Chairman Gramm, Senator Dodd, members of the Subcommittee, good morning. I am Marc E. Lackritz, President of the Securities Industry Association. Thank you for giving SIA the opportunity to share its views on the impact of privatization of the Social Security Trust fund on the stock market and the securities industry. We commend you for calling this hearing as a first step toward solving the problems that face our retirement safety net in the coming years. We agree with the Advisory Council on Social Security that a bold step such as investing a portion of the trust fund in the stock market - is necessary to ensure the long-term viability of Social Security. You are right to examine the implications of such a move on Social Security, the capital markets, the national savings rate, and the financial welfare of retirees.
SIA is well-qualified to comment on this subject. Our members - investment banks, broker-dealers, and mutual fund companies - are active in all markets and in all phases of corporate and public finance. They collectively account for 90 percent of securities firms' revenues, and manage the accounts of more than 50-million investors directly and tens of millions of investors indirectly through corporate, thrift, and pension plans. SIA members work with companies of every size to establish retirement plans for their employees. They also devote considerable time and effort to helping individuals assess their financial needs and invest to reach long-term goals. As the securities industry's trade association, SIA's highest priorities include increasing our country's savings rate and ensuring that all Americans have the necessary tools - such as fully deductible Individual Retirement Accounts, lower capital gains taxes, and portable pension plans - to save for a secure retirement.
For almost 60 years, Social Security has protected the economic security of America's retirees, disabled individuals, and children of deceased workers. The Federal Old-Age and Survivors Insurance trust fun is the most popular economic and social program in U.S. history because of its success in eliminating widespread poverty among the elderly. Despite its successes, dramatic changes in U.S. demographics leave the future of Social Security in doubt if policy makers do not address the coming crisis.
Social Security is basically a "pay-as-you-go" system, with current workers paying the benefits of current retirees. Right now, the Baby Boom generation is large enough to support current retirees while building up a surplus in the trust fund. Demographic trends, however, show the gap between workers and retirees widening as Baby Boomers start to leave the workforce in 2011 - only 14 years from now. The number of workers will fall sharply as the number of retirees increases - there simply are not enough members of "Generation V or "Generation Y" to support the Baby Boomers. In 1995, the Social Security trustees reported that Social Security financing at current levels would not meet Baby Boomers' retirement needs, despite a projected $2.8 trillion in trust fund assets by 2018. The trust fund is projected to decline after 2019 when payments to retirees will exceed annual Social Security revenues, including interest on the trust fund. If the system is unchanged, the trust fund will be depleted by 2029 and payroll taxes at current levels will only pay for three-fourths of the benefits due.
Meanwhile, improvements in lifestyle and medical technology have led to longer and healthier life expectancies (a "senior boom") while the birth rate has declined (a "baby bust"). Today, the average life expectancy is 25-percent longer than it was in the 1930s. By 2025, the over-65 population will have more than doubled. Such a dramatic demographic restructuring of the U.S. population has tremendous social, cultural, and economic implications. The working-age population will be shrinking while the retirement-age population is growing.
The need to finance a longer and more active retirement for the biggest generation in history presents challenges for both Social Security and for individuals. Social Security was designed in 1935 - when the average life expectancy of a child was only 61. Setting the retirement age at 65, therefore, was a reasonable policy decision. It is unlikely that today's policy makers will raise the minimum retirement age to a comparable level, so the system will have to be changed if all 76 million Boomers are to receive full benefits throughout their retirements.
In its recent report, the Advisory Council on Social Security offered three solutions to the funding crisis. Each solution proposes some measure of investment of trust fund assets into the equity markets. Mr. Chairman, you have asked us to examine how such fundamental changes in investment policy would affect the capital markets and the securities industry. Social Security privatization has been described by the press as a "boon" to Wall Street, but you do not have to scratch very far below the surface to find that little actual analysis has been done on how the stock market will be affected if Social Security funds are invested in equities. Our analysis of the numbers does not show a "big bang," but rather, when the markets are viewed as a whole, the projected flows from the Social Security trust fund are a drop in a very large bucket. Using the Advisory Council's numbers, we found that the projected flows into the equity markets would represent less than one percent of market capitalization, and would only account for about 0.5 percent of industry revenues.
From the industry's point of view, the most important aspect of allowing a portion of the Social Security funds to be invested will come from the additional clients who are attracted to securities firms if they can create personal savings accounts (PSAs) to manage part of their Social Security contributions. As is the case with any investor, these new clients would have the potential to grow in importance over time as their wealth increases and they diversify their investments to supplement their PSAs.
SIA believes that Social Security as we know it is in jeopardy unless major changes are made soon. At the outset, any reform proposal should preserve the fundamental aspects of the system - such as universal availability and minimum benefits - that are responsible for substantially reducing poverty among the elderly. We strongly support initiatives that benefit investors and the capital markets. On Social Security reform in particular, our Board of Directors has adopted three general goals that we believe should be an integral part of any reform plan:
1. Sooner Rather Than Later. SIA believes Social Security's problems must be addressed soon. Though the trust funds arc not projected to run out of money until 2019, delays increase the costs of the solution and heighten the possibility that large tax increases will be necessary. With a long lead time, reforms can be phased in and more dramatic steps - such as large tax increases or drastic cuts in benefits - can be avoided.
| Implimentation Date | Amount of Tax Increase Necessary to Maintain Benefits at Current Levels | Percent of Benefit Cuts to Maintain Taxes at Current Levels |
|---|---|---|
| 2002 | 20.16 percent | 20.5 percent |
| 2012 | 25.16 percent | 25.5 percent |
| 2022 | 32.58 percent | 33.5 percent |
In addition, individuals will need time to incorporate changes in Social Security into their long-term financial plans. Likewise, employers, who generally integrate their retirement plans with, and/or calculate benefits based on Social Security benefits, need time to adjust to the changes.
2. Increased Savings. Any solution to the Social Security problem should increase the savings rate in America rather than substitute one type of asset for another. Retirement income is often described as a three-legged stool, with Social Security, private pensions, and personal savings representing the stool's three legs. All three are necessary to support an individual in retirement. Each is based on saving and investing money earned during a worker's productive years to provide income in retirement. Of the three, Social Security has the least direct correlation to the level of contributions by individuals and their employers - benefits continue to be paid at the same level (adjusted for inflation) for as many years as a person lives in retirement. At one time, Social Security gave retirees a huge return on their investment. Today, on average, it offers young workers a negative real return. Thus, it follows that increasing the savings rate in the U.S. will benefit all three legs of the stool while taking some of the pressure off Social Security.
3. More Individual Choices. Any solution to the Social Security problem should transform at least a portion of Social Security into a true savings program that gives people a wide range of choices among investments and money managers. If individuals could invest a portion of their FICA taxes in stocks and bonds, history shows that the long-term financial return on those instruments could meet retirement needs at a fraction of Social Security's costs. For example, historical rates of return show that if people born in 1970 invested the same amount in stocks as they currently pay in Social Security taxes, they would receive nearly six times the benefit they are scheduled to receive under Social Security - as much as $11,729 per month. Even a low-wage earner would receive nearly three times the scheduled return.
As the accompanying chart illustrates, the stock market over time outperforms investments in government securities. SIA does not want to minimize the fact that the equity markets experience periods of volatility, which can reduce asset prices. The securities industry, however, has developed many different mechanisms to hedge against the dangers of bear markets. These mechanisms are used daily by individual investors, mutual and pension funds, and federal, state, and local governments to minimize risks.
With these principals as a framework, I would like to comment on the Advisory Council's three proposals and the impact each would have on capital markets and our industry.
The Advisory Council defined the problem but could not form a consensus on a single solution. All members of the panel, however, agreed that the basic features of Social Security - employee/employer contributions and universal participation - should continue and that partial advance funding should replace the current pay-as-you-go basis. They also agreed that Social Security should provide benefits that bear a reasonable relationship to total taxes paid, plus accrued interest, to each generation of workers. They agreed that this goal cannot be reached unless Social Security funds are put in investments that provide a greater return on accumulated funds than low-yielding government bonds.
Based on these areas of agreement, the Council proposed three solutions ranging from making a few changes to the current system (the Maintenance of Benefit Plan); to a more radical proposal, which would replace the current system with individually managed investment accounts (the Personal Security Account Plan); and an intermediate position (the Individual Account Plan). Each recommends some degree of investment in equities; however, they differ in their impact on the nation's savings rate, with the two individual account options raising national savings more than the Maintenance of Benefits plan.
1. Maintenance of Benefit Plan. SIA does not support the Maintenance of Benefit ("MB") plan, which calls for the government to invest directly up to 40 percent of the trust fund's balance in the equity markets. Instead of giving individuals a direct role in their retirement planning, the MB plan calls for an unusual level of direct government involvement in our capital markets. Direct government purchases of equities raises the possibility that the government would put a political stamp of approval on private enterprise - it is not hard to imagine how investment decisions could be made, not according to fiduciary considerations, but based on the politically correct or politically popular cause of the day. When state and local governments, universities, and even some mutual funds have traveled this road, investment results were generally below those of the overall equity markets. Moreover, the federal government would also face conflicts in its decision making because of the impact of tighter fiscal and monetary policy on the Social Security trust funds that the government would have placed in stocks.
To foster a true savings culture in America, individuals should be responsible for their investment decisions based on factors such as performance, service features, and costs. The MB plan, however, assumes the government is more qualified than individuals to assess their retirement needs.
2. Individual Accounts & Personal Security Accounts Plans. The Individual Account (IA) and Personal Security Account ("PSA") plans, on the other hand, directly involve individuals in investment decisions regarding a portion of their Social Security assets. SIA sees benefits and drawbacks in both plans:
Substantial investor education will be necessary to help Americans understand their options.
SIA is strongly committed to investor education, and has developed two publications to help
people make sense of available investment options. The first - Investor Topics - is a pamphlet
that answers the basic questions people have when they start investing. The second - SIA's
Your Guide to Understanding Investing - is a comprehensive and accessible guide that walks
the reader through the risks and rewards of investing. We have also worked with the
Securities and Exchange Commission in its well-received series of investor "town meetings."
As I noted at the beginning of my testimony, little actual analysis exists on the impact of investment of Social Security assets in the stock market. The Council noted in its report that it has not estimated the secondary effects on the economy that would result from the modification of the Social Security system, but points out that the initial effects on national income are essentially zero. Several organizations are working on models to predict what impact changes in Social Security will have on the economy, retirement savings, the stock markets, and the securities industry. A supposed "big bang" resulting from investment of Social Security funds in the stock market is speculation and cannot be supported by an analysis of the numbers.
As the accompanying chart illustrates, the projected flows from Social Security into the stock market would have a negligible effect on the market, given its size. At year-end 1996, the U.S. equity markets' capitalization was about $10 trillion. The value of stock flows peaks at 0.65 percent of market capitalization under the most dramatic proposal (the PSA plan) and in most years remains well under that level.
The amount of potential revenue generated under the three proposals is relatively insignificant when compared with the $120 billion in revenue earned by the industry in 1996. Assuming the industry could earn an additional one percent on the net flows into equities from Social Security funds, our firms could generate another $750 million to $1.2 billion annually from 1997-2007. As the following chart illustrates, though significant, these revenues never exceed 0.6 percent of projected industry revenues even under the PSA proposal.
We do not believe Social Security flows would overwhelm flows into equity mutual funds. As the accompanying chart shows, only the PSA proposal shows flows in excess of 25 percent of current volume into equity mutual funds, peaking in the years 1998 - 2000. After that, the percentage declines to 15 percent by 2010. This could have some positive impact on the market as the marginal demand for equities increases.
The problems facing Social Security present us with an unprecedented opportunity to
make real improvements to and restore confidence in our nation's public retirement system. Time
is running out, however, and policy makers should act soon to implement a reform plan that
preserves the strengths of the Social Security system while it repairs the flaws. Reform should
increase the U.S. savings rate and allow individuals to make choices among investment options
and advisers. While the economy - including our industry and the capital markets - will benefit
from the flow of Social Security funds into the stock market, the real winners will be American
workers who will gain a more secure retirement. Mr. Chairman, thank you again for holding this
hearing and focusing attention on these important issues. We understand that it is politically
difficult to propose changes to Social Security, but we believe changes are necessary if the system
is to thrive well into the next century.
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