Brad DeLong writes about “The Biggest Risk-Arb Transaction Ever,” namely the investment of social security funds in private stocks:
The plan, you remember, was for the federal government to sell a huge number of Treasury bonds, invest the proceeds in stocks, distribute the stocks to individuals as their Social Security Private Accounts, and use the equity premium–the average spread on the return on stocks over the return on Treasury bonds–to reap immense profits and save Social Security.
Brad offers a few options as to what would happen, I find the following two hypotheses most plausible:
…even though there is compelling evidence that the equity premium is too high and that there is lots of profit to be earned by long-run bets that go short Treasuries and long stocks, enactment of the Lindsey-Feldstein-Samwick plan will cause an immediate jump in the stock market. Current owners of stock will profit massively as people’s expectations of the massive future demand from Social Security Private Accounts. The equity premium will shrink quickly. And there will be little profit captured by beneficiaries and little money to save Social Security. (However, the falling equity premium will boost corporate investment, real profits, and real wages by eliminating the Harberger triangle currently created by the market inefficiency underlying the excessive equity premium.)
One [option] says that you might make $2.4 trillion in present value–that price pressure from the demand for stocks for Social Security Private Accounts will eventually shrink the excess equity premium to close to zero, but that will take a generation. And in the meantime, as the excess equity premium is still there (but shrinking), you do profit from the wedge caused by the fact that the private stock market grossly overprices systematic risk.
In other words, even if the stock market currently earns (an expected) seven percent a year, you can’t count on replicating that same seven percent on the money you pull from the social security trust fund. “Private investing” of the funds does not change this basic reality.
Let’s not forget another of Brad’s points: “this [plan] is no bargain if the risk the stock market will tank is borne by beneficiaries”
Brad’s earlier post offers some options on the politics of social security, I go with a view that he holds only on alternate Tuesdays, namely the following:
The fourth argument is: “You want the SSTF invested in private bonds and stocks? Are you crazy!? Do you want some government bureaucrat voting stocks and so electing corporate managers? That’s just insane!”
The bottom line: Reforming social security is not going to be easy.