Is This Proof That Social Security is a Ponzi Scheme?

My post from Tuesday generated quite a few comments. One of those comments was one from Jim. I copied the opening paragraph to his comment below:

I’ve paid the maximum every year for 46 years and invested even more than that in the stock market. Funny thing – one day I woke up and all my money in the stock market was now in the pockets of the bankers on Wall Street – and all I have left is my Social Security pennies. OK – I’m back at work again (Hello – Welcome to…..) and what I can earn and the savings I put away (in Social Security) are making ends meet.

I was curious as to what the maximum contribution to social security was over the last 46 years so I looked it up. I found the information here. I took that information and put into a couple of pretty little graphics for you, which you can see here:

From his comment, we know that Jim made AT LEAST $2.17 million over his 46-year career. We also know that he paid in over $252,000 into Social Security over his career. Looking at the Social Security website, I see that the maximum benefit amount is currently $1,809 per month (click here and scroll down to Table 2.A27), which implies an 8.61% yeild ($21,718.80 ÷ $252,127.95 = .0861 or 8.61%).

Now, some will say that’s a great return. However, I think it proves that Social Security is in fact a ponzi scheme. I mean, how else can they pay such a high-yielding payment compared to every other investment?


45 thoughts on “Is This Proof That Social Security is a Ponzi Scheme?”

  1. While your discussion on SS is interesting, I must question the comment concerning “. . . 46 years and invested even more than that in the stock market . . . and all my money in the stock market was now in the pockets of the bankers on Wall Street.”

    What kind of investment philosophy generates one’s loss of all his/her investment monies? A reasonable asset allocation over those years should generate a substantial portfolio, and one that can provide retirement income for life and probably allow that person to pass on a good sized estate as well.

    When we look to blame, it is often wise to first look in the mirror.

  2. Your numbers are wrong.

    First, the OASI portion is the part that pays for retirement income. You included the disability portion.

    Second, using only the OASI portion, he put $218,595.96 into OASI. Now, it is generally accepted that one can take out 4% (1/25) per year for a sustainable retirement. If the maximum monthly benefit is $1809 per month, or $21,708 per year, one would need 25 times that — $542,700 — to get that monthly payment.

    A 6.06% rate of return is required to get those payments to result in $542,700 — assuming that all contributions are made in one lump sum at the end of each year.

    If all contributions were made at the BEGINNING of the year (let’s assume that he is making so much money that he hits the limit on his first paycheck), then the return necessary is only 5.74%. Since neither is likely, let’s compromise on a 5.85% rate of return.

    That’s not so much.

    The real indicator that Social Security is a Ponzi scheme is the change in the rate of return over the years. The earliest recipients made out like bandits, because they were, in fact, bandits — stealing from the younger generations. In 1998, the Heritage Foundation said this:

    Security’s inflation-adjusted rate of return is only 1.23 percent for an average household of two 30-year-old earners with children in which each parent made just under $26,000 in 1996.1 Such couples will pay a total of about $320,000 in Social Security taxes over their lifetime (including employer payments) and can expect to receive benefits of about $450,000 (in 1997 dollars, before applicable taxes) after retiring at age 67, the retirement age when they are eligible for full Social Security Old-Age benefits.

    Of course, with their lower life expectancy, things are worse for Blacks:

    For the low-income African-American male age 38 or younger, the news is particularly grim: He is likely to pay more into the Social Security system than he can ever expect to receive in benefits after inflation and taxes. Staying in the current system will likely cost him up to $160,000 in lifetime income in 1997 dollars.

    As with any Ponzi scheme, those getting in early are screwing those who get in late. Eventually, someone is left holding the bag.

    Years ago, I was in a town-hall meeting with Rep. Moran. I stated then that Social Security was so bad for our children, grandchildren, and nation, that I would be willing to pay into the system until the day I die — taking NOTHING in benefits — so long as Social Security died with me.

  3. I’m not sure it is valid to do a ROR type of calculation for social security since there is no ‘lock-box’ / investment. Every penny paid into SS by workers is 100% spent the same year by the government, be that to people collecting SS-benefits today, or to help fund wars, or some rich a-hole’s tax break.

    I guess if you qualify it by saying:
    “Assuming the government makes good on promised benefits….”

    But, since I seriously doubt SS will be around for me when I retire, my estimated ROR is -100% (complete loss of “investment”).

  4. I certainly hope that Social Security will not be around when I retire. If we wait that long to get rid of it, it will only happen through the complete collapse of our economy.

  5. I must say that there is a gaping hole in my numbers. That gaping hole is that the 4% sustainable withdrawal means that there is something left over when you die. With Social Security, there is usually nothing to pass on to your heirs when you die. (The exceptions are for a spouse and for minor children (not usually an issue when you are retired).)

    So to make a proper assessment, one would need to look at the cost of an inflation-adjusted lifetime annuity for you and your spouse, and that would be the final “value” of the “investments”.

  6. Yes, it is.

    And so is the banking system.

    And so is the stock market.

    And so is Republican economics.

    And so is Democratic economics.

    The U.S. is running a gigantic Ponzi scheme on the rest of the world. That’s why we are so rich.

    SS is just an allocation of the Ponzi scheme. You just don’t like the way the loot is distributed.

  7. “The U.S. is running a gigantic Ponzi scheme on the rest of the world. That’s why we are so rich.”

    Please explain.

  8. That’s a bit more than I care to bite off. And you wouldn’t be able to accept it, anyway.

  9. What proves SS is a Ponzi scheme is that new “investor’s” money is used to pay off earlier “investors” because there is no money actually invested. All the money that goes in is consumed or paid out in some manner. That’s all you need to know about SS and Ponzi schemes.

  10. That’s what I thought, Retired.

    Would you like to try to explain this:

    “And so is the stock market [also a Ponzi scheme].”

  11. It is a generational Ponzi scheme: In the link to the Social Security document they all but say so.

    The assumption was that the economy would keep growing, there would be enough young people to support the older people, and that beneficiaries would live to a certain age. Well, Japan’s public pension scheme is screwed because people are living to be way older than they expected, their society is greying, and their economy is stagnant. We’re not quite as bad but getting there.

    Previous generations got more than what they put in. As things are, my generation will get less. Frankly, I’m furious at the leadership of my parents’ generation, as are peers of my age who are paying attention to their future. Their parents gave them prosperity and security; they left us with insecurity and debt.

    I’m a public servant because I’m not concerned about getting rich; I make enough, and I’d rather be making a difference and working for the people, not some shareholder or CEO. I’m pretty sure our leaders will find a way to bankrupt or steal from my pension before I retire, though. Thanks for fucking things up for us.

  12. The stock market is just a system based on faith like a Ponzi system. Why can the U.S. banking and stock market collapse in days? There is really nothing backing it up.

    If you compare SS and those two, there is really no comparison as to which is more of a Ponzi system.

  13. Nonsense, Retired. The Stock Market is backed up by companies. I simply do not care that the market dropped 5% today. I still own exactly what I owned yesterday. I own the same portion of Microsoft that I did yesterday. I own the same portion of McDonalds that I did yesterday. I own the same portion of all the companies that I owned yesterday.

  14. That’s true. A Ponzi scheme is backed up by the money in the system, too. There just isn’t enough to pay everybody.

    A stock market has more support behind it than a Ponzi system. But a great deal of the value of the system is operating on the Greater Fool theory.

    How much value you can extract at any given time is entirely dependent on the faith in the system at the moment.

  15. “But a great deal of the value of the system is operating on the Greater Fool theory.”

    Not at all. The value in the system is the profitability of the companies whose stock is sold on the exchange. As a stock-holder, I own a part of every company whose stock I hold, and share in the profits of that company in proportion to the amount of stock I hold.

    A Ponzi scheme, such as Madoff ran, or as Social Security, has no such store of value. Those putting money into the system own nothing.

    The clearest distinction can be seen at the beginning. In a Ponzi scheme such as Social Security, those who get in at the beginning put in very little, or even nothing at all, and are paid by those who come in later. Those who first sell a stock must have a company, and they are selling not only part of the future profits, but potentially even control of the company, since stock-holders generally have voting rights.

  16. I would also point out that “what one can extract at any given time” is not dependent on faith in the SYSTEM, but in that particular company to produce future profits. Since there are macroeconomic factors that affect many companies similarly, those companies’ stock prices will often go up or down in tandem. However, that has nothing to do with faith in the stock market system.

  17. It has everything to do with faith in the system. Every stock certificate in the United States clearly states its value as $0.01 per share.

    That is the company telling you that it does not back the certificate you are buying nor is the company’s assets pledged to it. What you are buying is faith in the faith of a future investors opinion of the company. Nothing more.

    That faith may or may not be driven by revenues. It may simply be the blind faith in the future of all stocks. Those revenues may be valued at 50x or 5x depending on faith in the system at the moment.

    Technically, neither the stock market or SS are a Ponzi scheme. But the difference is pretty minimal. Both face basic flaws that cannot assure that someone can get back the money they put in.

  18. No, Retired, when one buys the stock of a company, he buys partial ownership of that company — including the right to his share of the profits, and voting rights.

    Naturally, a company cannot say with certainty that you will be able to sell your stock for a profit at any particular time. But that is no different than any other purchase. If you buy an ounce of gold, you have an ounce of gold. Will you be able to see it for a profit some time in the future? There is certainly no guarantee of that. (And it won’t pay dividends in the meantime, either.)

    If you buy a bond, there is no absolute certainty that the originator of that bond will be able to repay it when it comes due, or even pay the coupons on time.

    In the case of Social Security, those who pay in own nothing. The courts have even ruled that there is no guarantee, and that the government can change or terminate the program at any time.

    In a Ponzi scheme, there is no ownership of anything. That is Social Security.

  19. The bond holder has the right to the assets of the company which the stock holder is not afforded and also has first claim on all revenues to claim their interest. That’s why bonds are considered much more conservative than a stock. They are actually backed by something.

    A stock is backed by virtually nothing which is why it is considered a speculative investment. It is only worth what someone will pay you, if you can find anyone to pay you anything.

    A Ponzi share owner does own the cash in the system and can redeem out at anything as long as not everyone else is redeeming at the same time. It’s all about the timing.

    Works the same way with stocks. In fact, some Madoff investors have gotten back more than some stock holders have even when their company did not go bankrupt.

    You keep the faith.

  20. Retired@40) That’s right, when a company files for bankruptcy, the order of who gets paid are:

    1) (back) Taxes owed
    2) (back) Wages to employees
    3) lawsuits / settlements, etc
    4) Bondholders
    5) Shareholders (if anything is left). This is subdivided with ‘preferred’ shares, etc.

    But as we saw with the GM bankruptcy, even bondholders can get screwed — but the bondholders only get screwed if every single shareholder is wiped out _first_.

    As for the stock market being the Greater Fool Theory — I agree. If I go out and buy a share of some company on the open market, it is difficult for me to call that “Investing” — what I’d be doing is giving up my cold-cash for a piece of paper that I hope to sell to someone else in the future for more money. Neither my purchase, nor sale of stocks on the open market affect the company one bit (they don’t get money to purchase equipment, hire people, etc).

    Bonds, on the other hand, is radically different (and is “Investing” in my mind). When I buy a bond, I am lending money to the company so that they can purchase equipment, hire people, expand, etc. The bond is a contractual obligation and the future “value” of the bond is known up front.

  21. You are correct, to a point.

    Let us say that I own a company, and you buy that company’s bonds.

    Who sold you the bonds? _I_ did.

    Why would you buy those bonds, and why would I sell them, if we did not both think that the money would not produce enough output to repay the note and the coupons? They may not, and I will still owe you money. That is a risk I accept. My profits are unlimited, yours are limited.

    Furthermore, if interest rates go up, the value of your bond does go down. If rates go down, and the value of your bond increases, I have the right to pay it off early buy selling new bonds at the lower rate and using the proceed to buy back your bonds. Yes, your FUTURE, dollar denominated value is fixed, but the value of the dollar is not, and I can buy it back at will.

  22. Jack) yep. In the case with bonds, what we are trading is the company’s promise to repay. You lend the company money, with their promise to pay you back in say 10 years.

    You wait 5 years, and then get tired of waiting, so you sell me the bond, that still carries the original promise, except that all 3 parties (you, me, and the company) have the understanding that the company will now pay me in 5 years. You and I calculate what the value of the bond is today (based on todays rates, etc), make a deal, and everyone is happy.

    I can either wait out the remaining five years, or sell it to someone else in the future, etc.

    In the end, though, the company will pay to whomever is the bold-holder as contractually obligated in the bond at the date of maturity.

    Compare that to Stocks, where there is no “promise to pay”. The company is not obligated to shite: though ‘legally’ the executives are supposed to do what is ‘best for stockholders’ — no one enforces that and executives seem to only do what is good for executives.

  23. Not quite. Let’s say you buy a $1000 10-year bond with a 5% coupon. So every year for ten years, you will get $50, and in ten years you will get back the original $1000.

    Now, interest rates drop. You might think that your bond would now be worth MORE. The problem is, the company has the right to redeem that bond at any time (it is “callable”). So the company sells new bonds at with lower coupon rates, and gives you back your $1000.

  24. Jack) I’m sure anything can be negotiated into the contract/bond. The point I’m making is that bonds _are_ a legal contract, and it is a direct investment in cooperation with a company: “investing.”.

    Stocks: no contract, no cooporation between the you and the company == speculative investing at best.

  25. “Speculative,” by definition, means “seeing.”

    One looks at the future prospects for a company to make a profit, and decides whether to purchase part of that company.

    If there is “no cooperation” then that is your fault for not voting your shares.

    Is bond investing not similarly “speculative”? One looks at the potential for that company to repay, and one looks at the possibility that interest rates will rise and hurt the bond price.

    If you’re getting 5% on a corporate bond while inflation is running 10% and interest rates 15%, you will not be so happy about that investment.

    (And you will pay a higher price for non-callable bonds, too.)

  26. spec·u·la·tive/ˈspekyəˌlātiv/Adjective

    1. Engaged in, expressing, or based on conjecture rather than knowledge.

  27. oops, didn’t give all 3 — please pick the one you prefer:

    1. Engaged in, expressing, or based on conjecture rather than knowledge

    2. (of an investment) Involving a high risk of loss

    3. (of a business venture) Undertaken on the chance of success, without a preexisting contract

  28. speculation Look up speculation at
    late 14c., “contemplation, consideration,” Speculation
    late 14c., “contemplation, consideration,” from O.Fr. speculation, from L.L. speculationem (nom. speculatio) “contemplation, observation,” from L. speculatus, pp. of speculari “observe,” from specere “to look at, view” (see scope (1)). Disparaging sense of “mere conjecture” is recorded from 1570s. Meaning “buying and selling in search of profit from rise and fall of market value” is recorded from 1774; short form spec is attested from 1794.

    Now, using definition 2, one can clearly see that long-term STOCK investments are LESS risky than long-term BOND investments.

  29. Thanks for that, Retired, but this is why finance professors are poor.

    First, he takes a model (Black-Scholes) that presumes geometric Brownian motion of the price (NO reversion to the mean), and then says that because it is not in the equation, it doesn’t matter.

    Second, his analysis is for a SINGLE stock, not a basket of stocks.

    Third, his view of inflation is flawed. One may get back the specified “a known number of units of purchasing power,” the unit itself loses purchasing power.

    I have known many idiots with PhD’s — as far as I can tell, it just means they were unable to get a job when they got their bachelor’s degree, so they stayed in school.

    1. Retired,

      I don’t think Jack is trying to be an expert. It’s just that these papers almost always have flaws in thinking (usually because the author is trying to make a point).

  30. I will, thank you. The reason for that is that stock value has a forcing function — the profit of the underlying companies.

  31. Your RoR calculation is fundamentally flawed. When you die, your estate does not get the principal back.

    The correct comparison is with an annuity. The first question to ask: What lump sum would I have to pay an insurance company at age 65, to generate a return of $1809 per month for the rest of my life?

    Once we know that number, then the second question is: What rate of return would I have had to receive on my SS contributions for the last xx years to end with that lump sum at age 65?

  32. I have to comment on the stocks = Ponzi and stocks vs bonds discussion above. The whole issue of stock as ownership of the company is lost in this discussion.

    Looks like we need a lesson in Finance 101:

    If my brother-in-law started a company and needed $100,000 to get started, I could lend him the money at an interest rate of 5% with principal to be repaid in 5 years, or he and I could agree that I kick in $100,000 in exchange for 30% of the company. If I lend, then I am “assured” of a steady income of $5,000 until he repays 5 years later. That is a bond.

    On the other hand, if I own 30%, then I will be entitled to 30% of whatever he makes each year, and own 30% of the company, however big it gets. We may agree that he reinvests it all, or that he pays me a dividend each year (either the full 30% of al profits) or some other deal. This is a “stock”.

    Neither of these is a Ponzi scheme, nor inherently better than the other. In the case of the bond, he is taking the risk of fluctuating profits but receiving all the rewards of his success. My only risk is that his business performs so badly that he cannot repay.

    For the stock, I am taking some of that risk, but in exchange I have more potential upside. Of course, we both want him to succeed because then we both get rich.

    Being a bondholder or stockholder in a publicly traded company is no different in principle. However, as an owner of a small fraction of the company, you probably cannot influence management as easily as you can your brother-in-law. Jence you have to trust the managers and the other larger shareholders to protect your interests. Some managers steal, some executives are stupid, and some shareholders get burned. If you think that is the likely outcome, then put your money somewhere else

    If I need to sell my shares, then I will get back what someone else believes that fraction of the company is worth that day. No-one is cheating me when I sell at a loss. They are offering to pay what they think it is worth.

  33. In regards to the bond, Mark says: “My only risk is that his business performs so badly that he cannot repay.”

    Which means that you, the bond holder, takes ownership of ALL assets, which are then liquidated in the hopes of making you whole. Any shareholders would get exactly $0.

    The difference here is that bondholders have a legally binding contract.

    With Stock holders (and social security), there are no contracts. You are going for the “Greater Fool” theory: you hope to profit at the expense of someone else (new) paying more for the stock than you did, or someone new (next generation) paying your Social Security benefits when you retire — but there is no contract and absolutely no guarantee that this will happen.

  34. “Legally binding contract”? Tell that to the GM bondholders.

    With bonds, there is also the risk that rates will go up, and you are stuck in a low-yield bond getting you less than the rate of inflation, and you have the risk that rates will go DOWN, in which case the company will issue new bonds at the lower rate, and call in your higher-rate bond.

  35. BG, if you are a day trader, sure you are a fool hoping some other fool will buy your stock for a higher price. Long-term stock purchases are a different story, since the price has a forcing function — the company’s earnings.

  36. Whether Social Security is a ponzi scheme or not has nothing to do with the numbers it has to do with the definition of a ponzi Scheme

    From the SEC:
    A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk.

    I am pretty sure my contributions are paying all those people that are currently on SS…and I doing so with the risk free promise that I will get SS.


  37. Jack) The old GM bondholders got 150 million shares in the new GM, plus warrants to purchase another 272 million shares (half at $10/share and the other half at $18.33/share). A trust was setup to distribute those shares on April 21.

    What happened is that the old bondholders became the owners of the new company.

    Sure, they may not be made completely whole — but they got _something_. The old shareholders got: ZIP.

    Evan) well said.

  38. What happened was that the old shareholders had 0bama bend them over a box and give their company to the union that bankrupted it.

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