If Social Security Had Been In Private Accounts The Stock Market Drop Could Have Been A Disaster

CREDIT: AP Photo/Paul Vernon

Republican presidential candidate Jeb Bush at an Americans for Prosperity event

The stock market continued a period of volatility on Monday. Media reports sounded the alarm as the DOW opened 1,000 points down and other indexes took huge hits, only to climb back up a bit later in the day. While that performance, which had some people calling it black Monday, may have knocked a good deal of money out of people’s 401(k) retirement accounts, Social Security benefits remain by and large untouched by such fluctuations.

Some Republicans, however, are interested in changing that.

In June, presidential candidate Jeb Bush said that he thinks the next president will have to try to privatize Social Security. Others have gotten behind the idea as well: Sen. Rand Paul (R-KY) drafted a plan in 2013 that included partial privatization, and Sen. Ted Cruz (R-TX) is in favor of using private accounts. Rep. Paul Ryan (R-WI) has included privatization in his budget blueprints.

The market drop, and ones before, expose the dangers of such a plan, which usually entails diverting some or all of the money workers contribute to Social Security through their paychecks into private investment accounts. That would put individuals in charge of making smart enough investment choices in the market to make big enough returns to support themselves in retirement.

But the reality is that’s not within reach for most individual people. During a market rout like Monday’s, many people will panic and sell. “We know a lot of people do what economists say is irrational, they sell at a low point,” said Dean Baker, co-director of the Center on Economic and Policy Research. Research shows that the best thing to do during a downturn is to hold out if possible. But that’s not how most people will react. “People see something like this and go, ‘I better get out,'” Baker said. “When they see the market start to go up, they say, ‘I better buy in,’ and then they’ve lost a lot.”

This is one of the big problems with privatizing Social Security: individual investors don’t tend to be that savvy in chasing higher returns. “A lot of people make wrong decisions,” Baker said. This is even true when it comes to retirement planning: Many people leave money on the table with their 401(k)s by not taking advantage of employer matches or cash out when they switch jobs and incur taxes. The point of Social Security contributions is to make saving for retirement mandatory, he pointed out. But “if you do that and then just tell people to do whatever you want [with the money], then a lot of people will make mistakes and end up with not very much in retirement.”

On a larger level, putting people’s Social Security contributions into private accounts makes them far more exposed to the irrationality of the market. “What’s beautiful about Social Security is that in the long the return workers get on contributions is linked to productivity growth and wage growth,” said Monique Morrissey, an economist at the Economic Policy Institute. “Whereas markets are notoriously volatile and often behave in ways that are not based on the fundamental strength and weakness of the economy.”

Americans are already affected by those ups and downs of the stock market through their 401(k) savings, which have skyrocketed in recent decades. Privatizing Social Security would increase the risks they have to take on. “We have a system where workers are already far too exposed to the vagaries of the stock market,” Morrissey said. “We don’t need to be expanding that.”

This is particularly problematic for anyone who needs to retire in the midst of a serious market downturn, such as during the recession. “We do have periods where the market is down for long periods of time,” Baker noted. Social Security “was supposed to be money you could count on and be sure it’s there. If it’s in the market or substantial portions are in the market, you run a really big risk of retiring at a time when it’s not there.”

That may have driven home an aversion to the idea of fundamentally changing Social Security. “The last stock market plunge in 2008 actually was the nail in the coffin of the idea of privatization,” Morrissey said. “It became very visceral for all the people who lost a huge amount of money in 401(k) plans.” But Republicans still seem intent on bringing the issue back to life.