Saturday, February 5, 2011

Madoff, Social Security, and the Mets

In the wake of the Madoff Ponzi scheme coming to light, many people debated whether or not Social Security was also a Ponzi-like scam.  According to the Securities and Exchange Commission, a Ponzi scheme has the following characteristics:
  1. Payments to existing investors are paid out of the investments of new investors.
  2. New investors are lured by promises of above average returns.
  3. Because the scheme requires a constant inflow of money from new investors to pay existing ones, the scheme falls apart when new investors cannot be attracted.
Social Security certainly satisfies property #1.  Contrary to popular belief, the money that you contribute towards Social Security is not set aside in a separate account just for you.  That money is used to pay existing retirees.  By the time you retire, your Social Security payments will be funded by the contributions of those in the work force at that time.

However, Social Security does not satisfy the other characteristics of a Ponzi scheme.  With very few exceptions all new workers are required to contribute towards Social Security, so there will always be a steady inflow of new funds.

At least that is the theory.

Unfortunately, Social Security faces a Ponzi-like conundrum known as the Baby Boomers.  Over the next couple of decades, a large number of people will be collecting benefits, and there will not be enough workers to sustain these benefits.  Here is what the Social Security Administration says about this demographic problem:

"The number of retired workers is projected to grow rapidly starting in 2008, when the members of the post–World War II baby boom begin to reach early retirement age, and will double in less than 30 years. People are also living longer, and the birth rate is low. As a result, the ratio of workers paying Social Security taxes to people collecting benefits will fall from 3.3 to 1 in 2007 to 2.1 to 1 by 2034. The Trustees Report projects that in 2017, when the ratio will be 2.7, there will not be enough workers to pay scheduled benefits at current tax rates. The Trustees Report also projects that redemption of trust fund assets will be sufficient to allow for full payment of scheduled benefits until 2041."

It appears as if there may not be enough investors to sustain the benefits for the existing investors.  This is where a Ponzi scheme would collapse.  Obviously something must be done to make Social Security sustainable once again.  Unfortunately, most of the solutions that have been put forth put most of the burden on future retirees:  the farther in the future you are going to retire, the more of a financial cost you will pay for reforming Social Security.

AARP has a poll running on its web site asking readers to vote on the single best way to sustain Social Security.  Here are the possible choices:
  1. Raise the retirement age.
  2. Eliminate the salary cap.
  3. Increase the payroll tax.
  4. Reduce benefits for future retirees.
  5. None of the above.
All of these choices are the standard solutions that have been proposed to save Social Security.  However, the younger you are, the more each of these solutions is going to cost you.  If you are 18 and just entering the workforce, either you will spend the next 50 years paying higher taxes (#2 and #3), or you will get fewer benefits (#1 and #4).  I rarely see any proposal which suggests cutting benefits to current retirees or raising taxes more for those who are closer to retirement.  Suggesting these things conjures up images of elderly people being forced to subsist on dog food or worse.  I certainly would never suggest that those senior citizens who need Social Security to survive should lose their benefits.  For those individuals, they should continue to get their full benefits, and we should consider increasing their benefits.  However, for those people for whom Social Security isn't a matter of life and death (i.e. retirees who are living on the golf course playing bridge all day), they certainly can afford to take on a little bit of the burden for saving Social Security.

I think the trustee for the Madoff victims has gotten this issue right.  Sports fans have probably heard that the owners of the New York Mets are being sued by the trustee in order to recover profits which they earned from the Madoff Ponzi scheme.  The trustee alleges that the owners of the Mets actually cashed out their investments, earning millions of dollars in the process.  Meanwhile those newer investors who did not cash out when the scheme fell apart lost everything. 

To me, it makes perfect sense that the owners of the Mets should share in the financial pain.  Why should they keep their profits just because they were lucky enough to be one of the older investors, while the newer investors take 100% of the hit?  The owners of the Mets should be required to return all of their profits back into the recovery pool, and then the trustee would distribute the monies to all of the aggrieved parties equatably. 

Likewise, why should most of the cost of fixing Social Security be paid by the newest workers?  All generations should share in the burden of making Social Security solvent.  It is only fair.


  1. I don't think the Mets knew this was a ponzi scheme. Why should they be penalized?

  2. It's not that they should be penalized. It's that they should not benefit. There is a difference.

    My understanding of the facts is that the Mets' owners actually made a profit from their Madoff investments. Of course, we now know that the profits were "stolen" from new investors to the scheme. Why should one person profit just because they happened to cash out before the scheme fell apart, while another investor should lose everything just because they happened to invest when the scheme collapsed? The owners of the Mets should have to give back any profits that they made, and that money should be distributed to those who lost their principal.

    Here is the analogy that I would make. It's not a perfect analogy, but it has some merit.

    Let's say that somebody sells you a used car that turns out to be stolen. Should you get to keep the car,should you be forced to give it back to the original owner, or should there be some arrangement in between (i.e. sell the car and split the proceeds)? Obviously, the first option isn't fair to the person from whom the car was stolen, and the third option isn't fair to the person who bought the car. Probably something in between is fair.

    That is all that the Madoff trustees are looking for. They want Mets owners to give back some of the stolen money so that those from whom it was stolen get something back.

  3. CORRECTION: Obviously, the first option isn't fair to the person from whom the car was stolen, and the second option isn't fair to the person who bought the car. Probably something in between is fair.