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Private Accounts, Public Accountability
By Martin Mayer, New York Times
April 22, 2005
According to many reports, the Bush plan would require retirees who have chosen "personal accounts" to use most or all of the money in those accounts to purchase annuities to supplement the payments that will remain after the government recalculates their Social Security benefits. How large an annuity that retirees can buy - and thus what standard of living they may expect - will be determined largely by interest rates set by the Federal Reserve. That's a lot of power to concentrate in one conference room on Constitution Avenue.
A simple annuity provides its purchaser with a certain amount of money every month for the rest of his or her life. The Bush annuities would have to be more complicated and expensive, because their payouts would have to rise with both the cost of living and the poverty threshold.
Apart from the inflation question, however, there is an even more complex issue: the percentage of a retiree's personal account that would go toward buying the annuity. That percentage could fluctuate substantially over the year, so someone who retires in April could wind up with significantly higher or lower income from someone with the same portfolio who did not retire until October.
This difference would, in part, be a matter of routine fluctuations in the value of the stocks and bonds in the personal account - it is not unusual for the market to rise or fall 10 percent over six months. The value of any personal account will depend on the prices in the market on the day the annuity is purchased. If someone retires when the market is up, the personal account will be larger and the cost of the annuity will take a lesser share of it; if he retires when the market is down, the annuity will absorb a larger part of his account.
Even more significant, because each annuity locks in today's interest rate for what would be an average of 15 or more years, any differences in interest rates between April and October would considerably influence the price of the annuity that must be purchased. The higher the interest rate, the cheaper the price of an annuity that yields a certain income; the lower the interest rate, the more expensive the same annuity will have to be.
The Federal Open Market Committee meets eight times a year to set short-term
interest rates. As the baby boomers age, several hundred thousand more Americans will retire between these meetings, just about all of them required under the president's plan to purchase annuities to supplement their reduced Social Security payments. (If there were no legal requirement to purchase annuities, many economists, analysts and just plain wastrels would maximize their return by spending their personal accounts as soon as they have access to the money - knowing that when it ran out, they would receive money from a government embarrassed by the sight of so many old folks shuffling into soup kitchens. The minimum annuity contemplated in the Bush program is one that pays enough to bring the retiree's reduced Social Security income to the poverty line.)
Voting on interest rates in a world of private accounts, then, the Federal Reserve governors and bank presidents will know - and if they forget, the AARP will remind them - that they are voting to alter the future income of many Americans close to retirement. As Mr. Greenspan must recognize, this is a burden the Fed does not need.
Most people concerned about the security of their pensions in a world of personal accounts worry that the money would be invested in an Enron. As advertised, diversification would take care of most of that problem. But you can't diversify time. If President Bush's proposal had been in effect for the last 30 years, an American retiring in the spring of 2000 - having earned an average income and built an average personal account in index funds - would retain a personal account at least a third larger than the personal account of his younger brother, who had the same income and the same investments but retired in the spring of 2003.
And this difference would have resulted not from anybody's working harder or investing more intelligently or more fortunately. It would stem simply from the accident of having been born a couple of years later.
Over the years, central banks have learned to cope with irrational and arbitrary government policies. This one may be a step too far. Alan Greenspan should weigh in on the debate.
Martin Mayer, the author of "The Fed," is a guest scholar at the Brookings Institution
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