Lincoln * Institute

Colin A. Hanna

Colin A. Hanna

President
Let Freedom Ring, USA

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Let Freedom Ring

Is Social Security a Ponzi Scheme?

by Colin Hanna
 

By Colin A. Hanna

For American Radio Journal

In the Republican presidential candidate debate this week, Rick Perry was asked about his characterization of Social Security as a Ponzi scheme. He said that he still stood by it, but he was somewhat inartful in his defense. His opponents, both on stage and in the media, immediately pounced on what they saw as a major gaffe. Commentators suggested that he had made the sort of mistake that would haunt him for the rest of the campaign, and maybe even cost him either the nomination or the general election.

Was Perry wrong, as well as somewhat inartful? No, I would argue that he was absolutely right, but that using the term without clearly defining it was a mistake. It was a mistake not to talk about how to reform it without hammering the retirement projections and expectations of anyone under age 55. So let's take a few minutes right now, first to look at what a Ponzi scheme is, and then to examine the Social Security program to see whether the term fits or not.

The term Ponzi scheme is named after Charles Ponzi, whose fraudulent investment scheme brought in millions of dollars in 1919 and 1920 before it collapsed and was exposed. For a while, he was treated as a financial genius.

Here's a definition of a Ponzi scheme from the Merriam Webster dictionary: an investment swindle in which early depositors are paid off from the new money being paid in by later depositors. The returns appear to the early investors to be profits, but in point of fact, there is no actual investment at all, and thus no profits. The system works as long as there is more new money coming in than is going out in payments to early depositors. At some point, however, the new money starts to dry up, or the greed of the scheme's operators results in theft of the assets, and there is no longer enough income to support the outgo. At that point, the scheme collapses, and everyone who is waiting to be paid gets nothing. That's when everyone learns that it's been a fraud.

How does Social Security work? When it was started, back in1937, there was of course no pool of savings paid in from retirees over their many working years. They had to start from zero. That is to say, the balance in the Social Security Trust Fund was zero. But with 33 workers paying in for every one taking out, it wasn't long before the Fund had plenty of new money with which to pay the early retirees. Now what should have been done with that extra money was to invest it in legitimate, money-making investments like stocks and bonds. Instead, the money was allowed to languish for a while, and then the government began borrowing from it, and leaving unmarketable notes, or IOU's, in place of the real money. Nonetheless, the scheme works just fine until the income falls below the outgo. With the ratio of workers to retirees falling from 33-to-one down to 3-to-one, that's beginning to happen now. Suddenly, everyone comes to the realization that the day of reckoning is not far off. Then the politicians begin using somewhat obscure works to describe the fix. The word "unsustainable" sounds much less inflammatory than fraud, or bankrupt, or monstrous lie -- but it's describing the same thing. In the long run, it won't work, it is destined for eventual collapse.

Pretty close to the definition of a Ponzi scheme, wouldn't you say? Everyone agrees that it's unsustainable in the long run -- even those who, like Governor Romney, Karl Rove and Dick Cheney criticized Perry's use of the term. The fact is, Social Security is very much like a Ponzi scheme and for someone who knows that it is, but instead tries to hurl insults at an honest if somewhat careless analyst who exposes the truth, they are guilty of a much more serious act of political malfeasance than inartful expression. Its name is demagoguery.