Addressing Social Security's Ponzi Scheme

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Ever since the creation of Social Security in 1935, politicians of all stripes have denied that this system is in any way problematic. They may have disagreed with its creation -- as articulated by Barry Goldwater in 1964, for example -- but no candidate at the presidential contender level had yet pointed out that the emperor has no clothes.

Until now.

Rick Perry frankly admitting that Social Security is a Ponzi Schemereminds us of those people who were ridiculed in the decade before theDec. 11, 2008, arrest of Bernie Madoff. Those who pointed outthat Madoff was most likely running a Ponzi Scheme were met withignorance, ridicule and even anger.

Same thing today with Rick Perry and Social Security.

There is a difference, though. Madoff operated in relative obscurityto the common man, so to undress his scam prior to Dec. 11, 2008,took considerable skill and knowledge of accounting. In contrast, themechanics of the Social Security system has been hiding in plain sightfor decades.

Everyone with even the most basic understanding of mathematics knowsthe nature of the Social Security system. It is not in dispute. Thegovernment itself has argued the truth in the courts. It is simply atax-and-benefit system that gives a vague appearance of being"savings" in "accounts." In reality, there are no such things -- nosavings and no accounts.

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President Roosevelt argued before the passage of the Social SecurityAct that it was a forced savings program, effectively insurance. Thiswas challenged in the courts on constitutional grounds, at which pointPresident Roosevelt's lawyers changed their tune and told the truth:It's just a tax-and-benefit program. No savings, no accounts.Roosevelt won the constitutional argument in the courts.

So the facts are not in dispute. The money that's being collected inthe name of Social Security is not saved. It is spent immediately ongeneral government expenses, just like the use of proceeds from anyother tax. Benefits come exclusively from those who are paying taxesduring the year the benefits are paid. A chain letter, in other words.

Call it whatever you want -- Ponzi Scheme, chain letter, fraud,Madoff. Except this Madoff isn't $50 billion, but rather on thegeneral order of $50 trillion -- a thousand times worse. Madoff got150 years behind bars for his $50 billion sleight-of-hand. Has asingle member of the U.S. Congress voting for Social Security beensentenced or even brought to trial?

From a political standpoint, a scheme such as Social Security works aslong as people in the chain letter's future look the other way. Thishas certainly been the case, with Social Security being considered"the third rail" of U.S. politics for decades.

Now, this may just be changing. Rick Perry has opened the door to anew front in American politics. For the first time, we may see thetables turned on these benefit programs. It has been conventionalwisdom for generations that to attack Social Security is to dig yourpolitical grave because there are more older voters than youngerpeople, who are less likely to vote.

At some point, though, people are getting sick of being lied to. Thebasic facts and arithmetic of Social Security are as well known as thefact that the Earth revolves around the sun, and not the other wayaround. Copernicus eventually commanded recognition and respect evenfrom those who initially opposed him on religious or politicalgrounds. Even people who benefit disproportionately from SocialSecurity feel ashamed to try to defend the indefensible. This is thekind of shame that enabled political revolutions around the world,ranging from East Germany to South Africa.

The Political Risk

Political analysts have gasped at Rick Perry's political naivete instating the heresy of Social Security being a Ponzi Scheme, or chainletter. Perhaps they will be proven right, politically speaking, andwe will know that if Perry loses the nomination against Romney orsomeone else -- or for that matter the general election against Obama.

But maybe this time it will be different.

Some alcoholics do go sober. The first thing an alcoholic needs todo, however, is to admit the condition. Is the country ready to admitthat the Social Security system is a Ponzi Scheme? Rick Perry hasrolled the dice, hoping that the country is ready. There is nowalking back for Perry now, having taken this biggest of bulls by thehorns.

The political calculation is enormous. Perry is counting on theself-interest of the young, as well as the conscience of at least someon the other end of the scale, to start the process of minimizing thedamage for future generations. On the one hand, we can say that thisis a calculation that has never worked before, politically speaking.

On the other hand, we can say that to some extent, it has never beentried before -- at least not with the backdrop of today's debt anddeficit problems, the collapse of Greece and other entitlementsocieties and general resurgence of debates around constitutionalityof government activities.

Beyond admitting the basic fact that Social Security is a Ponzischeme, what can actually be done about it? This is where it getstricky. Unfortunately, there is no perfectly happy ending to this.There is no perfect sweetness, light or jingles at the end of theSocial Security reform rainbow.

Why is reforming Social Security so hard? There are two reasons:

The Money Is Gone, Jim!

Starting in the late 1930s and for the first few years and decades,Social Security recipients got a lot more money than they put in. Atthe very beginning, some had put in absolutely nothing -- not onepenny. This changed on a graduated scale over the next few decades,but basically, it was free welfare for tens of millions of people --paid for by people who thought that they were saving for their ownretirement, not for those who had never paid a dime into the system.

That money is gone. Spilled milk. Whatever Madoff blew onconsumption, it's gone. Will never be recovered. This goes for thedifference between what people paid into the Social Security system,and what they received in benefits, too. When the government did runsurpluses, because many people were working, it spent the excessSocial Security money on other things: Guns and butter; wasn't ittempting? In 1969, the "unified Federal budget" was introduced,making this plunder very explicit, and Washington, D.C. has not lookedback since then.

Again, the money is gone. That's the first reason reforming Social Security is so hard. With that being the case, how do you unwind this fundamentallyunsound system before it causes more damage to our balance sheet?

There is no pretty picture here. Here are the levers:

1. Raise the age for benefits. This one is relatively easy, andperhaps the best near-term option. As we have all learned, whenSocial Security was introduced, most people lived until 62. Now theylive until 77. By those standards, the Social Security eligibilityage should be increased from 65 to 80.

2. Lower the benefits for those who actually receive them. This is amatter of degree, especially in the near term, but of course this alsogoes against what people were told when they paid into the PonziScheme.

3. Raise taxes. A non-starter. Burdensome taxes arealready killing the economy, and we might just as well roll down thecurtain on job creation and competitiveness.

4. Reduce benefits for younger people. Of course, the only long-term solution is to end the program for younger people, so this is anobvious outcome. Here is the crux: Right now, the young are on thehook to pay for the older people, so this would mean that they wouldbe paying while simultaneously knowing that they will receive nothing. Hardly an enticing prospect. If this were the only alternative,sooner or later enough younger people would simply vote to abolish ordrastically reduce benefits for the elderly. There sure would be alot of strife here.

5. A new source of financing. While not perfect, the only solutionto the Ponzi-scheme, chain-letter dilemma is to find a new source ofcapital, so that the older people can get paid off, without theyounger people having to pay for it in a very directed manner. Solution: The only way to un-tie this knot is to sell government property in order to pay off the Social Security obligations.

Here is how you do it: You start by abolishing the Social Securitysystem immediately. This clears the air, ends the Ponzi Scheme. It'slike sneezing when you've been trying to hold back your entire life.Clean the pipes. Then, you create a new program in its stead. Thisnew program will be the transition to a private 401(k) style system,or however people choose to save and invest in the future.

This is how the program transition would work:

1. Full Social Security-equivalent benefits would be paid to peoplewho are 65 years or older, from this new program. No change.

2. Over the course of a 30 year period, the eligibility age would beraised by 1 year every 2 years, so that after 30 years, theeligibility age would have increased from 65 years to 80.

3. Social Security-equivalent benefits would be paid on astraight-line declining scale for those aged between 65 down to thecurrent age of 35. If you are younger than 35 today, you get nothingfrom this new program.

4. Raise the funds to pay for this new program through the sale ofgovernment property. Sell government land and other installations,including roads, bridges, ports and airports. The government is byfar the largest land owner in the country, accounting for 80% of allland in some states such as Nevada. In California, government ownsspectacular beachfront property that would get top dollar.

This transition that I am proposing has the major benefit that itimmediately and permanently gets rid of the Social Security tax. Italso phases out the new Social Security-equivalent program to thepoint where it will cease to exist approximately 80 years from now,when the last current 35-year-old has died.

By the time this wouldpass Congress, approximately 80 years will have gone since theintroduction of Social Security, and now it will take another 80 yearsto wind it down. It's almost poetic in its symmetry.

The second reason it's so difficult to get rid of Social Security isthe inherent conflict in all government welfare programs. It is thepoliticization of economic life. Some people get benefits frompoliticians, who take the money from others. A politician whopromises to rob Peter in order to pay for Paul, can always look forsupport from Paul. Dividing up an economic pie with political meansalways causes strife, because what counts is political clout -- notvoluntary contracts.

When Rick Perry became the first major U.S. Presidential contender toundress the Social Security system, it is a really big deal. Itrepresents a paradigm shift in U.S. politics, the like of which wehave not seen since the 1930s. It will be a test of our society tosee if it is ready to not only hear the truth, but also accept it,just like Copernicus some 500 years ago convinced mankind to acceptthat Earth revolves around the sun.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Anton Wahlman was a sell-side equity research analyst covering the communications technology industries from 1996 to 2008: UBS 1996-2002, Needham & Company 2002-2006, and ThinkEquity 2006-2008.

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