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 Scheme reminds us of those people who were ridiculed in the decade before the Dec. 11, 2008, arrest of Bernie Madoff. Those who pointed out that Madoff was most likely running a Ponzi Scheme were met with ignorance, ridicule and even anger.

Same thing today with Rick Perry and Social Security.

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

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

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President Roosevelt argued before the passage of the Social Security Act that it was a forced savings program, effectively insurance. This was challenged in the courts on constitutional grounds, at which point President 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 in the name of Social Security is not saved. It is spent immediately on general government expenses, just like the use of proceeds from any other tax. Benefits come exclusively from those who are paying taxes during 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 the general order of $50 trillion -- a thousand times worse. Madoff got 150 years behind bars for his $50 billion sleight-of-hand. Has a single member of the U.S. Congress voting for Social Security been sentenced or even brought to trial?

From a political standpoint, a scheme such as Social Security works as long as people in the chain letter's future look the other way. This has 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 a new front in American politics. For the first time, we may see the tables turned on these benefit programs. It has been conventional wisdom for generations that to attack Social Security is to dig your political grave because there are more older voters than younger people, who are less likely to vote.

At some point, though, people are getting sick of being lied to. The basic facts and arithmetic of Social Security are as well known as the fact that the Earth revolves around the sun, and not the other way around. Copernicus eventually commanded recognition and respect even from those who initially opposed him on religious or political grounds. Even people who benefit disproportionately from Social Security feel ashamed to try to defend the indefensible. This is the kind 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 in stating the heresy of Social Security being a Ponzi Scheme, or chain letter. Perhaps they will be proven right, politically speaking, and we will know that if Perry loses the nomination against Romney or someone 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 to do, however, is to admit the condition. Is the country ready to admit that the Social Security system is a Ponzi Scheme? Rick Perry has rolled the dice, hoping that the country is ready. There is no walking back for Perry now, having taken this biggest of bulls by the horns.

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

On the other hand, we can say that to some extent, it has never been tried before -- at least not with the backdrop of today's debt and deficit problems, the collapse of Greece and other entitlement societies and general resurgence of debates around constitutionality of government activities.

Beyond admitting the basic fact that Social Security is a Ponzi scheme, what can actually be done about it? This is where it gets tricky. Unfortunately, there is no perfectly happy ending to this. There is no perfect sweetness, light or jingles at the end of the Social 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. At the very beginning, some had put in absolutely nothing -- not one penny. 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 own retirement, not for those who had never paid a dime into the system.

That money is gone. Spilled milk. Whatever Madoff blew on consumption, it's gone. Will never be recovered. This goes for the difference between what people paid into the Social Security system, and what they received in benefits, too. When the government did run surpluses, because many people were working, it spent the excess Social Security money on other things: Guns and butter; wasn't it tempting? In 1969, the "unified Federal budget" was introduced, making this plunder very explicit, and Washington, D.C. has not looked back 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 fundamentally unsound 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, and perhaps the best near-term option. As we have all learned, when Social Security was introduced, most people lived until 62. Now they live until 77. By those standards, the Social Security eligibility age should be increased from 65 to 80.

2. Lower the benefits for those who actually receive them. This is a matter of degree, especially in the near term, but of course this also goes against what people were told when they paid into the Ponzi Scheme.

3. Raise taxes. A non-starter. Burdensome taxes are already killing the economy, and we might just as well roll down the curtain 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 an obvious outcome. Here is the crux: Right now, the young are on the hook to pay for the older people, so this would mean that they would be 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 or drastically reduce benefits for the elderly. There sure would be a lot of strife here.

5. A new source of financing. While not perfect, the only solution to the Ponzi-scheme, chain-letter dilemma is to find a new source of capital, so that the older people can get paid off, without the younger 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 Security system immediately. This clears the air, ends the Ponzi Scheme. It's like sneezing when you've been trying to hold back your entire life. Clean the pipes. Then, you create a new program in its stead. This new 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 people who are 65 years or older, from this new program. No change.

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

3. Social Security-equivalent benefits would be paid on a straight-line declining scale for those aged between 65 down to the current age of 35. If you are younger than 35 today, you get nothing from this new program.

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

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

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

The second reason it's so difficult to get rid of Social Security is the inherent conflict in all government welfare programs. It is the politicization of economic life. Some people get benefits from politicians, who take the money from others. A politician who promises to rob Peter in order to pay for Paul, can always look for support from Paul. Dividing up an economic pie with political means always causes strife, because what counts is political clout -- not voluntary contracts.

When Rick Perry became the first major U.S. Presidential contender to undress the Social Security system, it is a really big deal. It represents a paradigm shift in U.S. politics, the like of which we have not seen since the 1930s. It will be a test of our society to see if it is ready to not only hear the truth, but also accept it, just like Copernicus some 500 years ago convinced mankind to accept that 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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