President Bush might be bullish on the idea of Social Security privatization, but a number of Wall Street experts are expressing skepticism over whether returns will live up to expectations.
To help head off an anticipated shortfall in Social Security benefits in the next couple of decades, the president has floated a proposal that would allow workers to contribute a portion of their earnings to private accounts, most likely mutual funds.
Although Bush is yet to offer a detailed plan, Democrats and powerful organizations like the AARP and AFL-CIO say the 75-year-old pension isn't in trouble. They largely argue that allowing workers to invest in private accounts leaves their retirement money susceptible to the ups and downs of the stock markets. And now, a report in the Wall Street Journal posits that risk is exactly what Bush's proposal fails to take fully into account.
"You can't just sort of invent free return," Goldman Sachs Chief U.S. Economist, William Dudley, told the Journal. "If it was that easy, you wouldn't have a Social Security problem in the first place."
Here's the dilemma: Bush says that under his plan, workers who choose private accounts will be better off than those who stick with traditional Social Security, given that stock and bond mutual funds in those accounts earn three percentage points above inflation annually. According to Social Security forecasts--which predict a 4.93% real return on a private account that's 60% stocks, 24% corporate bonds and 16% government bonds--that seems likely.
But the outlook, the experts note, fails to take into consideration that the government's own prediction for the upcoming Social Security shortfall is based upon economic growth of 1.9% between now and 2042. That pace of expansion would make it unlikely that the stock market could produce returns of 6.5%, which would be necessary to generate the 4.93% return on private accounts.
Perhaps more importantly, the Journal report offers, is that Bush's performance expectations for private accounts seems to ignore that fact that investing in a portfolio of stocks and bonds is riskier than the current Social Security plan. Under Bush's proposal, workers who choose private accounts would forfeit the guaranteed 3% real return under today's Social Security plan. Conversely, there's no guarantee what sort of returns a private account might deliver.
"If you go into stocks, you may outperform, but when you fall short, that may hurt a lot," said Jeremy Siegel, a professor at the University of Pennsylvania's Wharton School of Business.
The only alternative is a risk-free option, like inflation-protected Treasury bonds, but their current yield of about 1.8% would guarantee a loss.
So on a risk-adjusted basis, the outlook on private accounts appears bearish at best, the Journal concludes.