Could social security be the greatest Ponzi scheme ever?
Welcome to Finance and Fury, Furious Friday!
I saw an ad this week for a movie called ’Wizard of Lies’ – Bernie Madoff movie – 2008.
He was a stockbroker, investment adviser and financier who made headlines around the world when he was arrested for one of the largest accounts of financial fraud in U.S. history. What he was operating was known as a Ponzi Scheme (named after Charles Ponzi, who became notorious for using the technique in the 1920s)
For those who aren’t aware the definition of a Ponzi scheme is a form of fraud marketed as an investment – the usually have high, guaranteed returns – “too good to be true”
- Fraud – a thing intended to deceive others through wrongful or criminal deception intended to result in financial or personal gain.
- The success is reliant on new inflows from investors, as that is where returns come from.
- In other words: A Ponzi scheme is a system where the investor thinks their money is invested in something which is generating the returns, but are actually just used to pay other investors
- When the scheme runs out of new investors it then collapses – it’s doomed to fail
- The Ponzi scheme generates returns for older investors by acquiring new investors
Warning signs of a Ponzi scheme
- High investment returns with little or no risk. Be highly suspicious of any “guaranteed” investment opportunity
- Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions
- Unregistered investments. Ponzi schemes typically involve investments that have not been registered with regulators. Registration – this provides investors with access to information about the company’s management, products, services, and finances.
- Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
- Secretive and/or complex strategies. Avoiding investments that you do not understand, or for which you cannot get complete information, is a good rule of thumb.
- Difficulty receiving payments.
Ponzi scheme – People think they’re investing in something, but their money is actually being invested in nothing.
- This is why a Ponzi scheme is Fraud: Act of deceiving others for financial gain
- The only winner is the one who runs the scheme
Why have I been jabbering on about this? I was thinking that social security has a lot of similar characteristics
Is social security a Ponzi scheme?
First – we need to look at social security
- Social security is ‘any government system that provides monetary assistance to people’
- Social security is enshrined in Article 22 of the Universal Declaration of Human Rights (UDHR) – Adopted by UN General Assembly in 1948:
- Consists of 30 articles affirming individual’s rights
- It’s not legally binding but sets guidelines for countries to follow
- Expenditure includes a range of payments and services:
- Income support payments such as pensions and allowances (Age pension, Newstart, Veterans)
- Family Payments, paid parental leave, child care fee assistance
- Funding for aged care services and disability funding
- Put simply: Social Security is a transfer payment – transferring income from one person to another
- Transferred from: The younger working individuals (generation of workers)
- Transferred to: those who have ceased work – generation of retirees
How does this compare with a Ponzi scheme?
- Current Welfare Payments in Australia – $164bn p.a. now and looking to reach $191.8 billion in 2019–20.
- Income tax levied total is $390m, MTRs, payroll taxes, GST others
- Of this, $195bn is from individuals
- 84% of income tax paid goes to pay for social security
- The scheme – Payments (returns) are reliant on new money coming in.
- High investment returns with little or no risk -“guaranteed” opportunity
- For any return, some risk needs to be present
- The risk here: As long as taxpayers still are around it will be fine – 84% of income tax paid goes to paying Government benefits.
- Overly consistent returns – payments go up in large consistent annual growth
- Refer to previous – tax payer reliant – As long as the income tax increases over time, welfare can continue
- Unregistered and Unlicensed investments.
- No Regulation over the regulators – Registration is important because it provides investors with access to key information – how much do we get?
- There is nowhere near the level of reporting regulation imposed on CBA for example. That is, we have a good idea about the financials of CBA – We have a choice, so they need to be transparent…and it’s in their best interest to show off as well. When there is no competition or if you aren’t doing what you say, less transparency works best.
- Let’s use tax savings for example – When the government forecasts tax revenue based on policy changes, it is wishful thinking at best.
- Example – Make $10bn from franking credit removal – Assumes behaviours would stay the same. Would investors value dividends as much if they got rid of franking credits? If not, companies will change their dividend model and reinvest (high value to shareholders) – Like in the US where there are no Franking Credits
- Secretive and complex strategies
- Who pays attention to the bills being passed in parliament? More time is spent in the news on stories that sell
- Technically you don’t get a say either – we elect people to represent us – but no communication on policy
- Difficulty receiving payments – If you qualify you will get a payment, but…
- It won’t be the money you have put in, that has gone to someone else already.
- What you are getting is someone else’s contributions. The new money funding the returns of the older investors!
Warning signs add up, but technically not fraud
- There is the promise that when current workers retire, there will be another generation of workers behind them who will be the source of their Social Security retirement payments
- Can this last? Given its size, the welfare budget is often a target for savings measures, particularly in the face of budget deficits.
- Government website quote: “It will be difficult to achieve significant savings without looking at addressing spending in these areas, particularly the largest component: The Age Pension.”
- Risen from $100bn in 1998 to $164bn in 2017, $192bn in 2020 – which is an increase of about $10bn p.a. for the next 3 years
- “It is unsound” (Samuelson – Nobel Prize in economics) – Those who receive retirement benefits are actually receiving amounts that far exceed anything paid in by 5 to 10 times on average
- It relies on having new tax payers for the inflows to be sustainable
- Need to always have more youths than old folks in a growing population.
- Real income going up at 3% per year (compounding) then the taxable base on which benefits rest is always much greater than the taxes paid by those receiving the benefits, and there is no issue…just as long as the real income, population and tax base keeps on increasing
This may be a great Ponzi scheme ever… as long as the population (or tax base) continues to increase.
- But what happens when populations cease growing?
- Through history – People used to have a lot of kids, why?
- No mechanisms to save, which is how you prepare for retirement
- No Age Pension (Introduced in 1904 when average life expectancy was 63, age pension eligibility was 65)
- The funding mechanism was children – Better be good to them and have plenty to share the load
- Through history – People used to have a lot of kids, why?
- Why else did people use to have 6 kids? Infant mortality used to be 50% for one. But they had their retirement funding covered. Why do we see high birth rates in nations that don’t have the same privileges we do in the west?
- Small Problem – Used to live shorter lives, and there used to be higher birth rates (future people to tax)
- 1960 – Birth Rate per woman 3.45 – Average life expectancy 70.82 (Baby Boomer Generation being born)
- 1978 – Birth rate dropped below 1.95 – Average life expectancy 73.67
- 2018 – Birth rate hasn’t gone above 2 – Currently 1.83 – Life expectancy 82.45 (longer for woman)
- Birth rate of 2 would mean we are staying the same (less than 2 the population is declining, more than 2 the population is increasing). That is, you need 2 new people to replace mum and dad. But a lot has changed – contraceptives for example, as well as the need to have children reduced due to having social security.
Over the long term it’s uncertain that there is going to be enough of a population to tax at the appropriate level to fund required social security. As life expectancy goes up there are more people around that will rely on benefits.
Don’t fear though – While there is uncertainty, you can remove this by having a plan in place
- Nothing is impossible – Some systems do collapse
- When a reliance on a system is introduced
- Rather than being reliant on the system, reduce any uncertainty by working out what you’ll need and when you’ll need it by
What you can do:
- Invest for yourself –
- Super – Path of least resistance – Check a super fund calculator – Simple projection to see if you will have enough
- Personal investments – come up with a plan outside of super – Property/shares/managed funds
- Be self-sufficient in retirement, this removes the risk.
- When the success of payments is reliant on others, you have no control – Financial independence is the aim after all
- Being on the Age Pension isn’t fun – Centrelink want to know everything about you (updates)
- Get a plan and just start – Gaining back control
Thanks for listening!