Guest writer Mark Blyth holds a Ph.D. from Columbia University and is Professor of Political Economy at Brown University’s Watson Institute. He is the author of Great Transformations: Economic Ideas and Institutional Change in the Twentieth Century and is currently at work on the book Austerity: The History of a Dangerous Idea. While he awaits the imminent birth of his first child, he took time out to write this article for ThePublicProfessor.com
Q: What’s the difference between Bernard Madoff and Citigroup?
A: The security of their lines of credit.
Q: What’s the difference between Bernard Madoff, Citibank, and the Social Security Administration?
A: Everything.
Akim has already explained what a Ponzi Scheme is and what it is not. So let’s compare Bernie and Citi.
During the crisis, Citigroup was $99 billion in hoc to the Fed and got bailed. In contrast, Bernie was in the hole for $50 billion and couldn’t get a loan. Why not? Because Citi was too big to fail, but Bernie wasn’t. Citigroup’s total assets in 2010 were $1.2 trillion. Bernie was a mere $50 billion fish. When Citi cried for a bailout they got one because if they failed they would take a large chunk of the financial system with them.
So while Citi was too big to fail, Bernie was too small to bail.
But, I hear you cry, it’s completely different! Citi is a legitimate business. Bernie was a Ponzi scheme. There were no investments with Bernie, just money coming in the bottom to pay the top while Bernie sat in the middle taking a fee.
And you would be right, until you think about the structure of, say, financial derivatives.
Any derivative, like the famous Collateralized Debt Obligation, takes payments in from one party (the folks who have the mortgages in this case) and pays it out to the other side (the folks holding the security), with the bank sitting in the middle taking the fee. See the difference?
Right, there isn’t any. Except this is called ‘a legitimate investment’ and not a ‘Ponzi scheme’ because the security is expected to maintain its value and generate income. Until it doesn’t. And when it doesn’t, you don’t get to shout fraud, even if there is a good case for saying the security was fraudulent, because it was a legitimate investment. See the difference?
Right.
Yeah . . . now add the fact that Citi and other big banks do this with huge amounts of leverage: borrowed money amplifying their bets. This means that they have far more money out at risk than they have as capital hedging their bets. So you might be excused for thinking that Bernie’s biggest mistake was not opening a legitimate bank.
Now consider Social Security as a Ponzi scheme. Not even close. Ponzi schemes that don’t use leverage (Bernie’s, not Bank’s) need to double the folks coming in the bottom relative to the payout at the top, or else the payment cannot be sustained. They collapse when the volume required to maintain it becomes too great.
Social Security is a Pay-As-You-Go system. Current retirees are paid for by the tax income of current workers as part of an intergenerational contract. So long as the tax receipts coming in can cover the payments going out, there is no problem. Nor is there any leverage in the system. Social Security is not a Ponzi scheme since it requires no geometric doubling to make it sustainable. So long as the United States has tax capacity (and as one of the lowest taxed states in the world — really — it has LOADS of spare tax capacity) it is sustainable.
Social Security is not a Ponzi scheme. The only question is whether Americans wants to pay for it or not.
The basic idea, repellant to some, is that we are all members of a society. Each generation contracts with its parents to pay for their retirement with the proviso that their children will pay for them. The system was designed to make sure that people don’t have to eat dog food in their retirement, not to guarantee a nice life in Florida for all. It was also designed to make sure that society and the economy have some resilience in the face of adversity. It has the handy feature of putting a floor on consumption when the economy falls off a cliff.
Believe it or not, no one benefits from an extra 50 million poor people. Really, we have enough poor people already. But we do benefit if old folks keep spending when the economy hits a rough patch.
Q: So why then do we hear all this stuff about Social Security being a Ponzi scheme?
A: Politics.
Social Security is a fantastically successful program. Its overhead administrative costs are less than 2% of operating revenue. Private pension schemes charge anywhere between 10-30% overhead, 
depending on the contract. Social Security has also prevented widespread senior poverty for three generations. But most of all, it shows that there are some things that governments do better than markets.
After all, if you had put your Social Security money in the stock market, as per Bush’s proposal in 2004, and you had done so with the aim of retiring in 2008, you would have lost half of it. In fact, run it out over the long run and the rate of return on equities tracks that of the economy overall, but with a lot more risk.
Perhaps this is why all the other rich countries have a public pension system too.
Now some folks may object that they were never formally asked to make this contract, and they would be right. They may also claim that based on current demographic and other trends, Social Security will be bankrupt by 2046, or some such date. But really, if you are going to worry about such long term trends you might keep in mind that all the cheap oil will have gone by then, and Social Security will be the last thing you are worrying about as you try and find food on a Mad Max reality film set.
The bottom line is this. Big Banks are more like Ponzi schemes than Social Security will ever be, and Social Security at least has a guarantee; albeit from the federal government, which many don’t believe when it comes to Social Security’s safe unleveraged assets, as opposed to those leveraged assets held by banks that people still seem to trust. To compare a pay-as-you-go system with a Ponzi scheme is simply partisan politics by those who are ideologically opposed to the very existence of the state.
So we have a choice. Either we fund things properly by raising taxes and not spending money on such things as wars of choice and unfunded tax cuts (which are still expenditures), or we try and run a 21st century economy with a 19th century state and social policy.
Good luck with that.
The Germans will kill us on Research and Development, which is of course a largely government backed function. After all, where do you think the internet, atomic power, and biotech came from? Meanwhile, the Chinese will wipe us out of our remaining high value added manufacturing industries. China has no problem with the government backing markets, which is why they are growing at ten percent a year while we sit waiting for the ‘confidence fairy’ to return.
Myths are dangerous things, economic ones especially so. “Social Security is a Ponzi scheme” is one of them.