I thought this article was great. It came in an email newsletter from Silicon Valley Bank, and I can’t find it online anywhere. There is a printer-friendly link here.
Ponzi’s Revenge
On December 26, 1919, Carlo Ponzi, an immigrant from the town of Parma, Italy, founded The Security Exchange Company, an enterprise which dazzled investors with the promise of a 50 percent return in 90 days. In point of fact, those fabulous returns were paid out of funds received by enticing new investors. The critical factor behind Signor Ponzi’s success, of course, was the public’s continuous optimism and belief that such outrageous returns were possible. There was a big catch, however: without money from new investors, “dividends” could not be paid out. Without those remarkable payments, the public lost confidence, and the “fund” supporting the enterprise collapsed. Ironically, skeptics who first cast doubt on Ponzi’s investment vehicle were reviled by the public and denounced by those profiting from the arrangement. Even when Ponzi was deported to Italy (after serving a few prison terms throughout the U.S.), thousands of well-wishers turned up at Boston Harbor to see him off. George W. Bush is now becoming familiar with this same public pillaring, as he casts doubt on the largest “Ponzi Scheme” in history. . . . We are, of course, referring to the Social Security Act of 1934.
Perhaps the trouble with the current debate about Social Security is more elementary than we care to admit: while our esteemed representatives are good with words and sound bites, when it comes to basic arithmetic they struggle. So, they tend to focus on the words and the hyperbole (which they enjoy) and ignore the math (which, seemingly, they don’t). And, so, they’ve created a lot of “good” phrases to describe Social Security, like “trust fund,” “pension system,” or “retirement plan.” The problem with these words is that none of them have a shred of truth. The sad fact is Social Security has essentially been a welfare-type system from the outset. It was never “funded” and “contributions” were really just taxes that were taken from one generation and redistributed to an older one, based on a formula. There is no correlation between how much you “contribute” to the system, any “investment returns,” or what you get paid at retirement. And, it has always been that way. Consider the case of the first recipient of a monthly Social Security check, Ida May Fuller. On January 1, 1940, Ida May received her first check for $22.54. Before retirement, Ida May had paid a total of $24.75 into the system. Unfortunately for the system (but, no doubt, happily for Ida May), she lived to be 100 years old. In total, she collected $22,888.92 from the government. That’s an annual return of 2,642 percent. Ponzi was a piker compared to the Social Security Administration. Of course, in order for Ida May to have gotten a 2,642 percent return, it means that a whole lot of other people must get seriously negative returns.
Ironically, those negative returns were also by design. When the system was established, the retirement age was set at 103 percent of life expectancy — which in 1935 was 62.8 years. The government expected most people that paid into the system to die before they collected their first dollar. Since everyone was forced to pay (and they would hopefully die young), there was no worry about the Ida May Fullers of this world taking a disproportionate share of the money. Similarly, if the current retirement age was 103 percent of life expectancy (78.7 years), the system could probably go on forever — baby boomers or no. Of course, to accomplish this we’d need to instantly cut off payments to millions of retirees, which would send the AARP into convulsive spasms. The AARP is sort of the William McMaster character in this drama. McMaster was a well-respected PR guy Ponzi hired to improve his image after the government began to question Ponzi’s enterprise. Unlike the AARP, McMaster stopped representing his “client” after a few weeks. He determined Ponzi was a fraud and said so publicly. McMaster’s character and integrity were more important to him than the fees he got from Ponzi. Here’s where McMaster and the AARP seem to diverge. The AARP receives almost $500 million a year in direct payments from the beneficiaries of Social Security. We don’t think they should be accorded any credible voice in this debate.
If you want to find out if you are on a winning level of this pyramid, it’s easy to do so. The Social Security Administration habitually sends out statements to contributors. My recently arrived analysis states that by the time I retire I probably will have amassed contributions of $285,425.00. This, presumably, will allow me to receive payments of $1,499.00 per month at age 62. If I live until 78 (my life expectancy), I will receive $287,808.00 in checks. In case you’re wondering, the imputed IRR on this amount for my 16 years of retirement is 0.10 percent per year. Yes, that is not a typo — 10 basis points per year. The investment returns on the accumulated contributions prior to retirement are exactly zero. Ida May, my hat is off to you!
Back in 1994 I decided to get a cellphone (bear with me - this is relevant). The Motorola flip phones were new, and much smaller than the bricks of previous years. I called AT&T, and they asked me what area code did I want? 650 was still relatively new, and 415 seemed to have more cachet, so I went with that. Then they told me my exchange would be 699, but I did have the opportunity to pick the last 4 digits. I had the idea that I wanted them to spell a 4 letter word, because my college number had ended in DUKE. We spent at least 15 minutes on different combinations, starting with me thinking of words and converting them to numbers, and her looking to see if they were available. Soon we switched to her telling me available combos, with me rapidly writing down possible letter subsitutions and seeing if I could form a word. Finally we hit FISH and I said okay.