Analysis: The Coming Social Security Crisis

No good end comes of denying that there is a catastrophe looming in the Social Security system; neither will anything useful come of talking about solutions for problems that might or might not occur in fourteen, forty-four, or any other far-away number of years. The crisis is right around the corner, it will happen, and no solutions have been offered that would prevent millions of younger Americans from living the last years of their lives in poverty.

Although the fundamentals of what is about to happen are thoroughly covered in any respectable introductory class in financial management, it is only after long training and/or extensive experience that those lessons might soak in far enough for someone to understand the awful and unavoidably ruinous game that is about to be engaged. Read carefully what is to follow. Do not wave your mental hand in the air about how "theories are made to be proved wrong," or some such nonsense. This is not theory; it is the way of the markets, and it will not relent just because the new players need some slack.

Stock markets are the hunting ground of huge investors, some with the power to buy and sell literally hundreds of millions of dollars worth of securities in a single day. At their disposal is instantaneous access to thousands of formal and informal information streams, all pouring through their scope of awareness in real time, twenty-four hours a day, seven days a week, three hundred and sixty-five days a year. The consciousness of the institutional and other large investors is far beyond that of any given person or group of people within the machinery. Data passes to information, information is processed at the human and computer levels, and the distilled knowledge flows as light-speed rivers across trading screens around the globe as traders make their best moves to the end of profiting under conditions of risk.

Here are the rules of the game:

Rule 1:
The greater the risk, the greater the expected return.

If you want to make more money, you must bear a higher chance of getting knocked down. You have no business thinking that you'll get the same rate of return, for example, on a corporation's mortgage bonds as you will on that same corporation's stock. The bond is secured, and the coupon (interest) payments must be made before the shareholders can see a dime. Hence, the bond will be a less risky investment than the stock, and it will yield a lower expected return.

Rule 2:
Information more than a few seconds old is worthless.

You are dabbling in the world of people and machines that are, every second of every day, scouring every possible source of knowledge on the planet about securities and the assets that underlie them. Anything that is worth knowing is immediately and without prejudice pressed into service as purchases and sales of those securities, and the resulting buy and sell orders drive prices up and down, which then telegraphs that original information to every other market participant. If you think you've got the inside scoop on the "big boys," you are a damned fool.

Rule 3:
No one—but NO one—"beats the market."

The next time you hear about some fund manager whose mutual fund earned way above what all the other mutual funds earned, ask yourself the simple question, based on Rule 1, above: What risk was borne in that portfolio? There is nothing admirable, heroic, or even noteworthy about someone who takes on gobs and gobs of risk just to get a higher return. That's what's supposed to happen. What needs to be disclosed is not how high the fund's return was, but rather, was the risk that was assumed commensurate with that return?

Think about it this way. Your friend comes into the bar waving a hundred dollar bill. You and the other patrons are impressed, since this fellow is usually mooching drinks off everybody else; but tonight, it's his turn to buy. He tells you that he earned the money betting on one hand of blackjack, and all he had to bet was two dollars. You and the other patrons are now even more impressed, since he was risking very little for a significant return. However, a couple hours and quite a few drinks later, he mentions that if he had lost that hand of 21, not only would he have never seen his two dollars again, but he would also have been forced to surrender one of his kidneys.

Still think the hundred dollars was a great return? (If you do, you're ready to become one of those financial news commentators who drool all over the latest "genius" portfolio fund manager.)

Rule 4:
For every winner, there will be at least one loser.

No, all boats don't "rise together." The stock markets are where your money—your chump change, your "I'll-have-some-fun" money, your house payment money, your life savings money, your retirement money—is at best a modest meal for someone who is far richer, smarter, and more powerful than you'll ever dream of being. Deal with it.

If it's any comfort to you, the faceless guy who takes your life savings isn't any more significant to the stock markets than you are. He's just better at the game than you'll ever be.

Rule 5:
Investment advisers don't sell wealth; they sell a product.

If you pay someone to tell you how to invest, you will be given the benefit of a tiny shard—a snapshot, if you will—of the mass of information out on the Street. The investment adviser doesn't have time to give you special care. In the grand scheme of Wall Street, you are nothing, and so is he. What you'll get is canned advice about portfolio structures and the securities that would create general risk-versus-expected return profiles. The investment adviser can't sell you a roadmap to Wealth City any more than a television evangelist can sell you a cheap seat on the redeye to Heaven.

Now comes partial privatization of Social Security, where some of you get a real piece of the action in the new "ownership society."

You're going to be allowed to buy stocks with some of your Social Security withholdings. You'll be given a list—a fairly short one at first, but you'll have more options as time goes on. That list will be nice to have for guidance: it will focus your diligent analysis and keep you from spending too much time poring over historical stock price charts and old financials, which are completely useless, anyway, since historical information is already impounded in stock prices (see above). But it's okay if you waste your time looking at stuff like that since it will make you feel like you're one of the financially savvy sorts, especially when you sit at the all-night diner working out which stocks you're going to buy from your government-approved list.

Oh, but wait a minute. If you know what stocks are going to be available when the partial privatization goes into effect, won't the real big dogs know, too? Could that be a little problem?

Recall—if you didn't know it already—that many of the major stock indices have actually suffered negative annualized rates of return over the past four years. Right now, you could say that stock prices are "depressed," meaning that the heavy investors, if they so chose, could move in at fire sale prices. Now, why would they do that?

Well, let's see: tens of millions of suckers are about to start shoveling what will eventually amount to a couple trillion dollars into stocks. The list of what stocks the suckers are going to be allowed to shovel their money into will have already been out there on the Street.

The powerful, smart, capital-flush giants of Wall Street are going to buy in before the enabling legislation is even passed, and they'll do so with huge amounts of capital. They'll be methodical, systematic, and quiet. Of course, they'll be buying in at the depressed prices of the current era, and then they'll wait patiently for the fun to begin. Here comes two trillion dollars of amateurs' retirement money pounding into those stocks, driving their prices upward under surging demand. And there, at the other end of that money elevator, stand all of those big dogs who bought in at the low prices. Note the engraved inscription on their shovel handles; it reads: "Buy low, sell high."

As they sell out at the high prices your stock-buying binge created, suddenly that capital appreciation of yours just starts to wither away. No matter how hard you and your millions of fellow new investors hammer money into the system with buy orders, the shovels will just keep hauling it out the other end.

Oh, and unlike a normal investor who could bail at will on underperforming securities, you won't get to do that: you're in a retirement fund, which means that you have to wait for trading "windows" to open before you can get out. Of course, by the time your exit door opens, your portfolio will already have been stripped of any capital appreciation. Worse, you might even have lost some of the principal, as well, unless the underlying fundamental trend of these past four years somehow, miraculously turns around in the face of rising interest rates, a collapsing dollar, and nose-bleed federal budget deficits.

In other words, future investors, you're going to get your clocks cleaned, and you won't be able to do a thing about it.

But you can look on the bright side: some night very soon, a bunch of rich people are going to have a pretty decent meal with that retirement money of yours.

You can almost hear them saying, "Crisis? What crisis?"




The Dark Wraith has spoken.