How to Save Social Security!

Here is the new and improved version of the idea. The goal would be not just to “save” Social Security, but to allow it to guarantee people a 6% guaranteed return on their Social Security savings and to help reduce the volatility of the New York Stock Exchange. I’ve also now set out here a simplified version of the idea that includes fewer details of the system, to keep it simple and compelling…

The idea is that, instead of privatizing Social Security, we could have the US Government start up its own Mutual Fund, using part of the Social Security Trust Fund. The Mutual Fund, US Mutual, would take advantage of its economies of scale and target a 6% control of the predicted Total Market Valuation of the NYSE. It would circumvent its potential for corruption by basing its investments on a conservative investing strategy implicit in a simple algorithm that would only require 27 weeks of publicly available NYSE data. Almost everything would be based on simple but reliable statistics that could be verified by others. The goal would be to save Social Security, improve on the return to people’s savings therein, and to increase the stability of the NYSE and thereby attract more long term stable investment in it.

An example of the reliable statistics used would be a predicted value of the total market valuation of almost all of the NYSE. It would be based on the sum of the predicted total market valuations for all of its stocks that have been in the stock market for at least 27 weeks. The predicted valuation for each stock would be based on the median trends of their valuations from the previous 27 weeks. These predicted values would then be used as weights in the investment decisions and a simple panel-data regression whose predictions would be used in a simple algorithm to decide the weekly holdings of the mutual fund.

The algorithm would value all of the stocks in the stock market on the basis of their predicted median weekly log-returns, the log natural of 1 plus the percentage weekly return in value for a stock, and their predicted standard deviations, a measure of the stocks’ instability in value. The predicted median would be estimated by using 26 weeks of data in a median regression that would include one lagged value of the weekly log-return to predict the next week’s log-return for each stock.

The weekly log-return might have some advantages over the weekly return for the evaluation of stocks. It would fit with what has been shown to be human nature in Prospect Theory. People tend to be more averse towards losses in wealth than gains in wealth. The log-return would weight losses more than gains and mute the importance of larger gains while increasing the importance of large losses in value. To illustrate this:a 20% loss would have a log-return of -.223, a 10% loss would have a log-return of -.105, a 10% increase would have a log-return of .095, a 20% increase would have a log return of .182. This would tend to reward more stable stocks and penalize unstable stocks. It also tends to be a more stable measure of value, with a reduced kurtosis, or the fatness of the tails, that might make it easier to predict more reliably.

The median regression is also a more stable way to predict values. It minimizes the absolute value of the difference between observed and predicted values, rather than the square of the difference like a mean regression. This means the formulas used to predict next week’s log-return and its standard deviations would tend to change slowly and the holdings of the US Mutual Fund would be relatively stable.

The fund would then each week invest two-thirds of its funds, based on the target of maintaining a 6% control of the predicted total stock market valuation, in buying long in the top 20% of the stocks (weighted by their predicted total market valuations) and the remaining one-third would be used to sell short (making money for the fund off of a decline in stock value) in the bottom 5% of the stocks. This would reflect a chastened optimism that would hedge well against a worst case scenario of a general decline in the stock market value. The higher concentration in the selling short would be to compensate for their higher volatility. The specific holdings of each company in both groups of stocks(the ones the mutual fund would buy long on or sell short on) for each week would be based on a standardized value of their predicted weekly log-return.

This sort of strategy could easily be tested using historical stock market data, including the 1987 stock market crash, or even the Great Depression. Although the Mutual fund would likely perform better due to its considerable market power. I am convinced that if it targeted 6% control of the NYSE that it would save Social Security and provide more stability for the US Stock Market. It would maybe force out some of the more volatile stocks, discourage stockbrokers from trying to time the market, and reward more long-term investment strategies like that of Warren Buffet and Berkshire Hathaway. I also think that the overall reduced volatility of the market would then attract more capital away from hedges like bonds so that it can be allocated more productively.

If this issue were paired with requiring companies to list compensation under employee option plans as a direct business expense, it would make a decent rallying point this fall for economically progressive candidates, perhaps especially against the economically conservative Democratic Incumbent Joseph Lieberman in Connecticut.

dlw

Comments

11 Responses to “

How to Save Social Security!”

Alan Avans on July 7th, 2006 8:41 pm

Alan’s in da house!

“It would maybe force out some of the more volatile stocks, discourage stockbrokers from trying to time the market, and reward more long-term investment strategies like that of Warren Buffet and Berkshire Hathaway. ”

Ah. You do not know it yet dlw, but have given me the ultimate segway to a critique of your monstrous and incidious plan…bwahaha….exceeded only by the glorious and radiant light of my own thrice monstrous and incidious designs….thrice bwahahahaha

Really.

It goes something like this. It may indeed be prudent to invest Social Security funds in much the same way that Berkshire Hathaway is invested, but not quite for the curve-smoothing reasons you suggested. Berkshire Hathaway is a Business Development Company regulated in accordance with the Investment Company Act of 1940, and as such is a closed-end mutual fund that is required to invest in PRIVATE companies.

Allowing Social Security to be invested in private companies seems to me to be a good thing. It gives Main Street investment a fighting chance against Wall Street churning and speculation and would certainly increase the job creation ability of USAmerica’s small and medium-sized firms. Increased access to investment will lead to increased productivity and increasing wages, a happy outcome that investing on Wall Street does NOT guarantee.

Who’s da man?
dlw on July 7th, 2006 9:28 pm

I’m da man, but Warren Buffett’s still my daddy…

Now help me keep it simple and compelling to sell it to voters… We also might want to compare it with CalPERS…

Here’s a take:US Mutual would take advantage of its economies of scale and considerable diversification. It would have reduced overhead relative to most mutual funds. It would determine its holdings with a simple algorithm that embody Warren Buffett-style investment principles and circumvent . (We would need to get him to endorse publicly the idea. ) The effectiveness of the algorithm would be proven with historical stock market data. Such studies would demonstrate its ability to provide for a very reasonable stable return that would compare very well with other mutual funds and the overall market, particularly once adjustments are made for the leverage the mutual fund would have from its size.

This plan would have serious historic implications for the US stock market and economy. When US Mutual consistently sells short significantly on the most unstable and consistently underperforming stocks in the market, it will force behavioral changes throughout the Stock market. It will force out the most unstable stocks and reduce the overall volatility of the stock market to the advantage of smaller and medium-sized firms and small individual investors. It would also attract a lot of capital away from hedges like bonds and land.

So what say you? Let’s spread the word that Social Security will be saved!

dlw
The Anti-Manichaeist » Blog Archive » How to Save Social Security, take II! on July 8th, 2006 1:23 am

[...] I was reminded today of the importance of keeping my political reform ideas simple and compelling. I decided to rewrite my earlier idea to save Social Security, again. The basic idea would be to guarantee a 6% return for everyone’s savings held in the Social Security Trust Fund (SSTF), by having the US Government set up its very own mutual fund, US Mutual, using just a portion of the SSTF. [...]
Andy Lang on July 8th, 2006 1:22 pm

I’m a retired health and pension consulting actuary. I have known how to fix Social Security for 42 years and more recently how to use the same financial/actuarial substructure for heath care as well.

To fix Social Secuirty we need to make it as real defined benefit pension system, instead of the Potemkin Village one (that is, fake) it is now.

You do this by (a) replacing the PayGo way of financing it, with actuarially advance funding, using an actaurial Cost Method known as Entry age Normal and (b) by adding storng laws with teeth to protect the assets and the past service benefits from being cutback.

No changes in the benefits need to be made, certainly no cut backs or increases in retirement age and avoid like the plague privatization–which is the exact oppposite of what a defined benefit system is.

In fact, privatization is a scam that began from within the life insurance industry back in 1974 and from within the stock brokerage industry a year later. I’m quite familiar with both. It is all about money–gobs of it–many tens of billion each year–trillions over the next 75 years–and is unethical and immoral.

Like all good scams that have lasted a while, however, there are some things that are correct; the system needs far more investmnet returns and you need to get the bulk of them from common stocks.

You will lnever get them from individual accounts, because most people are poor long term investors and also pay far too much in fees. Also, of course privatization would place even good investors at great and unnecessary risk–the vagaries of overall markets at the time you are planning to retire.

You get them from professional experts in investing and by holding fees down by virtue of size, and by suing the aforementioned actuarial cost method–which is rigorous and self-correcting and sets aside money long in advance of it being paid out, such that the long time horizon for a significant portion of the portfolio assets works in the systems favor.

This is a collective form of investing, with very little financial risk to the system’s assets and zero risk to any participant’s benefits, since they remain ‘defined’ by a benefit formula.

It is mathematcially and actuarially impossible to have an affordable decent retirement at a decent retirement age (65) without such funding.

Actuarial advance funding has been evolving for more than 150 years, was first used by a defined benefit pension system in the early 1980s and evolved over a half century almost entirely in the private pension system, into the Entry Age Normal Actuarial Cost Method.

The reason the private pension system has nearly collapsed has been the failure to adhere to this method, eqully bad laws protecting the assets and participant benefits, and large plan sponsors and their pension actuarial consultants wanting to get rid of these systems by screwing millions of employees.

Pension consulting actuaries are the highest paid segment of the highest paid professionals on earth. It is not unusual to have top pension actuaries get paid well over $500 per hour.

It is funny what some people will do if you pay them enough money and you are in a very small, very secret profession, little understood by most people, and in nation that is financially and economically illiterate, especially in Washington DC, where few in the majority party care much about ordinarly people, except to get their votes by taking advantage of them.

By the way, we also need a national health care system that has exactly the same two components. and such a system of funding will benefit the nation not just socially but economically too–and both big time.

I am:

Andy Lang, FSA, MAAA
1426 Springton Lane
West Chester, PA 19380
610-738-9678

You may contact me if you wish to comment to me personally on andyclang@comcast.net
dlw on July 8th, 2006 5:37 pm

dlw: I think your ideas and mine can be complementary. I have a problem with basing the investing on “professional experts”, inasmuch as (1) considerable problems with the potential for corruption. (2) There’s simply too much variety across the wide range of stocks invested in the NYSE to compare and pick stocks based on qualitative factors. (3) Stocks aren’t like probability distributions, they are subject to booms and busts due to psychological factors, including future expectations.

My idea bases the holdings on a relatively simple algorithm that permits economies of scale, wide diversification, and low overhead. It removes the arbitariness of the fund holdings and circumvents the potential for corruption. It is designed to promote stock market stability and to hedge well against a worse-case, general downturn. The use of 27 weeks of data, log-returns, medians and the weight given to the stability of stocks will ensure significant continuity in fund holdings and also allow for changes. It will also likely affect the behavior of the NYSE that will make it easier for individual investors and for small to medium-sized companies to raise the capital they need. It could also draw capital away from hedges so that it will be more productively allocated.

I think also that the US Mutual fund would help to set a fire-wall around the SSTF from being raided by the gov’t, as you point out as being critical for the actuarial cost method. This is not unlike the way the state of Alaska set up a fire-wall around its Alaska permanent fund by establishing an annual income guarantee benefit from its interest earned.

dlw
Andy Lang on July 25th, 2006 11:03 am

Let’s not confuse the essence of what I am saying with the politics of how to get there or make it unnecessarily complicated.

It is impossible, mathematically and actuarially, for the vast majority of people to have a decent retirement unless you set aside money long in advance, invest it, with stocks being the key asset class, and use that money plus the invest returns to pay for the benefits.

And the returns will pay the vast bulk of the benefits too. Basically, when done right, a very good retirement can be had at very low cost–surprisingly low–when done right.

But individuals will never get those returns because they

(a) Are lousy investors, especially in stocks;
(b) Pay far too much in commissions and fees, and typically enormous amounts in transaction costs (because they buy into the mantra from the retail sector of the financial service industry, that speculation and ‘trading’ is the way to easy riches); and

(c) Many lack the disposable income, the time and the necessary knowledge of finance and economics, along with the basic contrarianism (and skepticism of basic human nature) to make intelligent long-term investment decisions.

Lastly, the use of individual accounts places everyone at great risk of retiring at the wrong time, and also of having to buy overpriced and unnecessary annuities in order to get a lifetime pension.

The way to do the investment is collective, avoids all of the above and was invented 150 years ago, used for the first time for a pension system in 1923, and then in the early 1950s, began to get rid of the insurance industry as the sole provider of retirement ‘products’ and began to use ‘Fully Trusteed’, self insured defined benefit pension plans, which invested a significant portion in stocks–because the mathematics of good retirement planning both demanded it and it was perfectly safe for the participants, as well as quite safe financially in the long run when done right.

This system, along with the concept of defined benefit pension systems was hated by that industry because it cut back those profits and heavy duty agents commissions, and because some of those renegade pension actuaries who helped this come about also knew one of the best kept secrets of that industry, namely that once you get about 1000 or so people covered, so long as you can reasonably prevent anti-selection, the group is self insured anyway–so why pay all those unnecessary ‘risk charges, to say nothing of the overhead, profit charges and those enormous, and totally unnecessary agents commissions.

In 1974 this industry put their agents in as phony actuaries–lobbied them in as Enrolled Actuaries under ERISA. ASPA, The American Society of Pension Actuaries they called themselves (Now called ASPPA, having added the term ‘Pension Professions and..” before the term actuaries.

Before that the only legitimate actuaries were all Fellows of the Society of Actuaries (FSA) and had to pass 10 rigorous examinations, far and away the hardest set of examinations of any profession.

Interestingly, at least one FSA helped this group get started a decade earlier at my firm, The New York Life Insurance Company, so they could sell more insurance products, and bypass the legitimate actuaries in the Home Office.

Even more interestingly the SOA helped this phony group become legitimate in 1974 and then they began the process of designing and pricing–doing the work of the Enrolled Actuary–for many tiny micro plans, which were nothing more than tax shelters for rich people, like doctors and dentists.

Many of these ‘plan sponsors’ got taken the cleaners because the products used for the funding were these same overpriced insurance products.

Taxpayers, of course foot the ultimate bill for this scam, because, under ERISA, the IRS required plan contributions were tax deductible to these rich folks and the interest is also tax deferred.

Over many years, in an effort to stop these scams, Congress and the IRS would enact rules and legislation that would become a nightmare for legitimate pension actuaries and their clients, accountants would do the same for pension accounting, and that ultimately would lead to the situation we find today–which is that the entire pension industry is a shell of what it was in 1980, less than half.

The life insurance industry is one of the two retail parts of the financial service industry that has caused this disaster.

They are also major players in trying to scam the American people with this privatization nonsense and for exactly the same reasons.

The other major part of the retail sector of the financial service industry that has joined with them in this Joint-Venture of Evil is the stock brokerage industry.

They began about a year later when President Ford decommissioned stock brokerage commissions.

This had the desired effect of substantially lowering commissions and this industry would then respond in exactly the same way and for exactly the same reasons as the life insurance industry.

If they could get rid of the defined benefit pension industry and also privatize Social Security, the field would be wide open for ripping off ordinary Americans.

Bush, when he was Texas Governor, made his first statement in support of privatization in 1977.

Never let it be said that ‘W’ and his partner, Karl Rove, do not recognize what side their bread is buttered on.

Again, to me the ironic part is that much of the support given to Bush has been from Red-State Americans who are precisely the ones most vulnerable to these scam artists–rural, blue collar workers–and also the ones who need retirement security the most.

This is also true of good jobs in general. Their policies have been consistently in favor of big business, the rich and connected and have widened the gap between the rich and everyone else to dangerous proportions.

It is Karl Rove’s genius to have taken the very groups who would be harmed the most by Republican and Bush’s policies and get them to support Mr. Bush–by the so-called ’social and morality issues’.

These folks in the GOP leadership have no morality–many are completely amoral–while the rest are immoral–basically a big bunch of crooks feeding at the public trough.

Lastly, Bush et al are also very much interested in privatizing Medicare and their drug law was the opening salvo into doing just that.

And, importantly, the only way you can save that system is to have a national health care system that is also actuarially advance funded, just as Social Security needs to be.

***

I now have my own Blog and will be posting these and other comments there from now on–so come join me if you wish!

http://SavingSocialSecurityAndMedicalCare.Blogspot.com/
dlw on July 25th, 2006 1:15 pm

thankyou,

This is even better written than before and still fits with my idea for a new sort of index fund.

I think that the redstaters are getting scammed easily because they have neglected to build deeper habits of political deliberation. Often times, their religious ideology exhorts them to personal holiness, avoiding all traces of sin and this practically has the effect of discouraging them from any engagement with politics, except along venues that they have been convinced (wrongly) are a-political!

Thankyou for your post. I will hope to spread the word.

dlw
The Anti-Manichaeist » Blog Archive » Words of Wisdom from Uber-Actuary Andy Lang! on July 25th, 2006 4:11 pm

[...] Lang, who has now started his own blog titled “Saving Social Security, Medicare and Capitalism”, posted again some wise comments about how to save Social Security along with some interesting history of how the insurance industry have subverted the implementation and spread of ideas/practices that would overturn their bread ‘n butter. [...]
Andy Lang on October 28th, 2006 10:04 am

The crooks in the leadership of the Republican Party are enormous. It has been going on since the ealry 80’s too.

Report Says Iraq Contractor Is Hiding Data From U.S.
By JAMES GLANZ and FLOYD NORRIS
A Halliburton subsidiary has systematically misused federal
rules to withhold information on its practices, an
oversight agency said.

http://www.nytimes.com/2006/10/28/world/middleeast/28reconstruct.html?th&emc=th

***
Man Linked to Abramoff Is Sentenced to 18 Months
By PHILIP SHENON
The former White House budget official, David H. Safavian,
wept as he pleaded for leniency from the judge as he was
sentenced for lying about his relationship to the lobbyist
Jack Abramoff.

http://www.nytimes.com/2006/10/28/washington/28lobby.html?th&emc=th

***

No Taxes Until After the Election
The possibility that I.R.S. commissioner Mark Everson is
wielding power in ways to please his boss, President Bush,
is especially disturbing given that he has courted that
suspicion before.

http://www.nytimes.com/2006/10/28/opinion/28sat2.html?th&emc=th
dlw on October 28th, 2006 12:42 pm

thanks for the posts, Andy.

dlw
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