I Must Be Missing Something

Now that President Bush has won his reelection there has been a lot of chatter about privatized social security and how it will be good for Americans and for asset management companies. Let me go on the record that I think it will not be good for anybody. While plenty of other folks are against it, I believe my rationale is somewhat unique.

This week's Barron's has a snippet about privatizing social security that says individual accounts would be earmarked for 2%-4% of the FICA tax. Well how much is 4% of your FICA contribution? The average salary in the US, I believe, is around $40,000 and the mean number is probably much lower, but I am not sure. The total contribution from employer and employee is about 12% the employee's salary. 12% of $40,000 is $4800. 4% of $4800 is $192.

Asset managers can't be profitable on $200 account. Some brokerage firms can not be profitable on $50,000 accounts. Schwab charges a $30 quarterly fee for small accounts that don't trade much. A tiny little account for every working American would create a tidal wave of paperwork, record keeping, and some sort of costly obligation to try to educate participants in the plan, who would otherwise never be exposed to capital markets. I view this as nothing but a quagmire for the financial services industry. That so many think this will be a good thing for T. Rowe Price et al gives me more conviction that this is a time to fade consensus. That is not to say I would short the asset managers because they will benefit from the money cycle that baby boomers are going through, but little social security accounts will be a head wind.

The other reason why I think privatized social security is a bad idea is more behavioral. The President wants to empower citizens with these accounts and give them more control over their financial futures. While that is emotionally appealing, there are countless studies that show people succumb to fear and greed and buy and sell at exactly the wrong time. There would be vast numbers of people that would wipe out their accounts because of poor timing. This is a mistake that people don't usually learn from but more importantly might not recover from. I have heard that the government might protect losses up to a point. Does anyone think that is a good idea?

I have an idea about how to deal with this that I am sure has its own set of flaws. I would like to see the government contract out the management of a small portion of the social security need and have that be indexed to the equity market. If 20% of contributions were put into the S+P 500 index and the index averages 5% price appreciation and a 1.8% dividend, the entire social security "trust fund" would get an extra 136 basis points of return. The other wrinkle I would add would be to require that the fund set some sort of criteria to get defensive to try to miss most of future bear markets, not by selling stock but by using futures contracts to get delta neutral. This would cause a lot less market disruption than selling.

The biggest obstacle I see is the start up costs to this. I will leave it to someone that is smarter than I to specifically address that and any other flaws my idea has. Am I dead wrong about this?