary, the CBO and Social Security Trustees now expect the fund to suffer deficits indefinitely. There may be two or three years of surplus if the US economy can avoid a double dip recession, but over the long term, in the words of the SS Board of Trustees, “program costs will permanently exceed revenues.”

(Quick aside: That is one ugly revision. There’s nothing wrong with changing your mind, but someone at the CBO had quite an awakening in 2010.)

In summary of the CBO’s findings, the credit crunch and subsequent “Great Correction” moved a future Social Security crisis into the present tense. In fact, the whole issue is now worse. Stock market crashes and unemployment plights like those we’ve suffered lately have long term, arguably irreversible effects on wages, income inequalities, retirement plans and tax revenues…all of which will pile on top of Social Security at a time when it’s already bearing a heavy load.

But as you might remember, we’ve been here before. A not-so-dissimilar bout of high unemployment and lousy economic growth in the ’70s brought the Social Security fund to a sudden crisis in the early ’80s. By 1982, the powers that be weren’t just fretting over the program entering deficit…they had every reason to believe the Social Security would be out of money in as little as a year.

The Regan Administration’s solution was a bi-partisan study group called The National Commission on Social Security Reform (NCSSR). To lead the commission, Washington hired a man who has since proven to be one of the most unsuccessful monetary and fiscal planners in American history: Alan Greenspan.

Long story short, the Greenspan Commission marked “the end of Social Security as we know it”… or at least as we knew it in 1983. That year the Commission released its findings and recommendations, most of which were gradually implemented over the next decade. Here are some of the basic elements of their reform:

• Social Security tax rates (including Medicare taxes) rose from 9.35% in 1983 to over 15% by 1990.
• The minimum age to file for full benefits was slowly raised from 65 to 67.
• The cost of living adjustment (COLA) was re-engineered to track growth in wages or inflation, whichever is lower. Previously, COLA just rose with inflation.
• The taxable wage base rose dramatically. In 1983, all individual income over $32,400 was not subject to Social Security taxation. Today that base level is $106,800.
• Greenspan’s plan offered Social Security coverage (and colluded participation) for most tax-exempt and federal employees that were previously excluded.

Essentially, Greenspan’s fix for Social Security was to take in more money and pay less of it out at a later date. And with the help of a booming American economy through most of the ’80s and ’90s, it worked… until it didn’t. As noted above, we’re just about back to square one.

(The real irony here is that there’s reason to believe there was nothing long-term about Greenspan’s solution in the first place. The Greenspan commission was formed by President Regan’s chief of staff Jim Baker, and it’s an open secret Baker’s key objective was only to make Social Security a non-issue for the 1984 election. As with most administrations, the real crisis was left for the next guy to deal with.)

The current generation of leadership is now “that guy.” Worse yet, this Social Security crisis is larger than the one we faced in 1982, which was a combination of a cyclical economic downturn and SS rules and mechanisms in need of reform. Today we face a structural crisis…they’re called baby boomers.

76 million Americans were born between 1946-1964, the so-called baby boomers. On January 1, 2011, the oldest member of this demographic – the largest America has ever known – will turn 65. At present they make up about a third of the entire US workforce. Taking their place will be Generation X, about 46 million people strong. Forgive us for the back-of-the-envelope math, but that sounds like 30 million fewer contributors to the Social Security fund and tens of millions of new beneficiaries. Hmmm…

When the whole idea of Social Security was first brought to the table, way back in post-Depression FDR days, there were 16 Social Security contributors for every 1 Social Security beneficiary. Today, that ratio is closer to 4:1. By 2030, when America will be bearing the full brunt of retired baby boomers, that ratio will be 2:1. To accommodate that ratio, either recipients will have to get less, or workers will have to pay more. The current method of funding the program is simply no longer applicable.

And there’s a whole other “problem” with current or soon-to-be Social Security beneficiaries: They’ll likely live much longer (and expensive) lives than their parents. In 1935 the average life expectancy was 65, making the minimum age to collect SS almost a cruelly ironic death sentence. Today, the average American will live to around 77… yet the minimum age to collect full benefits has only risen by 2 years. And if you believe tech-savvy people like my colleague Patrick Cox, we are on the verge of generational medical breakthroughs that could expand our life expectancies into the triple digits.

So what happens when the largest demographic America has ever known taps into a fund already in deficit? And what will we do if they…well…won’t die on time?

You can whine about “paying into Social Security every month for the last 40 years and I deserve every penny” till the cows come home… But this is simple, cold math. If you’ve been in the working world that long, you must understand by now the difference between what’s fair and what’s reality. The reality of the moment is this: You must…

• Prepare to pay more Social Security taxes
• Prepare to receive less Social Security benefits

As it stands today, there’s just not enough money to fund the Social Security program as we know it. With $2.5 trillion left in the SS warchest, there is no immediate threat to the status quo. But as the SS Board of Trustees forecast in August, “Over [a] 75-year period, the Trust Funds would require additional revenue equivalent to $5.4 trillion in present value dollars to pay all scheduled benefits.” That gap will be filled by borrowing from abroad, taxing at home or slashing the benefits of those yet to retire. Either way, it’s hard to picture a happy ending for Social Security. It’s in your best interest to build a substantial retirement fund of your own and – probably more importantly – one for your children.

Good luck,

Ian Mathias
for The Daily Reckoning

The End of Social Security as We Know It originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Now it looks like ease of access is coming to India.

“India is planning to open the country’s equity markets to foreign retail investors,” The Financial Times reported earlier this month. While there’s nothing definite yet, an Indian government panel recently recommended the finance ministry remove many of the barriers that currently prevent small international investors from buying Indian companies. (At present, only institutional-sized investors can have the full pick of Indian companies.)

According to the FT, Indian regulators are taking the panel’s advice and beginning to build an exchange capable of handling the rush that would likely ensue.

“One of the biggest frustrations I have with India is the small number of stocks we can invest in,” Chris Mayer adds. “This is unlike China, which has a well-developed Hong Kong exchange, not to mention the many companies that trade on the NYSE and NASDAQ. In India, foreign investors like you and me can’t buy Indian stocks, save for the small number that list in the US.

“While I was in India, I remember talking to brokers and money managers who told me it was only a matter of time before that changed. The big institutions have been allowed to invest in India for 18 years. But now it looks like the common fellow will be able to pick up shares soon, too.

“On my last trip to Mumbai, I spent some time with analysts who shared their favorite ideas with me. There are many Indian small-cap stocks growing 30-40% a year and still trading cheaply. But they’ve been off-limits so far. Maybe not for much longer.”

Ian Mathias
for The Daily Reckoning

Indian Markets Open the Foreign Floodgates originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

That’s where the good news ends.

But first, the Cliff’s Notes to this mess, according to the SEC’s allegations:

In 2001, New Jersey increased pension benefits for state employees without having the funds to cover new benefit expenses. For the next six years, at least, the state continued to underfund the pension system – but hid that information from municipal bond investors. On 79 separate occasions the state sold a total of $26 billion in bonds while “withholding and misrepresenting pertinent information about its financial situation,” said SEC director of enforcement Robert Khuzami.

In other words, they lied so that the bonds they were selling would appear more attractive. It’s classic balance sheet fraud, committed by senior state officials working for both democrat and republican governors. And the state’s bond underwriters – JP Morgan, Citi, Morgan Stanley, Bank of America, Barclays, Merrill and (of course) Goldman Sachs – all probably lied too. At the very least, they all failed to conduct due diligence before vouching for the quality of the state bonds.

What’s the penalty for this outright fraud? Nothing.

The State of New Jersey will pay the SEC precisely zero dollars. Not one state employee will pay a fine either, or go to jail…not even lose his job. In fact, the State didn’t even have to admit wrongdoing. “New Jersey agreed to settle the case without admitting or denying the SEC’s findings,” calmly explains the SEC press release. Come again? Essentially, the only provision of the settlement is Jersey’s promise that it won’t do this in the future. That’s it.

And Goldman Sachs, JP Morgan and all those other mega-banks? C’mon… They weren’t even mentioned in the SEC’s statement.

It’s worth repeating: We’re talking $26 billion in bonds sold under purposely false pretenses. This isn’t some small-time phony IPO. Pretend a company like McDonald’s, which has a market cap of roughly $77 billion (that’s about the same value of New Jersey’s pension fund system) sold $26 billion in bonds under similar guise. Heads would freaking roll. They’d be lucky to not go bankrupt.

Yet, here we are. New Jersey officials were so unfazed by the SEC settlement – the status quo was so unchanged – that they proceeded with a $2.2 billion bond sale on August 19, 2010. That’s less than 24 hours after the SEC announced the results of their investigation. SEC investigators did a fine job forging into uncharted territory and exposing State fraud, but they offered literally the most toothless settlement possible.

That’s not to say no lessons have been learned. The smart investor should already be leery of municipal bonds, with so many states struggling to close budget gaps while honoring swollen pension agreements. Now you have all but absolute proof that State administrators are not only unable to balance their books, but they’re willing to cook ’em too. Plus, there is really no incentive for States to change their ways, aside from a gentle tap on the wrist from the SEC.

And this whole mess ought to (though it likely won’t) highlight fundamental unfairness in the way we regulate the $3 trillion municipal bond market. Having the SEC patrol state funds is a hot mess of conflict of interest and political gamesmanship. At the end of the day, this is government policing government…an operation likely to be as inefficient as it is ineffective.

Of course municipalities need a regulator, as they have proven unable to regulate themselves. But once the SEC discovers such a fraud, why not – at the least – order the state to hire a team of private sector auditors that will report their findings to the government every year for the next five…or as long as it takes for the State to get its act together.

How’s that for a stimulus plan? Auditing state pension programs would employ thousands of accountants for years. And those are real jobs, with a real purpose… Bean-counters could get back to work and bureaucrats would have to be just as responsible and forthright as the rest of us. While they’re at it, those auditors can figure out exactly how long those struggling pension funds will last before running out of money. Wouldn’t that be nice to know?

We’ll be on the lookout for an e-mail from Mr. Obama, asking for more details on our stimulus plan. In the meantime, know what you’re getting into when you buy muni-bonds. Only one state has ever defaulted on its bonds – Arkansas back in 1934. So the odds are still in your favor. But reason is not. Now ethics aren’t, either.

Ian Mathias
For The Daily Reckoning

Another Warning Shot for Bond Investors originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

To be clear, the Treasury “will make sure the GSEs have the resources to meet their financial commitments,” Geithner added. Whatever the fate of Fannie and Freddie, it will be financed with tax dollars and controlled by government. Both companies, despite being at the very heart of the financial crisis, were left out of the recent Financial Reform Bill.

“Government is part of our future,” Bill Gross responded. “We need a government balance sheet. To suggest that the private market come back in is simply impractical. It won’t work.”

Scary stuff, eh?

But as menacing as this all ought to sound, here’s an interesting twist: Some of the best-performing stock markets in the world this year are in socialist-leaning nations. Denmark’s OMX 20 (like our Dow) is up 22% so far this year, the best-performing index in the developed world. Incredibly, Hugo Chavez’s IBVC index of Venezuelan’s stocks is close behind.

Compared to the S&P 500, it’s no contest… 2010 is the year of the socialist investor.

There’s more going on here than just form of government. Denmark, for example, is in the catbird seat of the euro crisis — part of the EU but not a euro nation, very low debt and a conservative banking system.

But still, it’s worth noting… in a world that’s terrified of excess government involvement, two countries with massive state presences are giving investors top-rate returns.

Ian Mathias
for The Daily Reckoning

Government Meddling: Bad News, Unless You’re an Investor originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Worker productivity fell at a 0.9% annual clip from the first quarter this year to the second, the government announced yesterday. Thus, we’ve found an end of an incredible boom for this D-list data point. Companies have been asking more and more out of fewer employees for the last three years, and the threat of joining the 14.6 million “officially” unemployed has compelled workers to comply.

Now, for one reason or another, we’re collectively working less than we did last quarter (if, we presume, the government’s numbers add up.)

So why are we less productive?

Either America has found a temporary peak of human productivity, and without greater technology, greater incentive to work harder or more Americans in the work force, productivity growth is no longer possible…

OR

There’s just no reason to work so hard. In other words, demand for our products and services is less than our current productivity rate.

Which is it? We promised you two nice charts… Here’s the other:

Capital stock is the total inflation adjusted value of all “business equipment” in the US. That’s machines, robots, vehicles, tools, software, computers, pencils, paper…the whole shebang. For the first time since World War II, US capital stock is contracting. Meaning, employers are not reinvesting in their equipment. More machines are left broken or outdated than are being replaced or upgraded.

Employers likely underinvested in capital stock during the darkest days of the credit crisis. But why aren’t they catching up now? Perhaps worker productivity is down – along with capital stock – because there’s simply not enough business to warrant investment…either in people or equipment.

Ian Mathias
for The Daily Reckoning

The Continuing Decline of US Productivity originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

But before you read them, have you ever seen Italian television? A Mexican talk show? If you have, then you can accurately picture Mello bounce around the room with wild, infectious, almost cartoonish enthusiasm. This was by far the most charged presentation this week…a great show:

“There are no disasters. There is no bad news – only opportunity. BP is not bad news. Accidents happen, but oil drilling is the safest operation in the world. This is the first accident there, EVER! The global energy industry drills 1,500 offshore wells a year with no accident.

“Thousands of barrels of spillage a day is a great sign! Look at how much oil could have been produced if they didn’t have this accident. There is so much oil deep in your Gulf of Mexico that America is so blessed. There is so much, one day it will be hard to believe in Peak Oil. It is great news.”

The one real lesson to learn from BP, says Mello, “is people. I put all my money in the right people. People…that’s it. Countries, government, assets, NO… Put your money in good people and you will never lose. Who?”

Crowd responds: “People.”

“I can use data; I can use history; I can use good sense. But when I doubt, I always put my money in the one thing that never fails me. Say it with me:”

An excited crowd responds: “People!”

Mello: “No… s**t… oil!”

Ian Mathias
for The Daily Reckoning

Is the BP Oil Spill a Good Thing? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.