“The Biggest Ponzi Scheme in America” - August 23, 2009

While Charles Ponzi didn’t invent the Ponzi scheme, the technique became widely associated with him after he bilked investors of millions of dollars in 1920. The deception is a simple one. Promise investors huge returns then deliver on those promises by using the funds of new investors. As long as new investors invest more money than is paid out to existing investors, the scheme works. Modern day Ponzi scheme specialist, Bernie Madoff, perfected this strategy by adding an element of credentials (he was chairman of the NASDAQ stock exchange) and exclusivity to the scheme stealing more than $60 billion from investors over thirty years.

The deception that these hucksters managed to orchestrate on thousands of Americans pales compared to the largest Ponzi scheme in American history…Social Security. Originally signed into law in 1935 under President Franklin D. Roosevelt, Social Security has morphed into the largest government and social program in the world representing over 20% of our federal budget. Originally the Social Security Trust Fund was funded as you might expect. Taxes on wages were deposited into the trust fund which, in turn, paid retirement benefits. Excess money was held in the trust fund via treasury securities. In 1982, the trust fund fell into financial crisis due to large-scale unemployment (sound familiar?) and was in danger of running out of money. To address the crisis, the government created a commission chaired by none other than Alan Greenspan. The commission recommended, and the government adopted, amendments that increased tax rates and the full benefit retirement age as well as taxed benefits above a certain income threshold. The trust fund swelled so the government, using slight-of-hand accounting began including excess Social Security funds as part of general funding…meaning there is no longer any money in the trust fund, only government IOU’s. This has created the world’s largest Ponzi scheme. You see, since that time the Social Security system has been funded based on the premise that there will forever be more workers contributing to Social Security than retirees taking money, hence, no need for ‘reserves’. In the beginning this was true as you had sixteen workers for every retiree. But that ratio has constantly dwindled over the decades. Today, the system faces a one-two punch as the Baby Boomer generation is beginning to retire (80 million people) and we face massive unemployment (15 million fewer people paying into the system). Social Security is again on the threshold of financial crisis and may face deficits as early as next year.

While no one is talking about this, I expect this to be one of the biggest crises of Obama’s administration. If you are a taxpayer, any solutions are likely to impact you directly in your wallet. Possible solutions include: the Next Great Bailout; higher payroll taxes for employees and employers; taxes on Social Security benefits; reduction of future benefits; or the adoption of needs based benefits verses the current entitlement based benefits.

What you should do. If you are ten years or more away from retirement, don’t count on Social Security as part of your retirement planning. This will force you to save more and invest more wisely. Because of the potential political fallout, I expect that current Social Security recipients will not be materially affected.