Commentary

Meltdown Was Perfect Stress Test For Market-Based Pension Reform

We learned a few lessons in 2008.

First, markets can decline dramatically everywhere, and all at the same time. Not just stocks, but bonds, commodities, real estate, you name it.

Second, a leveraged economy is an ugly thing when the music stops.

Third, government amplifies the ugliness by playing favorites. (Housing, for example.)

Fourth, irrespective of the global market meltdown, saving and investing still provide greater retirement benefits than does Social Security, and by a lot.

The last lesson may seem counterintuitive, for many pundits suggest that the events of 2008 finally established that free-market Social Security reform is ill-advised. It isn’t. Furthermore, 2008 provides an excellent stress test of the reform theory — for it is an almost perfect laboratory condition of what can go wrong.

The U.S. stock market fell by 37% last year, the worst year since 1931 when it plummeted by 43%. Given historical returns, the odds of such a decline were quite low. Not only was this unusual, but for someone set on retiring it was devastating.

The reason is not so much that the market fell so drastically, but rather that it did so when it did. A big portfolio loss is best endured at the beginning of a worker’s career, not the end when all the accumulated assets are subject to the decline.

Balanced funds did poorly as well. A portfolio of 70% stocks and 30% bonds dropped 21%. Historically, this decline was also unusual and unusually bad; it was the third-worst year since 1926. And, importantly, this portfolio is one that workers could possibly choose as a replacement for Social Security.

To compare retirement benefits financed from this portfolio to Social Security’s benefits, let’s assume a worker with a history of average wages retires in 2008 at age 66 and receives his first Social Security check in January 2009. Based on Social Security’s benefit formula, his first monthly check is $1,527, or $18,324 for all of 2009.

Under present law this benefit will increase with inflation. If our worker is married, his spouse, who is usually younger, may receive a benefit at the same time even if she does not have any wage history.

Their combined annual benefit of roughly $25,100 will drop by one-third on the death of either family member, and will be zero upon the death of both. These amounts are not guaranteed by the government, and beneficiaries have no legal right to their receipt.

William G. Shipman is chairman of CarriageOaks Partners LLC and co-chairman of the Cato Institute Project on Social Security Choice.