U.S. GOVERNMENT PRINTING OFFICE

55–156CC WASHINGTON : 1999

THE MARKET IMPACT OF THE PRESIDENT’S

SOCIAL SECURITY PROPOSAL

HEARINGS

BEFORE THE

SUBCOMMITTEE ON

FINANCE AND HAZARDOUS MATERIALS

OF THE

COMMITTEE ON COMMERCE

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

FEBRUARY 25 and MARCH 3, 1999

Serial No. 106–5

Printed for the use of the Committee on Commerce

(

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COMMITTEE ON COMMERCE

TOM BLILEY, Virginia, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

MICHAEL G. OXLEY, Ohio

MICHAEL BILIRAKIS, Florida

JOE BARTON, Texas

FRED UPTON, Michigan

CLIFF STEARNS, Florida

PAUL E. GILLMOR, Ohio

Vice Chairman

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

NATHAN DEAL, Georgia

STEVE LARGENT, Oklahoma

RICHARD BURR, North Carolina

BRIAN P. BILBRAY, California

ED WHITFIELD, Kentucky

GREG GANSKE, Iowa

CHARLIE NORWOOD, Georgia

TOM A. COBURN, Oklahoma

RICK LAZIO, New York

BARBARA CUBIN, Wyoming

JAMES E. ROGAN, California

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

VITO FOSSELLA, New York

ROY BLUNT, Missouri

ED BRYANT, Tennessee

ROBERT L. EHRLICH, Jr., Maryland

JOHN D. DINGELL, Michigan

HENRY A. WAXMAN, California

EDWARD J. MARKEY, Massachusetts

RALPH M. HALL, Texas

RICK BOUCHER, Virginia

EDOLPHUS TOWNS, New York

FRANK PALLONE, Jr., New Jersey

SHERROD BROWN, Ohio

BART GORDON, Tennessee

PETER DEUTSCH, Florida

BOBBY L. RUSH, Illinois

ANNA G. ESHOO, California

RON KLINK, Pennsylvania

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

THOMAS C. SAWYER, Ohio

ALBERT R. WYNN, Maryland

GENE GREEN, Texas

KAREN MCCARTHY, Missouri

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

THOMAS M. BARRETT, Wisconsin

BILL LUTHER, Minnesota

LOIS CAPPS, California

JAMES E. DERDERIAN, Chief of Staff

JAMES D. BARNETTE, General Counsel

REID P.F. STUNTZ, Minority Staff Director and Chief Counsel

SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS

MICHAEL G. OXLEY, Ohio, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

Vice Chairman

PAUL E. GILLMOR, Ohio

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

STEVE LARGENT, Oklahoma

BRIAN P. BILBRAY, California

GREG GANSKE, Iowa

RICK LAZIO, New York

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

VITO FOSSELLA, New York

ROY BLUNT, Missouri

ROBERT L. EHRLICH, Jr., Maryland

TOM BLILEY, Virginia,

(Ex Officio)

EDOLPHUS TOWNS, New York

PETER DEUTSCH, Florida

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

DIANA DEGETTE, Colorado

THOMAS M. BARRETT, Wisconsin

BILL LUTHER, Minnesota

LOIS CAPPS, California

EDWARD J. MARKEY, Massachusetts

RALPH M. HALL, Texas

FRANK PALLONE, Jr., New Jersey

BOBBY L. RUSH, Illinois

JOHN D. DINGELL, Michigan,

(Ex Officio)

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C O N T E N T S

Page

Hearings held:

February 25, 1999 ............................................................................................ 1

March 3, 1999 ................................................................................................... 57

Testimony of:

Glassman, James K., Dewitt-Wallace Reader’s Digest Fellow, American

Enterprise Institute ...................................................................................... 32

Greenspan, Hon. Alan, Chairman, Board of Governors, Federal Reserve

System ........................................................................................................... 78

John, David C., Senior Policy Analyst for Social Security, Heritage Foundation ............................................................................................................. 27

Pomeroy, Hon. Earl, a Representative in Congress from the State of

North Dakota ................................................................................................ 10

Reischauer, Robert D., Senior Fellow, Brookings Institution ....................... 21

Sanford, Hon. Mark, a Representative in Congress from the State of

South Carolina .............................................................................................. 13

Smith, Hon. Nick, a Representative in Congress from the State of Michigan .................................................................................................................. 6

Summers, Lawrence H., Deputy Secretary, Department of the Treasury ... 111

(III)

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THE MARKET IMPACT OF THE PRESIDENT’S

SOCIAL SECURITY PROPOSAL

THURSDAY, FEBRUARY 25, 1999

HOUSE OF REPRESENTATIVES, COMMITTEE ON COMMERCE, SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS, Washington, DC.

The subcommittee met, pursuant to notice, at 10:20 a.m., in room

2123 Rayburn House Office Building, Hon. Michael G. Oxley (chairman) presiding.

Members present: Representatives Oxley, Gillmor, Greenwood,

Cox, Lazio, Shimkus, Shadegg, Fossella, Ehrlich, Bliley (ex officio),

Stupak, Luther, Markey, and Pallone.

Staff present: David Cavicke, majority counsel; Linda Dallas

Rich, majority counsel; Brian McCullough, majority professional

staff; Robert Simison, legislative clerk; and Consuela Washington,

minority counsel.

Mr. OXLEY. The subcommittee will come to order, and before we

recognize the members of the panel, there is a call for a floor vote.

So I would yield to the gentleman from Massachusetts for 5 minutes.

Mr. MARKEY. Thank you, Mr. Chairman, very much. I want to

highly commend you for having this hearing. Key components for

any Social Security reform legislation have to come through the

aegis of this committee.

I am an advocate for investing a portion of the surplus in the private sector, and Mr. Bartlett and Mr. Pomeroy and I will be introducing a bill to do this in a fair and measured way this afternoon.

This idea has many detractors, and we will be hearing from some

of them today. But to paraphrase Winston Churchill, investing a

portion of the Social Security surplus in the private sector is the

worst method of saving Social Security except all the other methods.

We could, of course, close the gap in some other way. For example, we could raise the progressive payroll tax or we could cut the

benefits. But it is no accident that these alternatives have few political champions. After all, they both involve tipping people upside

down and shaking money out of their pockets. The President’s proposal to invest some of the trust money in the private sector closes

that gap by another 6 years.

Critics of investing a portion of the surplus in the financial markets are frightened by these new potential dangers. One is the potential danger of gambling on a market that could crash. The second is the potential danger of political meddling in the economy.

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Both of these concerns are valid, but their potential for materializing can be reduced to near zero by limiting the investment authority in important ways. It is certainly valid to be concerned

about tying the level of an individual’s benefit to the rise and fall

of the market.

The stock market crash in 1929 was a defining event for the families of many of today’s retirees, and they have a visceral negative

reaction to giving up the current system, which guarantees benefits, in favor of a system in which benefits vary from the whims of

what they view to be the stock market casino.

To reassure these anti-gamblers, we must not alter the fundamental guarantee of the Social Security system, that benefits will

be maintained no matter what the condition of the economy on the

day an individual retires.

That is the fatal weakness of the proposals to privatize Social Security, where the guarantee is either eliminated or reduced in favor

of, well, gambling by individuals of a sort so aptly detailed in this

morning’s Washington Post. Such a system would no longer merit

the term ‘‘security.’’ Instead, it crosses that thin line between vision

and vagueness.

Now, the concern about political meddling comes in two forms.

First, great fear that this proposal will destroy the market simply

because of the sheer size of the trust fund. But we are limiting the

amount of the trust funds that could go into the markets to just

4 percent of the market, less than half of the amount currently accounted for by State and local pension funds.

Are critics of the President’s proposal suggesting that we should

ask the State and the local pension funds to no longer be in the

market? I do not hear that suggestion. And they have at least twice

as much as anything that is being proposed for the Federal Government.

Second, opponents say that this proposal would socialize our

economy by allowing Federal ownership of corporate America, leading inevitably to meddling in the marketplace by politicians intent

on disinvesting in tobacco or South Africa or unloading investment

in housing in the inner city or in pockets of rural housing.

But at the Federal level, we have had a decade of experience

under the Federal Employee Retirement System, FERS, with investment or choosing stock and bond index funds for investment by

Federal employees. It was authorized by Congress without introducing social investment objectives, and it has operated free of any

effort by politicians to influence the board’s exercise of its fiduciary

duties.

Why cannot we offer our constituents the same type of proven

apolitical system that every Member of Congress and every Federal

employee has in place for their retirement needs?

Our Nation’s experience with the successful establishment of an

independent board overseeing the investment of Federal employee

pensions has provided a blueprint for how to succeed. Robert

Reischauer and Henry Aaron have refined this model to meet the

needs of the Social Security system. The President has called on us

to move ahead. And the bill that Mr. Bartlett and Mr. Pomeroy and

I have worked on reflects this work by establishing an independent

board empowered to oversee the investment of a portion of the SoVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00005 Fmt 6633 Sfmt 6633 X:\HSECOM\55156.TXT txed01 PsN: txed01
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cial Security trust fund in a passive, common stock index fund like

the Russell 2000 or Wilshire 5000, overseen by qualified external

money managers and operated solely for the economic benefit of

the fund. That will assure that every public company is covered

from smokestack to high tech.

Mr. Chairman, it seems to me that anyone who really believes

that higher payroll taxes or lower benefits will be necessary to ensure solvency, Republican or Democrat, liberal or conservative,

faces a critical threshold question. How can you ask workers to

shoulder still more burdens involving higher payroll taxes or lower

benefits if any of those burdens could be avoided by implementing

this type of modest, common-sense investment strategy? At least

we should be able to agree on this important first step.

Mr. Chairman, I congratulate you on this important hearing. I

do not think you can actually have a debate on Social Security reform unless we resolve these issues first. I congratulate you and I

thank you.

Mr. OXLEY. Ladies and gentlemen, we will not be entertaining

opening statements from the Chair or the members at this time.

We went out of order for our senior member from Massachusetts.

[Additional statements submitted for the record follows:]

PREPARED STATEMENT OF HON. PAUL E. GILLMOR, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF OHIO

Now that the proposal is out there of using the equity markets in one form or

another to help finance Social Security, we need to carefully examine the proper

roles of the public and private sectors. What does the government do better than

the private sector? What do the equity markets do better than the government?

Regarding the return on Social Security funds, it is clear that the private markets, over time, offer superior returns. In as much as the equity markets provide

better returns, politicians have a natural interest in exploring this option. That’s because each dollar of increased return the stock markets can provide for the Social

Security trust funds, is one dollar less the government needs to raise taxes or reduce benefits.

But while the markets may provide a better return over time, I also think the

government is in better position to provide a ‘‘social insurance’’ guarantee. How do

we find the right balance between giving individuals more responsibility for managing their retirement security and ensuring that the social insurance safety net is

firmly secured underneath them?

Recently, one 48 year old worker from Northwest Ohio called my office and stated

that he would be willing to give up everything he has paid into Social Security in

exchange for being allowed to invest his share of his payroll taxes. This individual

knows that, as a pay-as-you-go program, the money that he has put into Social Security isn’t actually being held for him when he retires. And that is why he is willing to give up everything he has paid in return for the opportunity to know that

he has his own individual account. There is a certain sense of security derived from

owning a personal account established from your own paycheck.

Besides the concerns about federal ownership of corporate America, this is one

reason why I think if we move at least some of the Social Security dollars into the

private markets, American workers, not the federal government, should privately

own such accounts.

If the purpose of Social Security is to insure against widespread dependency

among the senior citizen population, we need to ask ourselves how so many senior

citizens have come to depend on the program for their entire financial needs. While

finding a better return on Social Security may boost beneficiary checks a little bit

in the short term, this fails to solve the underlying question: How can we get workers to save and invest more for themselves? I know our distinguished panels will

provide their expertise and insight into these questions.

Thank you, Mr. Chairman.

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PREPARED STATEMENT OF HON. JOHN SHADEGG, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF ARIZONA

Today in my home state of Arizona, President Clinton will promote his proposal

to save Social Security. The President has proposed using $2.8 trillion of the $4.5

trillion projected budget surplus over the next 15 years to shore up Social Security.

Twenty-one percent of that $2.8 trillion—or $588 billion—will be directly invested

in the stock market by the federal government under the President’s plan.

For several years now, a great deal of attention has been given to the anticipated

decline of the Social Security system and proposals to save the system. As we all

know, an aging U.S. population combined with a shrinking workforce will result in

increased benefits to retirees but fewer tax receipts for the Social Security account.

Experts estimate that as early as 2013, just as the baby boomers begin to retire,

Social Security will become dependent upon other federal receipts, including the interest currently paid to the trust funds. And as early as 2026, Social Security will

be insolvent.

There are, essentially, three options for saving Social Security: increase taxes, decrease benefits, or increase the rate of return of Social Security funds. Considering

that I am a strong advocate of reducing the tax burden on the American people,

I could not, and will not, support any proposal to save Social Security that would

result in a tax increase. Furthermore, I am not inclined to support lowering Social

Security benefits to today’s retirees, and those who will retire in future years. I

don’t imagine either group would support it as well. This leaves us with the option

of increasing the rate of return on Social Security funds. At this hearing, I hope to

find answers to some important questions regarding investing in the stock market

to increase the rate of return. Specifically, should we allow the use of personal retirement accounts or should investment be determined by the creation of an independent investment board?

I strongly believe in the tenets of individual liberty and individual responsibility.

I have long supported legislation that reduces the size and scope of the federal government and returns power to the American people. For these reasons, I am inclined to support the use of personal retirement accounts to invest in the stock market and to provide for America’s retirees in the future. Several pieces of legislation

proposed during the 105th Congress, including H.R. 2782, introduced by a witness

for the first panel, my friend Mr. Sanford from South Carolina, and H.R. 4824

spearheaded by my colleague from Arizona, Mr. Kolbe, would have diverted a percentage of the Social Security tax imposed on workers into new personal retirement

accounts. I am confidant that today’s discussion will spark a renewed interest in a

Social Security proposal that includes the use of personal retirement accounts.

Prior to joining the House of Representatives in the 104th Congress, I was an attorney both in private practice and as a Special Assistant State Attorney General.

I believe very strongly in the ethical standards and practices to which all attorneys

must adhere. In the same way, pension fund managers have a fiduciary responsibility to investors. Simply put, they must provide for as high a rate of return as

possible with an appropriate level of risk to satisfy future liabilities. This fiduciary

responsibility is intended to insure responsible management of investors’ money to

the greatest extent possible.

However, I am uncertain of this fiduciary responsibility because of political pressures that could arise from government investment in the stock market. Although

proponents of the President’s Social Security plan are confident that an independent

investment board could be insulated from political pressures, I have serious doubts

about the government’s ability to maintain objectivity when investing in companies

that are not politically appealing, such as the tobacco companies. Furthermore, I am

deeply concerned about government ownership of private corporations not only because this would be a dangerous step away from our capitalist economy, but also

because of the potential and likely negative impact on the market itself.

Finally, current state and local pension funds have been cited as models for the

President’s proposal. I would simply point out one significant distinction between

these pension programs and the system that would be established under the President’s proposal: these state pension funds provide retirement benefits only to state

government employees and not to the residents of the entire state. However, the

President’s proposal would include every single American.

I am very anxious to hear the witnesses’ thoughts on the President’s proposal and

the potential market impact of the federal government investing in the capital markets, including your thoughts on investor protections and corporate governance in

those markets. I believe we can all agree that many unanswered questions remain

regarding the President’s proposal, such as:

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• Will the federal government have the ability to purchase a large percentage of

shares of one company? • What is the appropriate ceiling on the percentage of outstanding shares of one

company that the federal government would be allowed to purchase? • Will investing be limited to blue chip stocks? • Will investing include not only equities, but bonds or derivative instruments as

well? • What would be the rules of carrying cash? • Who would be appointed to an independent investment board and what qualifications would be necessary for an appointment? • If a private investment firm would be used to manage the fund and what, if any,

guidelines would be put forth by the independent board to regulate the purchase of stock?

I look forward to discussing these points and yield back the balance of my time.

PREPARED STATEMENT OF HON. EDOLPHUS TOWNS, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF NEW YORK

I commend Chairman Oxley for holding this important hearing. Preserving Social

Security is the number one domestic priority of the President and the Democratic

Party. I am heartened that there is bipartisan support for that goal.

For almost 60 years, Social Security has protected the economic security of America’s retirees, disabled individuals, and children of deceased workers. The Federal

Old-Age and Survivors Insurance fund is the most popular economic and social program in U.S. history because of its success in eliminating widespread poverty among

the elderly. Whatever reforms are adopted must not undermine that safety net for

our senior citizens.

As you know, I represent the 10th Congressional District in New York. New York

is the home of Wall Street, the New York Stock Exchange, the world’s premier stock

market, and most of this country’s major investment banks, broker-dealers, and

money managers. The Securities Industry Association has testified in favor of Social

Security privatization. So I am pleased that this subcommittee is holding this hearing and beginning the process of examining the issues raised by the President’s

plan. In his State of the Union Address, the President proposed that 62 percent of

the unified budget surpluses over the next 15 years be transferred to the Social Security Trust Fund, in order to increase the ability of that fund to meet promised

Social Security benefit obligations. The President further proposed that about a fifth

of the transferred surpluses be invested in equities to achieve higher returns for Social Security, helping to extend the life of the Social Security trust fund to 2055.

This action does, however, raise understandable concerns about the possible extension of political influence on investment decisions and the risks that this might pose

to the economy and the Trust Fund. Any system of collective investment can and

must address these concerns.

I am taking no position on the President’s plan at this time. It would be helpful

to have a concrete legislative proposal on the table. In any event, I look forward to

hearing from Deputy Treasury Secretary Lawrence Summers and Federal Reserve

Board Chairman Greenspan next week on specifics.

Whatever the outcome of this debate, experts agree that investing in the stock

market, while helpful, is no panacea for what ails Social Security. In that regard,

Mr. Chairman, I am hopeful that we will begin a dialogue with the Ways and

Means Subcommittee on Social Security earlier rather than later in this process. An

effective solution is going to require us to work together and draw on our combined

expertise.

PREPARED STATEMENT OF HON. LOIS CAPPS, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF CALIFORNIA

Thank you, Mr. Chairman, for holding this important hearing.

Social Security is a critical lifeline for millions of senior and ensuring its long

term viability must be one of our highest priorities. That is why I was so pleased

when the President’s budget continued the call for saving Social Security first, and

that on both sides of the aisle this call was well received.

As you know, there are many different reform plans floating around. But one

thing they all have in common is that they all seek to increase the return on Social

Security dollars by looking to the private markets. The President’s plan would invest a small portion of the Trust Fund in equities and establish outside Social Security Universal Savings Accounts that citizens would control. Other plans have called

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for establishing private accounts within Social Security, that would supplant part

of their Social Security benefit and that would manage themselves. Still other plans

call for the privatization of the program entirely.

While I am still studying the various approaches to Social Security reform, I have

come to some basic conclusions. First, the public safety net approach that Social Security embodies must be retained. The current structure of the program—with its

provisions for spouses, the disabled, and survivors—is a critically important program for millions of Americans. For example, Social Security is disproportionately

important to women, who live longer than men, are paid less than men, and leave

the workforce an average of 11.5 years to raise and care for their families and consequently have lower savings and pensions to rely on as seniors. These major demographic differences between men and women must be taken into account when considering any changes to Social Security.

And second, the issues this hearing is about must be fully explored in order for

us to make a fully informed decision. For example, the President’s plan calls for

competitively chosen private sector managers to handle equity investments for the

government to avoid any political interference in the markets. What mechanisms

would be in place to keep Congress from passing a law instructing the managers

to avoid investment in companies that do business in China, lay off American workers, or whose CEO’s donate to one political party or the other? What are the possible

effects of the government controlling 4-5% of the equity markets?

Private account plans call for all Americans to make their own investment decisions regarding their accounts. This option also brings a host of questions, many

still unanswered. What would those investment choices be? Would they be limited

to the types of investment options in the Federal Thrift Savings program? How

much of the returns would management fees eat up? Could small businesses afford

the added expensive that would come with setting up the individual accounts for

every single employee? If not, who would pay? What happens to citizens whose retirement years come in the middle of a long lasting bear market that has substantially diminished the value of their private account?

Simply put, Mr. Chairman, I believe there remains a number of questions regarding all facets of tapping into the equity markets returns. I look forward to a vigorous debate in the coming weeks and months on all these important topics.

Mr. OXLEY. Let me now turn to our distinguished panel: our

friend Nick Smith from Michigan, as well as our good friend from

North Dakota, Earl Pomeroy. And let me begin with Nick Smith.

STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF MICHIGAN

Mr. SMITH. Mr. Chairman, Mr. Markey, and Mr. Stupak, thank

you.

When I came to Congress, I brought two bills with me, so after

I was sworn in I introduced two pieces of legislation. One was what

was called neutral cost recovery to encourage savings and investment, and the other was a Social Security bill. I have introduced

a Social Security bill that has been scored by the Social Security

Administration to keep Social Security solvent in each of the last

two sessions.

Looking at the President’s proposal, I see some strengths and

weaknesses. Most important is the decision that the President

made to invest some of these funds in the capital markets. The

change, I think, is vital because there are only two ways to solve

the Social Security problem. You either reduce benefits or you increase revenues coming into the system.

Now, if you cut benefits, I think our preference is to steer away

from that. I think the President has wisely concluded that stock

market investments would bring in real money and should be part

of the solution.

I hear both Republicans and Democrats suggesting that if we

just invest part of the surpluses in the capital markets somehow

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it is going to solve the Social Security problem. Not so. If every

penny of the surplus for the next 5 years, both the surplus coming

in from the Social Security taxes and the general fund surplus, if

every penny of that was invested in the stock market at 10.5 percent, Social Security would still be broke by 2040.

And let me just say that again. If we invest every penny of the

surplus that we expect over the next 5 years in the stock market

at a 10.5 percent interest rate, it will only keep Social Security solvent until the year 2040. So it is going to take more than just pretending that investing a little bit of that money is going to solve

the problem.

First we should all be concerned that government ownership

under one of the President’s proposals could lead to political tinkering. In the Michigan legislature we had totally removed the decisions of where the State employee pension funds could be invested, but when the highly emotional question of apartheid came

along, we changed the law. And, Mr. Markey, we brought it back

in and said, well, we are going to decide that we are going to

disinvest our pension funds in the State of Michigan from any company that does business with South Africa.

So regardless of the initial law that we passed, if government is

going to invest those moneys, there is always the danger of tinkering. Even at the 4 percent government ownership level, government could significantly reduce the value of a particular company’s

stocks because they are not doing what politicians want on the environment or worker relations or something else.

I think the markets will also think about the implications of government ownership of private companies. It is estimated that the

government would own at least 4 percent of all the companies on

the stock market within the 5 years under the President’s proposal,

and this percentage would continue to grow over time.

This ownership creates worrisome potential for government interference. History suggests that this is a real danger.

Finally, markets will question the credibility of the plan, I would

suggest. Today the actuaries at the Social Security Administration

calculate the shortfall in the program as between $3 trillion and $8

trillion dollars. That depends whether it is a closed system; in

other words, are we going to depend on the babies that are not

born yet to still help bail out the system. And if it is a closed system and we do not save, we are going to lean on them to help solve

the problem in future years, then we approach the $8 trillion to

$10 trillion dollar range.

The enormous sum represents a significant challenge. It seems

to me that in light of these facts, Members of Congress should ask

themselves, what does the President’s plan do to narrow this imbalance? Unfortunately the President’s plan ducks this problem

with complicated accounting gimmicks. The President in the State

of the Union address and elsewhere says he is using 62 percent of

the surplus to save Social Security. This is certainly misleading.

What the President has actually suggested is adding a new giant

IOU to the Social Security trust fund. It becomes an asset to the

trust fund, but at the same time it becomes a liability to the rest

of the government and the general treasury of the United States.

So, in effect, it is a wash. In fact, it is even more than a wash, beVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00010 Fmt 6633 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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cause I think it is misleading; it puts off the tough decisions of how

we are going to save this program, and I think it is important that

we do not talk about saving Social Security without also talking

about how we are going to save Medicare.

I mean, we could increase Social Security, but if we substantially

cut Medicare, then that senior retiree or those disabled or those

widows are still just as bad off.

In conclusion, the financial markets, which are run by people

who earn their living judging financial risk, will not be fooled by

an accounting dodge such as has been proposed. Thus, it is hard

to imagine that we will see the positive economic effects that the

President has claimed for his proposal.

Congress should not dwell too long on the faults in the President’s proposal. He has brought us forward in this debate, and I

compliment him for it. If we simply demagogue and criticize, we

will lose the opportunity to develop and present a better plan to the

American people.

As chairman of the Budget Committee Task Force on Social Security, I hope to work with the President and Democrats and Republicans over the next year to reach a compromise bill to achieve

permanent solvency for Social Security. If all sides will enter into

the negotiations in a spirit of bipartisanship and good will, I am

confident that we can ensure that Social Security will benefit many

generations of Americans to come.

I look forward to any of your questions, having introduced the

two bills that have been scored to keep Social Security solvent over

the past 5 years. It is a challenge. It is a complicated issue as you

look at the trust funds that are increasing by three different aspects. One is the actual cash tax revenues coming into the fund;

the second is the interest earned on those non-negotiable bonds;

and the third, of course, is the Social Security taxes that would otherwise be paid by Federal employees.

Mr. Chairman, thank you.

[The prepared statement of Hon. Nick Smith follows:]

PREPARED STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF MICHIGAN

In this year’s State of the Union address, the President unveiled his long awaited

plan to protect and strengthen Social Security. While I have strong reservations

about aspects of the President’s proposal, it must be recognized that the President

has moved the Social Security debate forward and offered a starting point for serious reform. As a long time advocate of Social Security reform, I think that we

should commend the President for putting a proposal forward over the opposition

of some in his party and emphasize the positive aspects of his plan.

Looking at what the President has proposed, I see some strengths and some

weaknesses. The most important decision that he has made is to use the capital

markets to increase the rate of return on Social Security assets. In doing so, he has

decided to break with some in his party. This change is vital because there are only

two ways to address the long-term imbalance in the Social Security system: cut benefits or increase the revenues coming into the system. The President has wisely concluded that stock market investments—which would bring in real money—should be

part of the solution. It should be noted that even if every penny of the budget surplus over the next five years was invested in the capital markets at a nominal return of 10.5%, Social Security would still be broke in 2040.

To the degree that the President’s plan can lead us to a solution based on savings

and real investment rather that the current system of income redistribution, the

markets should rejoice. But, and this is important, the markets have to be wary of

other aspects of the plan which could presage a large and dangerous expansion of

9

government control in private markets, and a corresponding diminution of the market influences which ensure the efficiency of the financial markets.

First, we should all be concerned about government ownership and control of

stock market investments. With government ownership, there is no guarantee that

workers will see the benefits from higher returns. The government might spend

those earnings on other government programs as it has spent the Social Security

Trust Fund. In my opinion, there is no point in requiring workers to assume the

limited but real risk of market investment without some guarantee that they will

share in the gains as well. Because the Supreme Court has ruled that workers have

no ownership rights in the current Social Security program, regardless of taxes paid

in, worker ownership is the only way to ensure that gains from the market actually

accrue to workers.

The markets, however, will also think about the implications of government ownership of private companies. It is estimated that the government would own at least

4% of all the companies on the stock market within five years under the President’s

proposal, and that this percentage would continue to grow over time. This ownership creates worrisome potential for government interference to reward and penalize

private companies for political reasons.

History suggests that this danger is real. A number of states have come under

pressure to direct pension investments away from companies that produce products

that some people object to or that do business in disfavored countries. Both the

enormous size of the trust fund and the centrality of Social Security in our politics

will intensify these pressures. Indeed, the Rev. Jesse Jackson recently testified that

he would organize opposition to investments in liquor, gun and tobacco producers

if the President’s plan was adopted. We have to recognize that the government will

inevitably fall under pressure to use resources that it holds in the trust fund to

achieve political ends.

Finally, markets will question the credibility of the plan. Today, the actuaries at

the Social Security Administration calculate that the shortfall in the program is between $3 trillion and $8 trillion. This enormous sum represents the difference between what the government has promised to American workers and what it is prepared to pay under current law. It is also worth noting that this shortfall is calculated under the optimistic assumption that the government will repay the Social

Security Trust Fund in full and with interest. Thus, we really need to add the Trust

Fund balance to this estimate to get a true accounting of the problem.

In light of these facts, members of Congress should ask themselves, ‘‘What does

the President’s plan do to narrow this imbalance?’’ Unfortunately, the President’s

plan ducks this problem with complicated accounting gimmicks. The President, in

the State of the Union address and elsewhere, says he is using 62% of the surplus

to save Social Security. This is certainly misleading.

What the President has actually suggested is that another giant IOU representing

62% of the surplus should be put into the Social Security Trust Fund along with

all of the other IOUs. To the public, the new IOU conveys the impression that the

Trust Fund will have additional assets to back future benefits. It does not, however,

increase the government’s financial capacity to pay benefits at any point in the future. In short, it increases the assets of the trust fund by the same amount that

it increases the liability of the general fund. In other words, it’s a promise we have

no ability to keep.

The financial markets, which are run by people who earn their living judging financial risk, will not be fooled by this accounting dodge. Thus, it is hard to imagine

that we’ll see the positive economic effects that the President has claimed for his

proposal.

Congress, however, should not dwell too long on the faults in the President’s proposal. If we do so, we will lose the opportunity to develop and present a better one

to the American people. As Chairman of the Budget Committee Task Force on Social

Security, I hope to work with the President and Democrats over the next year to

reach a compromise bill to achieve permanent solvency for Social Security. If all

sides will enter the negotiations in a spirit of bipartisanship and good will, I’m confident that we can ensure that Social Security will benefit many generations of

Americans to come.

Mr. OXLEY. Thank you, Mr. Smith.

We now turn to our friend from North Dakota, Mr. Pomeroy.

10

STATEMENT OF HON. EARL POMEROY, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF NORTH DAKOTA

Mr. POMEROY. Thank you, Mr. Chairman. I appreciate very much

you holding this important hearing. I am also pleased to participate with my colleagues. I have had over the years many discussions with them. We have quite different notions in terms of how

Social Security should be protected and enhanced, but I know that

they are very sincere and have given this a lot of time and effort

over the years.

As we all know, the reason we are discussing investment of the

trust fund is to address the Social Security shortfall. To close this

long-term financing gap, we basically have three policy choices: Increase taxes; cut benefits; or increase investment return.

Now, investing a modest share of Social Security reserves in equities strengthens the program’s financial position and reduces the

magnitude of benefit reductions or tax increases that would otherwise be required.

The President has proposed a plan that requires transfers to be

made from the U.S. Treasury to the Social Security trust fund each

year for 15 years. Of the amount transferred, $2.8 trillion in total,

a portion would be invested in the private sector on a phased-in

basis from 2000 through 2014, producing an ultimate investment

position of 14.6 percent of the trust funds in equity indexes.

The remaining 85.4 percent would continue to be held in government securities. This allows the trust fund to achieve a higher rate

of return without assuming undue risk.

Now, no one is pretending that this is the silver bullet to fix the

shortfall in Social Security. It is a part of the answer and an important part of the answer.

Investment of the trust fund in equities brings Social Security in

line with the best practice of both private and public sector pension

plans. An overwhelming number of private and public pension

plans involve equity investment as part of their strategy to maximize an optimal investment return.

Among large private-sector defined benefit plans, more than 40

percent of the total assets are in equities. Contrast that with the

not quite 15 percent proposed by the President.

State and local pension plans invest $1.3 trillion in the market

today. No one is suggesting we socialize corporate America through

that investment position, even though it represents 10 percent of

the entire valuation of the stock market.

I previously served on an investment board. I have done the socialist undertaking of investing State tax dollars in private stocks

as a member of the State investment board. We did not social engineer. We served what the law required, the exclusive benefit of

North Dakota employees and existing retirees as required, again,

under Federal law.

Federal funds are also privately invested. The pension reserves

of the Tennessee Valley Authority and the Federal Reserve System

as well as participants of the Federal Thrift Savings Plan, TSP, are

now invested in common stocks.

I want to note the Federal Reserve Board’s own pension program

has a 65 percent equity position with their own asset allocation.

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But despite these successes, questions have legitimately been

raised about whether it is possible to invest a small portion without risking political interference in private business decisions.

I believe that President Clinton’s proposal gives sufficient safeguards and agree with Treasury Secretary Robert Rubin’s observations that there are really two layers of protection against political

interference. Those two layers he identified consist of an independent oversight board and a selection of private fund managers.

The first layer, this independent board, members of which would

be top-flight financial experts, would be established to select and

oversee private fund managers. That is all. Board members would

be appointed for lengthy staggered terms, and neither the President nor Congress would be able to remove them.

The second layer is private fund managers selected by competitive bidding and charged with investing a small portion of the Social Security reserves in broad market index funds. Secretary

Rubin has emphasized, and I quote, ‘‘the government will be involved absolutely not at all in the investment.’’ And to that end the

structure we are proposing is triply insulated beyond what a State

pension fund would be, including the one that I served on.

In reality, there is a third restriction on political interference

similar to the Thrift Savings Plan. It is likely that these indexes

would also contain index funds from a number of private parties

further guaranteeing the strictest fiduciary standards in the investment of these funds.

In conclusion, I think that this proposal, the President’s trust

fund investment proposal, is best understood as a proposal to professionalize the management of Social Security reserves, diversifying the trust fund’s investment so American workers can get a

better return, and moving the money in management reserves not

held in Treasury bonds outside of the political realm and beyond

the reach of elected officials.

In my view, if it is politically taboo for Congress to intervene in

workings like the Federal Reserve Board, believe me, it will be

even more taboo for Congress to interfere with the professional

management of Social Security pension reserves of nearly 150 million workers and retirees.

I am pleased to join Congressman Markey in proposing a framework for consideration with bill introduction today, cosponsored by

Congressman Bartlett. I think that this question of political interference is an important one, and we can design the structure that

will prohibit it. This bill takes a first crack at putting into place

the safeguards. And I invite all of you not just to say no, no, never,

never, but work with us on making certain we have a design structure that provides the safeguards we all want.

Thank you.

[The prepared statement of Hon. Earl Pomeroy follows:]

PREPARED STATEMENT OF HON. EARL POMEROY, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF NORTH DAKOTA

Mr. Chairman and Members of the Subcommittee:

Thank you for holding this important hearing to evaluate the issue of investing

a portion of the Social Security trust fund in the stock market. As we are all aware,

the reason investment of the trust fund is under consideration is to address the Social Security shortfall. It is estimated that the Social Security trust fund will run

12

out of money by the year 2032, resulting in benefits being funded exclusively from

FICA tax collections at that time and potentially resulting in benefit reductions of

25 percent.

To close this long-term financing gap that Social Security currently confronts and

place it on a sound financial footing for future generations, we have three basic policy choices—increase taxes, cut benefits, or increase investment returns. Investing

a modest share of Social Security reserves in equities would strengthen the program’s financial position to the benefit of future generations and reduce the magnitude of the Social Security benefit reductions that would otherwise be needed.

In his State of the Union address, President Clinton proposed a plan that would

require that transfers be made from the U.S. Treasury to the Social Security trust

fund each year for 15 years. The amount transferred each year would be specified

in law, so that by 2015, about $2.8 trillion would have been transferred. A portion

of these funds would be invested in the private sector each year, from 2000 through

2014, until such time as 14.6 percent of the trust funds are in private investments.

The remainder, 85.4 percent, would continue to be held in government securities.

This allows the trust fund to achieve a higher rate of return without assuming

undue risk.

This investment of the trust fund in equities would bring Social Security into line

with the best practice of both private and public sector pension plans. An overwhelming number of private-sector defined-benefit pension plans invest part of their

reserves in equities. Among large private-sector defined benefit plans more than 40

percent of total assets are invested in equities.

Similarly, pension reserves of the Tennessee Valley Authority and the Federal Reserve system, as well as assets of participants of the Federal Thrift Savings Plan

(TSP) are now invested in common stocks. The Federal Reserve’s pension plan for

instance, has 65 percent of the portfolio backing their defined-benefit pension plan

invested in equities.

Despite these successes, there is some question as to whether it is possible to invest a small part of the Social Security reserves in common stocks—as the President

has proposed—without risking political interference in private business decisions.

I believe that President Clinton’s proposal gives more than adequate safeguards

and agree with Treasury Secretary Robert Rubin’s observation that, ‘‘there are really two layers of protection against political interference.’’ Those two layers he identified consist of an independent oversight board, and the selection of private fund

managers.

The independent board, the members of which would be top flight financial experts, would be established to select and oversee private fund managers. Board

members would be appointed for lengthy staggered terms, and neither the President

nor Congress would be able to remove them. The private fund managers would be

selected through competitive bidding and would be charged with investing a small

portion of the Social Security reserves in broad market index funds. Secretary Rubin

has emphasized, ‘‘the government will be involved absolutely not at all in the investment.’’

In reality there is a third restriction on political interference created by the fact

that all funds would be passively invested in very large index funds. Similar to the

Thrift Savings Plan it is likely these indexes would also contain investment funds

from a number of private parties, further guaranteeing the strictest fiduciary standards in the investment of those funds.

The President’s model mirrors the existing structure of the Federal Reserve Board

and the Federal Retirement Thrift Investment Board.

With this structure, the Fed has successfully maintained its independence for decades in setting monetary policy; it, not Congress or the executive branch, establishes

those policies.

The Federal Retirement Thrift Investment Board has similarly maintained its

independence and not been subject to political meddling since its creation in 1986.

As Francis X. Cavanaugh, the board’s first executive director, has noted, Congress

designed the board to be insulated from both political interference and corporate decision-making, and this design has worked. The TSP investment board, and Mr.

Cavanaugh made clear from the beginning that economic, not social or political,

goals were to be the sole purpose of the investment board. The TSP has perpetuated

this norm by refusing to yield to pressure to invest in economically targeted investments or to divest stocks of particular companies.

In some ways, the President’s proposal is best understood as a proposal to professionalize the management of Social Security reserves, diversifying the trust fund’s

investments so American workers can get better return, while moving the reserves

not held in Treasury bonds outside the political realm and beyond the reach of elected officials.

13

In my view, if it is politically taboo for Congress to intrude upon the workings

and decisions of the Fed, it would likely be even more taboo for Congress to interfere with the professional management of the Social Security pension reserves of

nearly 150 million workers and retirees.

As Henry Aaron and Robert Reischauer recently observed, ‘‘no public policy can

meet the standard of zero possible abuse. If such a standard applied to all decisions,

we would not have a standing army for fear some rogue general might run amok,

or a Federal Reserve because some Congress might interfere with its independence.

In each case, Congress acted because the benefits were clear and safeguards minimized risks.’’

Some contend the better way to pursue higher investment returns within Social

Security is to create individual accounts for each person covered under the program,

and allow private investment on an individual basis.

On closer evaluation, however, this alternative is not as desirable as may first be

assumed.

Inevitably, risk and uncertainty would be substituted for the guaranteed nature

of Social Security benefits.

In addition, there are very substantial administrative costs that attach to a plan

offering private investment opportunities to individuals within the Social Security

plan. Estimates are as high as 30 to 40 percent, counting annuitization costs. Obviously, net investment gains could be completely wiped out by the expense of purely

private investment accounts within Social Security.

As a result, most proposals establishing private accounts use the Thrift Savings

Plan as a model, which could reduce administrative expenses to eight percent. This

is still substantially higher than the nominal cost of the trust fund investment approach.

The result of pursuing individual accounts similar to those of the Thrift Savings

Plan ultimately produces the need for a government board charged with selecting

private money managers to invest the pooled individual accounts. This is virtually

identical to the framework required for trust fund investing.

In summary, investing 15 percent of the Social Security trust fund in equity index

accounts makes an important contribution to addressing the financial shortfall in

Social Security without sacrificing the guarantees of Social Security or relying completely on raising taxes or reducing benefits to beneficiaries. The President’s proposal professionalizes the management of this portion of the trust fund and removes

it from the political realm for the exclusive benefit of American families covered by

this program.

Mr. Chairman, this concludes my remarks. I would be happy to take questions

from the Subcommittee.

Mr. OXLEY. Thank you.

Our third panelist is the distinguished gentleman from South

Carolina, Mr. Sanford.

STATEMENT OF HON. MARK SANFORD, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF SOUTH CAROLINA

Mr. SANFORD. Thank you, Mr. Chairman, and thank you, members of the subcommittee for allowing me the chance to talk about

the market impact of the President’s proposal on Social Security.

The ultimate answer is: I do not know. In other words, I think

given the complexity of the capital markets, you cannot say based

on one very little business what the capital markets will do, but

what I can say is that there are certain probabilities based on how

capital markets react to what the President has proposed. And to

look at those, I think you would simply look at what is it that he

proposes.

He proposes three things: one, precommitting dollars to government in a way, frankly, that has never been done before; two, investing part of the trust fund in equities as was already mentioned;

and, three, introducing USA accounts which would be supplemental savings accounts.

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On the first point, precommitting dollars to government in a way

that has never been done before, this is very significant, because

they do this by precommitting $2.8 trillion of anticipated general

fund surpluses over to the Social Security trust funds.

Now, leaving aside the fact that this may never happen—I do not

know if you all saw the Economist article 2 weeks ago entitled

‘‘Counting Your Chickens Before They Hatch,’’ which was all about

maybe these surpluses come, maybe they do not. But let’s just assume the surpluses came. What is dangerous about this is that

prefunding precludes the private allocation of capital.

Let me say that again. Prefunding, precommitting, precludes the private allocation of this $2.8 trillion of capital.

Now, that is very significant, because almost any economist you

talk to would say that ultimately the private markets, the capital

markets, are better at allocating capital within our economy than

government. Not to say that one is bad and one is good, but just

better in this sense: if you were to take two hypothetical chain saw

factories and one was to be made by the capital market, the capital

markets would decide on that chain saw factory based on return

on equity. government, if we were making the decision because we

make politically base decisions, we would decide in part is it in my

district, is it in my country, does it have a certain type of labor

force, a lot of other considerations which are important to us in politics. But it makes for two very different sets of investment choices

and a very different allocation. And that is on the good one, that

is if it was an investment.

If it was in something less than an investment, for instance, a

social welfare system that possibly did not work, that was structurally flawed, or let’s say a road to nowhere, but it did happen to

have a Senator or Congressman’s name on it, I mean all those to

are possibilities within government.

So I would say at the onset that this proposal, because it precommits $2.8 trillion of anticipated general fund surplus to government, means that there will be poorer asset allocation of that

money, and consequently a drag on GDP which affects markets.

The second point would be it precommits—in other words, since

we are now within the government section, it precommits to consumption rather than investment. And I think that my friend from

Massachusetts would be the first to say that, for instance, there

are certain very good uses of government capital, for instance, an

investment in human capital; in other words, investment in education.

Well, that is not what this would do. This precommits that $2.8

trillion not to education, but to consumption. And we have to ask:

Would that be a good or a bad investment? It would be, from a

macroeconomic standpoint, a relatively poor investment choice, because savings drives investment which drives productivity which

ultimately affects standard of living, and consequently growth of

GDP, and growth in GDP is a direct tie back to market. So we

would also have a drag on markets from the standpoint it is an infusion for consumption rather than investment.

The third point would be it precommits a tax increase. And I

would say that, because if you look at the—if you look at page 30

at the analyst perspectives of the President’s budget, what you

15

would see there is under discretionary spending, which in 1995, 7.6

percent of GDP, it pulls down to 3 percent of GDP. So that is saying one of two things. That is saying—it is saying basically since

baby boomers to come, there are 70 million of them, and since, you

know, we have got this large flow there, therefore to keep the numbers within any kind of sustainable range—historically we have

been at or around 20 percent of GDP, government expenditure,

keep that going to 30 percent, we just have to waive domestic discretionary. How realistic do you think it is that we will have domestic discretionary? I think we would probably agree that that is

probably unrealistic, and then given the political clout of the babyboom generation, again, 70 million strong, is it realistic to think we

would cut benefits or raise taxes? I think it is more likely that we

raise taxes.

Finally, it leaves uncertainty and markets do not like uncertainty. Come 2056, there is nothing better in terms of the prospects

for a retiree at that point than exist today. In other words, there

is still a cloudy horizon and markets do not like uncertainty. It has

already been tested in terms of trust fund. Investment equity, I

think Alan Greenspan can well address that issue.

And the final component, which are USA accounts, accounts,

Australia interestingly addressed that issue, and it was a labor

movement and a labor government that ultimately said, voluntary

accounts do not work because they turned out to be very regressive.

People at the lower end of the socioeconomic scale did not have the

money or the credit, and consequently could not exercise it. It was

the labor movement and labor government that pushed for mandatory accounts.

Thank you very much.

[The prepared statement of Hon. Mark Sanford follows:]

PREPARED STATEMENT OF HON. MARK SANFORD, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF SOUTH CAROLINA

Thank you Mr. Chairman and members of the subcommittee for allowing me the

opportunity to talk about the market impacts of President Clinton’s Social Security

proposal.

The ultimate answer is, I can’t say for certain what the market impacts will be.

Given the complexity of the capital markets, it is difficult to say based on one variable that, ‘‘this is what the capital markets will do.’’ What I can say is that there

are distinct probabilities how the capital markets would react to what the President

has proposed.

The President’s proposal includes three components: 1) Pre-committing dollars to

government in a way that has never been done before, 2) investing part of the trust

fund in equities, and 3) introducing USA accounts, or supplemental savings accounts.

On the first point, pre-committing dollars to government in a way that has never been done before is very significant. The Administration’s proposal pre-commits $2.8

trillion of anticipated general-fund surpluses over to the Social Security Trust Fund,

in essence shifting debt held by the public to debt held in the form of IOUs by the

trust fund.

I don’t know if you saw the Economist article that came out about two weeks ago

entitled ‘‘Counting Their Chickens Before They Hatch,’’ which spelled out the case

for why it is dangerous to rely on surpluses before they materialize. Let’s leave that

aside for the moment and assume these surpluses materialize.

While I agree with the President on the worthiness of reducing the public debt,

it does nothing to shore up Social Security. The President’s plan commits 62% of

the unified surplus to reduce the debt held by the public. The Administration’s plan

simply shifts debt from being held by the public to being held by the Social Security

trust fund. The net effect on the national debt, which counts both public and

intragovernmental debt, is zero.

16

There is no question that, in the short term, the President’s plan to reduce the

public debt will lower interest rates as the federal government would no longer be

bidding up the cost of borrowing money. Over the long term, the implications of

such a plan are uncertain at best.

The President’s plan pre-commits us to a tax increase. After 2013 when we start

cashing in the bonds in the trust fund to pay benefits, if the money isn’t in the

budget, Congress would have just two familiar options: 1) raise taxes or 2) cut benefits.

The President’s projections utilize a tactic that has never worked: his plan assumes that domestic discretionary spending will be cut more than half. I say that

because, if you look at page 30 of the analytical perspectives of the President’s budget, you would see that his assumptions are that domestic discretionary spending,

which in 1995 was 7.6 percent of GDP, pulls down to 3 percent of GDP in future

years. Folks in Congress, on both sides of the aisle, want to bust the prudent budget

caps set not even two short years ago. The current debates over extremely modest

trims of spending caps should make it crystal clear that future Congresses and

Presidents will definitely not cut domestic discretionary spending by more than half.

What does that leave us with? How realistic do you think it is that we will cut

domestic discretionary spending in half? Given the political clout of the baby boom

generation at 70 million strong, isn’t it more realistic to think we would cut benefits,

raise taxes, or borrow more money? I think it’s likely that we’d raise taxes.

The President’s proposal leaves uncertainty and markets don’t like uncertainty.

As for the President’s proposal to have the federal government invest $700 billion

of the trust fund in private equities, I think most serious independent experts side

with Fed chairman Alan Greenspan’s assessment that this is a misguided idea. No

matter how many firewalls we might attempt to erect, no matter how independent

we try to make the investing body, politics would inevitably infect the process.

Just look at the nature of government compared to private markets. Let’s take

two hypothetical chain saw factories—one operated by the capital markets which

would make decisions based on return on equity, and the other operated by the government. The government makes decisions, unfortunately, based largely on politics.

Government officials ask questions like ‘‘is that factory in my district, is it in my

country, does it have a certain type of labor force’’ when they make decisions. This

makes for two different sets of investment choices and a very different allocation.

I would say that the President’s proposal to have the government invest a portion

of the trust fund will cause poorer asset allocation of that money and consequently

a drag on GDP.

As Greenspan noted, government investing does not necessarily increase national

savings—it would more likely simply displace other capital. Personal accounts with

savings, however, would increase national saving. From a macro-economic standpoint, it would be a relatively poor investment choice to pick government over private individuals. Savings drive investment, which drives productivity gain, which

ultimately affects standard of living, and consequently grows the GDP. Growth in

GDP is a direct tie back to markets.

As for the third component of the President’s plan, Universal Savings Accounts,

it falls short of the mark. Australia interestingly addressed this issue. It was a labor

movement and a labor government which ultimately said voluntary supplemental

accounts don’t work because they would turn out to be very regressive. People at

the lower end of the socio-economic scale didn’t have the money for the credit and

consequently couldn’t exercise it. It was the labor movement that pushed for personal accounts funded by diverting payroll taxes into the accounts.

The real solution is to personalize Social Security by allowing people to divert a

small portion, say 2-3%, of their FICA taxes into an account with appropriate safeguards and limited investment options. Social Security taxes are taxes on first-dollar earnings, so every working American pays them—which is the best qualification

for a way to fund personal accounts. Under this system, no working American would

be turned away for a lack of money. At the same time, we would chip away at the

unfunded liability of the program and grant people a great opportunity to build and

create wealth.

If we reject personal retirement accounts in favor of pre-committing money to the

paper ledger of the Social Security trust fund, then we would preclude the private

allocation of capital. Let me say that again—pre-committing precludes the private

allocation of this $2.8 trillion of capital through personal accounts. That is significant because just about every economist says that ultimately, the private markets

are better at allocating capital within our economy than government. Not to say

that one is bad and one is good—the private markets are just better in this sense.

Thank you Mr. Chairman.

17

Mr. OXLEY. Thank you to our panel, and because we had a late

start today, we are going to waive questions for the panel. We appreciate your participation and staying engaged in this very important issue.

Mr. SANFORD. Mr. Chairman, will our written statements be included in the journal?

Mr. OXLEY. The written statements will be part of the record.

Mr. SANFORD. May I make a short 30-second comment?

Mr. OXLEY. Sure.

Mr. SANFORD. The Supreme Court—the main decision was Fleming v. Nestor—decided that there was no entitlement for Social Security payments; regardless of the taxes or how long you paid into

Social Security, there was no right to receive any benefits. And I

think it is reasonable to expect that if government controls these

funds, they will take the additional revenue from these funds and

use them in the same way as they have the Social Security trust

funds.

In other words, if we come to crunch on a balanced budget, they

will simply spend those funds for other government spending and

it will not give any assurance that future retirees will have extra

assurance for retirement.

Mr. OXLEY. Thank you, and thank you all.

Let me now return to regular order, and I see our friend from

Richmond at the dais. Does the gentleman have an opening statement?

Chairman BLILEY. Mr. Chairman, I thank you for recognizing

me. In the interest of time, I will submit it for the record. I applaud

you for having this hearing today on this very, very important subject.

[The prepared statement of Hon. Tom Bliley follows:]

PREPARED STATEMENT OF HON. TOM BLILEY, CHAIRMAN, COMMITTEE ON COMMERCE

This is the first hearing of the Finance Subcommittee in the 106th Congress. I

think that it is appropriate that this hearing is devoted to an examination of market

impact of the President’s Social Security proposal.

Solvency of the Social Security system is vitally important. I commend the President for beginning the debate by coming forward with a proposal to deal with the

impending problems of Social Security.

A number of estimates by the CBO and the bipartisan task force on Social Security indicated that absent reform, Social Security will begin paying out more than

it takes in sometime around 2013. Obviously, the earlier we deal with the structural

issues causing this problem, the easier it will be to fix them.

The President has recognized that the Budget Surpluses we have worked so hard

to produce in the last Congress and the surplus from current workers now paying

into the Social Security system, gives us an opportunity to work to save Social Security and improve the retirement of all Americans.

The President has recognized, as did the members of the Advisory Council on Social Security, that there is a role for investment in the stock market as part of any

reform of Social Security. Simply put, the rate of return to investors in the stock

market has been about 13% per year over the past forty years. This return is much

more attractive than anemic or sometimes negative returns that participants in Social Security receive on their contributions.

If the returns of the market can be extended to all Americans we can substantially improve the lives of Americans as they retire.

I believe that this Committee which has historically looked to promote capital formation will play an important role in protecting investors and insuring that increased market participation by Americans will be safe and fair.

There are four basic principals that I will use to evaluate any Social Security proposal:

18

First, there can be no diminution of benefits to current retirees. We have made

an agreement with millions of Americans, who depend on Social Security and we

must keep it.

Second, any changes to the Social Security System that involve private investment should be completely voluntary. If a person doesn’t want to participate, he or

she should be able to stay in Social Security as it currently exists.

Third, any system of private investment must have appropriate safeguards. We

are not going to have Social Security money put in risky derivatives, cattle futures

or other speculative instruments.

Fourth, any Social Security reform must increase the rate of return to the participants. I understand that for many young people, the expected return for their lifelong contributions will be negative. For others, less than a paltry 1% per year. People can do better in pass book savings accounts. We should look to find a way for

the benefits of the market to be shared, prudentially with all Americans.

This hearing will be the beginning of a long process. I commend the Chairman,

Mike Oxley for holding this hearing, and for his superb leadership in the last Congress which included moving the Stock Exchanges to Decimal Pricing, passing Repeal of Glass-Steagall in the House, and enactment of Uniform Securities Litigation

Standards.

I welcome the new Ranking Member of the Subcommittee, Mr. Ed Towns from

New York. He has been a good friend for many years and I look forward to working

with him in his new role. I also commend John Dingell, the Ranking Member of

this Committee. Over the years we have solved many problems and this one will

be no different.

The Committee will be active in the area of Social Security reform. We will work

to improve the retirement of all Americans and see that any private investment is

done safely. Next week we will continue this hearing. I am pleased that Federal Reserve Chairman Alan Greenspan has agreed to come and analyze the President’s

proposal for us. Additionally, we are working with the Treasury to facilitate an appearance by a representative of the Administration.

I welcome the witnesses and yield back the balance of my time.

Mr. OXLEY. Thank you, sir. All opening statements will be made

a part of the record. The Chair would, before calling up our second

panel, enter his opening statement.

This is the first in a series of hearings that the subcommittee

will be holding on what is probably the most important financial

issue facing this Congress: how best to ensure a secure retirement

for all Americans. The next hearing on this subject will be next

Wednesday, March 3, when the Federal Reserve Chairman Alan

Greenspan will offer his views on the President’s proposal, as well

as a representative of the Treasury. We expect Mr. Lawrence Summers will be testifying that day as well.

By now, people have heard the alarming fact that in at least 14

years the Social Security system will be paying out more in benefits than it is receiving in taxes. While it is estimated the interest

income that will be paid to the Social Security trust fund will delay

depletion of the fund for about 7 more years, the fact is that in a

very short time we as policymakers will be given a very limited list

of options to choose from to keep the system in the black: raise

taxes, cut spending, or borrow the money to make up for the deficit. At that point it is going to be too late to being talking about

reform.

That is why it is so important to begin work on reforming Social

Security today. We do not want to find ourselves a few years down

the road trying to convince the American taxpayers that they really

should not mind paying more taxes to bail out the system if the

government fails to act in time, or try to convince American retirees they should not expect all the same benefits that they paid for

years into the system to provide for their predecessors, or putting

off the inevitable by applying a temporary patch to the problem,

19

which is only going to grow worse when more Americans retire and

fewer workers are available to support them. We cannot fail the

American people by taking such an irresponsible attitude toward

their future.

What is heartening to see is that the President has recognized

this very problem. He indicated in the State of the Union address

that he intends to put saving Social Security among his top priorities.

It is also good to hear the notion that investing in the stock market is a component of a proposal to save Social Security. As we

learned the last time there was a hearing before this subcommittee

on this subject, the rate of return that today’s workers have seen

on the taxes they pay into the system is a business despite the over

1 percent for an average household with two 30-year-old working

parents who each make under $26,000. For today’s youngest workers, the rate of return is expected to be negative. That means they

are losing money for every tax dollar they pay. That rate of return

would be enough to make an investment by an investor advisor on

the spot. We can increase the rate of return. In the example I just

mentioned, if the family’s tax dollars were invested not in the Social Security system as we know it, but in a conservative private

investment like a low-risk mutual fund, the expected rate of return

would be over 5 percent per year.

Many experts believe that such a higher rate of return for even

just a portion of the Social Security payroll tax would more than

offset the anticipated shortfall of the fund. Putting back a sum of

money into the stock market, however, would have enormous impact on our capital markets. How that money is invested into the

markets, as well as what happens to the markets as a result of this

capital infusion, raises numerous questions that we will consider in

this and upcoming hearings.

One concern that has been raised by Chairman Greenspan,

among others, is the disturbing conflicts of interest that would be

created by giving the government direct or indirect control over investment of Social Security dollars in the market, as the President’s proposal contemplates.

Mr. Greenspan is implying that government-controlled investment would put at risk the efficiency of our capital markets and

our economy. Politically motivated investment decisions by government pension fund managers have often led to losses for investors.

Even worse, granting government control over investments in the

marketplace would lead to an ominous blurring of what is private

and what is government.

Embracing government-controlled investments would suggest

that creating private accounts, which investors rather than the

government would control, is a better approach to saving Social Security. But creating private accounts would require an American

worker who may not have any experience in investing in the markets to make investment decisions that will affect their retirement

security.

How can we assure that these new investors have the tools they

need to manage those accounts? How can we better protect them

against fraud? How can we maximize the benefits for American investors while minimizing risks? These are questions that go to the

20

most fundamental concerns we have: the integrity and success of

our capital markets and protection for investors.

We look forward to tackling these issues together with Chairman

Bliley, the ranking member John Dingell, and friends on both sides

of the aisle in the spirit of bipartisanship.

That concludes the opening statement of the Chair. I recognize

the gentleman from Illinois for an opening statement.

Mr. SHIMKUS. Thank you, Mr. Chairman, and I would like to

thank you for holding this hearing. I applaud your effort to use this

subcommittee to examine the President’s proposal to invest a portion of the Social Security trust fund in the stock market. Although

the Ways and Means Committee has jurisdiction over Social Security, Rule 10, clause 1(b)15 gives this subcommittee jurisdiction

over the stock market. I believe we should vigorously protect our

committee’s jurisdiction to ensure the compatibility of the President’s proposal for the stock market and savings.

I look forward to this hearing because I am very interested in the

aging and how it affects Social Security, and how to ensure its existence for my children and your children. Social Security has fundamentally changed the life in America. Before Social Security, elderly Americans had virtually no retirement income unless they

were very wealthy. Now all Americans have an investment and an

income when they retire.

No one wants to live solely off of Social Security, but the simple

fact is that in my district many people do. We also know that we

must ensure that Social Security is available for future generations. Under the current system there is no way that Social Security will survive with the retirement of the baby-boomer generation.

However, in our efforts to preserve the trust fund, we should not

make hasty, radical changes that increase the risks to the system.

We must save Social Security, not destroy it.

I, like the President and many of my colleagues on both sides of

the aisle, want to ensure that the Social Security trust fund receives the maximum return on its investment. I believe any discussion of investing the trust fund in the market must be guided by

three core principles: first, the investment must limited to a portion of the trust fund. We cannot allow the trust fund beneficiaries

to be 100 percent dependent on the stock market. Social Security

has been successful, but if all else fails, our elderly citizens need

to know that they can count on their income from Social Security.

We cannot allow Social Security to evaporate if the market crashes

or other adverse events occur.

Second, we must ensure that the government does not become involved in the business decisions of corporations or become a player

in the market. The U.S. Government cannot and will not be a productive player in the equities market. Instead, we should establish

an oversight board, similar to the Thrift Savings Plan, to ensure

the investment decisions of millions of Americans are not made by

politicians.

Finally, Mr. Chairman, we should require diverse investment for

the trust fund. Spreading the risk over diverse industries as well

as different investments will both increase exposure to the fund to

21

make sure the government does not become too powerful in one industry or market.

Mr. Chairman, I have not decided whether or not to entrust the

savings of millions of Americans in the stock market is the solution

to extending the solvency of the Social Security trust fund and protecting a program that is the life blood of our Nation’s elderly.

However, I do know that we need to explore this issue. I commend

you again for calling this hearing and the March 3rd hearing, and

I look forward to many more. Everybody agrees that it will take bipartisan cooperation to save Social Security. I hope this committee

can set an example for the entire Congress.

Mr. Chairman, I am going to run off to another hearing. I plan

to be back. Thank you again for the opening statement.

Mr. OXLEY. I thank the gentleman.

Any other opening statements on my right?

[No response.]

Mr. OXLEY. Then we will proceed to the second panel: James

Glassman, DeWitt-Wallace Reader’s Digest Fellow, American Enterprise Institute; Robert Reischauer, Senior Fellow at the Brookings Institution; and David C. John, Senior Policy Analyst for Social Security with the Heritage Foundation.

Gentlemen, we appreciate your patience and your attendance

here today and look forward to a discussion about a very important

subject which is as near and dear to all of us as is the capital markets and Social Security.

Let me begin, if I may, with Mr. Reischauer, and again, we appreciate all of your testimony.

STATEMENTS OF ROBERT D. REISCHAUER, SENIOR FELLOW,

BROOKINGS INSTITUTION; DAVID C. JOHN, SENIOR POLICY

ANALYST FOR SOCIAL SECURITY, HERITAGE FOUNDATION;

AND JAMES K. GLASSMAN, DEWITT-WALLACE READER’S DIGEST FELLOW, AMERICAN ENTERPRISE INSTITUTE

Mr. REISCHAUER. Mr. Chairman, members of the committee, I

appreciate the opportunity to participate in this hearing. It is, as

you have heard from several of the previous witnesses, an unpleasant yet inescapable reality but there are three and only three ways

to close Social Security’s long-term fiscal deficits: taxes can be

raised; benefits can be reduced; or the return on the trust fund’s

reserves can be increased.

Given this reality, it is important to compare proposals to invest

a portion of the Social Security reserves in private securities with

the realistic alternatives that are out there. Although there are legitimate concerns with this option, which I will discuss in a

minute, there are problems with all of the alternatives as well.

There are problems with raising payroll taxes, with increasing the

age at which unreduced benefits are paid, increasing the age at

which initial benefits can be taken, or reducing the size of the annual cost-of-living adjustment.

There are two good reasons why it makes sense to invest a portion of the trust fund reserves in private securities. First, such a

policy will boost the earnings of the reserves and thereby reduce

the size of the benefit cuts and payroll tax increases that will be

required to deal with Social Security’s problems. As other witnesses

22

have said, investing the reserves in higher yielding assets is not a

complete solution. It can help but it cannot solve the problem by

itself.

Second, easing the restriction that requires Social Security to invest reserves exclusively in government securities would provide

workers with a fairer return on their payroll tax contributions, one

that is closer to the benefit that their contributions are making to

the Nation’s economy. To the extent that reserve accumulations

add to national savings, they generate total returns to the Nation

equal to the average return on private investment, which runs

about 6 percent more than the rate of inflation. By paying Social

Security a lower return, a return that is projected to average only

2.8 percent over the next 75 years—that is 2.8 percent over and

above inflation—the system denies workers a fair return on their

contribution.

There are, however, some legitimate concerns that have been

raised about investing trust fund reserves in private securities.

Many fear that such investments could disrupt or destabilize financial markets. Others are worried that politicians, both in the executive branch and in the Congress, will be tempted to use reserve investment policy to interfere with markets or meddle with the activities of private businesses.

If there were no way to reduce the risk of political interference

to a de minimis level, it would be imprudent to propose private investment of a portion of the trust fund reserves, and I would be

adamantly opposed to such a policy. Fortunately, institutional safeguards can be created to provide the necessary protections.

Such an institutional framework should have five elements: first,

an independent agency modeled after the Federal Reserve Board

should be created and charged with the task of managing the trust

fund’s investments; second, this agency should be required to select

through competitive bids several private sector fund managers,

each of whom would be entrusted with investing a portion of the

trust fund’s reserves that were going to be devoted to private assets; third, these managers could be authorized only to make passive investments—that is, investments in securities of companies

chosen to represent the broadest of market indexes, not the standard, but rather a Wilshire 5000 or even a broader index; fourth, Social Security’s investments should be commingled with the funds

that private account holders have invested in the same index funds

that the managers chosen by the agency offer to the public; and finally, the fund managers should be required to vote Social Security

shares solely to enhance the economic interests of future Social Security beneficiaries.

All of these five elements, each of them, should be established in

law, not through regulation, not through some measure that would

be easy to change.

As Mr. Smith pointed out, Congress can always change laws.

There is a risk here, one which could be reduced if this were placed

in a constitutional amendment, but I would say that that is going

too far.

I think that this set of institutional arrangements, if established

in law, should be sufficient to insulate the trust fund investment

decisions from political pressures and provide payroll tax contribuVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00025 Fmt 6633 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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1Senior Fellow, The Brookings Institution. This statement draws on Countdown to Reform:

The Great Social Security Debate, by Henry J. Aaron and Robert D. Reischauer (The Century

Foundation Press, 1998). The views expressed in this statement should not be attributed to the

staff, officers, or trustees of the Brookings Institution.

tors with a fair return on the payments that they are making to

the system.

Thank you, Mr. Chairman.

[The prepared statement of Robert D. Reischauer follows:]

PREPARED STATEMENT OF ROBERT D. REISCHAUER 1, SENIOR FELLOW, BROOKINGS

INSTITUTION

Mr. Chairman and Members of the Subcommittee, I appreciate this opportunity

to discuss with you the issues raised by proposals to invest a portion of Social Security’s reserves in private securities. My statement addresses three questions:

• Why do the Administration and others believe it would be helpful to diversify the

portfolio of assets held by the Social Security trust fund?

• What legitimate concerns are raised by investing trust fund reserves in private

securities? and

• Are there ways to address these concerns?

Why invest in private securities?

It is an unpleasant yet inescapable reality that there are three, and only three,

ways to close Social Security’s long run fiscal deficit. Taxes can be raised, benefits

can be reduced, or the return on the trust fund’s reserves can be increased. Recently, some have suggested that a fourth way exists, one that avoids unpleasant

choices. This route would be to devote a portion of the projected budget surpluses

to Social Security. However, transferring resources from the government’s general

accounts to Social Security would only shift the locus of the inevitable adjustments.

Rather than boosting payroll taxes or cutting Social Security benefits sometime in

the future, income taxes would have to be higher or non-Social Security spending

lower than otherwise would be the case.

Because neither the public nor lawmakers have greeted the prospect of higher

taxes or reduced spending with any enthusiasm, the option of boosting the returns

on Social Security’s reserves is worth close examination. While higher returns can

not solve the program’s long run financing problem alone, they can make the remaining problem more manageable.

Since the program’s inception, the law has required that Social Security reserves

be invested exclusively in securities guaranteed as to principal and interest by the

federal government. Most trust fund holdings consist of special nonmarketable

Treasury securities that carry the average interest rate of government notes and

bonds that mature in four or more years and are outstanding at the time the special

securities are issued. In addition to their low risk, these special issues have one

clear advantage. They can be sold back to the Treasury at par at any time—a feature not available on publicly held notes or bonds, whose market prices fluctuate

from day to day. They also have one big disadvantage—they yield relatively low

rates of return.

It is not surprising that, when the Social Security law was enacted, policymakers

viewed government securities as the only appropriate investment for workers’ retirement funds. They were in the midst of the Great Depression. The stock market collapse and widespread corporate bond defaults were vivid in people’s memories.

Many believed that a mattress or a cookie jar was the safest place for their savings.

For many years, the restriction placed on trust fund investment made little difference because Congress decided, before the first benefits were paid, to forgo the

accumulation of large reserves that were anticipated under the 1935 law. Instead,

Congress voted in 1939 to begin paying benefits in 1940 rather than 1942, boost the

pensions of early cohorts of retirees, and add spouse and survivor benefits. The system was to operate on a pay-as-you-go basis.

Legislation enacted in 1977 called for moving from pay-as-you-go financing to

‘‘partial reserve financing’’ with the accumulation of significant reserves. These reserves failed to materialize because the economy performed poorly. Further legislation in 1983, together with improved economic performance, subsequently led to the

steady growth of reserves. By the end of 1998, the program had built up reserves

of $741 billion, roughly twice annual benefits. Under current policy, these reserves

are projected to grow to more than $2.5 trillion—about 3.4 times annual benefits—

by 2010. As reserves have grown, the loss of income to Social Security from restrictVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00026 Fmt 6633 Sfmt 6621 X:\HSECOM\55156.TXT txed01 PsN: txed01
24

2This estimate is based on the difference between the estimated long-run returns on government securities and private assets, not on the actual differences during 1998. 3General revenues have been used in Social Security in limited ways. The allocation of revenues from income taxation of Social Security benefits is an application of general revenues. So

were payments made to provide Social Security earnings credits for the military. In addition,

when minimum Social Security benefits were eliminated in 1981, they were preserved for those

born before 1920 and financed through a general revenue transfer. 4With $3.7 trillion in outstanding debt, an increase in borrowing costs of ten basis points (0.1

percentage points) would raise annual federal debt service costs by $3.7 billion.

ing its investment to relatively low-yielding special Treasury issues also has increased.

The restriction that has been placed on Social Security’s investments is unfair to

program participants, both workers paying payroll taxes and beneficiaries. To the

extent that trust fund reserve accumulation adds to national saving, it generates

total returns for the nation equal to the average return on private investment,

which runs about 6 percent more than the rate of inflation. By paying Social Security a lower return—a return projected to be only 2.8 percent more than inflation

over the next 75 years—the system denies workers a fair return on their investment. As a consequence, either the payroll tax rate has to be set higher than necessary to sustain any given level of benefits or pensions have to be lower than would

be the case if the program’s reserves received the full returns they generate for the

economy.

The restriction placed on the trust fund’s investments has had another unfortunate consequence. It has added considerable confusion to the debate over alternative

approaches to addressing Social Security’s long-run fiscal problem. Advocates of various privatization plans argue that their approaches are superior to Social Security

because they provide better returns to workers. In reality, the returns offered by

these structures look better only because the balances they build up are invested

not in low-yielding Treasury securities but rather in a diversified portfolio of private

securities. If Social Security were unshackled, its returns would not just match, but

almost certainly exceed, those realized by the various reform proposals.

There exists a very simple mechanism for compensating Social Security for the

restrictions that are placed on its investment decisions. Each year, Congress could

transfer sums to the trust fund to make up the difference between the estimated

total return to investment financed by trust fund saving and the yield on government bonds. This could be accomplished with a lump sum transfer or by agreeing

to pay a higher interest rate—say 3 percentage points higher—on the Treasury securities held by the trust fund. The transfer required to make up the shortfall in

1998, when the average trust fund balance was approximately $700 billion, would

have been about $23 billion, more than two and one-half times the amount that is

transferred to the trust fund from income taxes on benefits.2

While general revenue transfers to social insurance plans are commonplace

around the world, they have been controversial in the United States.3 Some would

oppose such a transfer, arguing that general revenue financing would weaken the

program’s social insurance rationale through which payroll tax contributions entitle

workers to benefits. Others would object to the tax increases or spending cuts needed to finance the general revenue transfer. Still others would question the permanence of such transfers, especially if the budget debate begins to focus on maintaining balance in the non-Social Security portion of the budget, out of which the transfers would have to be made.

An alternative approach would be to relax the investment restrictions on Social

Security and allow the trust fund to invest a portion of its reserves in private stocks

and bonds. Such investments would increase the return earned by the reserves and

reduce the size of future benefit cuts and payroll tax increases. Shifting trust fund

investments from government securities to private assets, however, would have no

direct or immediate effect on national saving, investment, the capital stock, or production. Private savers would earn somewhat lower returns because their portfolios

would contain fewer common stocks and more government bonds—those that the

trust funds no longer purchased. Furthermore, government borrowing rates might

have to rise a bit to induce private investors to buy the bonds that the trust funds

no longer held.4 Nevertheless, the Social Security system would enjoy the higher returns that all other public and private sector pension funds with diversified portfolios realize.

Concerns about investment of trust fund reserves in private securities

In 1935, Congress ruled out trust fund investments in private stocks and bonds

for good reasons. First, policymakers were concerned that the fund’s managers

might, on occasion, have to sell the assets at a loss, a move that would engender

25

public criticism. Second, they feared that if the fund had to liquidate significant

amounts of securities, these sales might destabilize markets, depressing the value

of assets held in private portfolios and upsetting individual investors. An even more

important consideration was that they feared that politicians—like themselves—

might be tempted to use reserve investment policy to interfere with markets or meddle in the activities of private businesses.

The concerns that Congress had in 1935 were certainly legitimate ones. But conditions have changed over the past 64 years in ways that reduce their saliency. Stock

and bond markets are far larger, less volatile, and more efficient now than they

were in the 1930s. Trust fund investment activities, therefore, are less likely to disrupt markets. Moreover, the trust fund is unlikely to be forced to sell assets at a

loss because the fund has significant and growing reserves, most of which under the

various proposals that call for trust fund investment in private securities would continue to be held in special Treasury securities. The trustees would almost certainly

sell the fund’s government securities to get past any short-run gap between benefit

expenses and revenues.

On the other hand, the pressures special interests place on lawmakers and the

stresses imposed by reelection are probably greater now than they were in the past.

For these reasons, many justifiably continue to be concerned about possible political

interference in trust fund investment activities. Chairman Greenspan of the Federal

Reserve Board has stated that he does not ‘‘believe that it is politically feasible to

insulate such huge funds from government direction.’’ Others have been less judicious, charging that equity investment by the trust fund ‘‘amounts to nationalization

of American industry’’ and ‘‘would threaten our freedom.’’

Those who oppose trust fund investment in private securities point to the record

of some private and state government pension funds that have chosen to use social,

as well as economic, criteria to guide their investment policies. In addition, some

of these pension funds have voted the shares of companies whose stock they own

to further social objectives, ones that might sacrifice some short- or long-run profits.

The fear is that the Social Security trustees might be subject to similar pressures.

Congress could force them to sell, or not buy, shares in companies that produce

products some people regard as noxious, such as cigarettes, alcoholic beverages, or

napalm. Similarly, Congress could preclude investments in firms that engage in

business practices some regard as objectionable, such as hiring children or paying

very low wages in the company’s foreign factories, polluting the environment, or not

providing health insurance for their workers. Critics also fear that the trust fund

might retain shares in such companies and use stockholder voting power to try to

exercise control over these firms.

Safeguards to protect trust fund investment decisions from political pressures

If there were no effective way to shield trust fund investment decisions from political pressures, the advantage of higher returns that a diversified investment strategy would yield would not be worth the price that would have to be paid. However,

experience suggests both that concerns about political interference are exaggerated

and that institutional safeguards can be constructed that would reduce the risk of

interference to a de minimis level.

A number of federal government pension funds now invest in private securities.

They include the Thrift Saving Plan for government workers and the pension plans

of the Federal Reserve Board, the U.S. Air Force and the Tennessee Valley Authority. The managers of these pension funds have not been subject to political pressures. They have pursued only financial objectives in selecting their portfolios and

have not tried to exercise any control over the companies in which they have invested.

Of course, the fact that the managers of smaller government pension funds have

not been subject to political pressures provides no guarantee that the much larger

and more visible Social Security system would enjoy a similar fate. Special interests

might seek Congressional sponsors for resolutions restricting investments more for

the publicity such limits would provide their cause than for any economic impact

the directive might have if carried out. In addition, some Members might feel

obliged to propose restrictions against investing in corporations that have been

found to violate anti trust laws, trade restrictions, workplace health and safety regulations, or other federal limits. Political pressures might cause others to pressure

the trustees to exclude investments in companies that have closed a plant in their

district and moved their production facilities and jobs abroad.

For these reasons, it would be essential to enact legislation that would create a

multi-tiered firewall to protect trust fund investment decisions from political pressures, one that would forestall efforts by Members of Congress or the executive

branch from using trust fund investments to influence corporate policy. The first

26

tier of such an institutional structure should be the creation of an independent

agency charged with managing the trust fund’s investments. This board—which

could be called the Social Security Reserve Board (SSRB)—could be modeled after

the Federal Reserve Board, which for over eight decades has successfully performed

two politically charged tasks—controlling growth of the money supply and regulating private banks—without succumbing to political pressures. Like the governors

of the Federal Reserve, the members of the SSRB should be appointed by the president and confirmed by the Senate. To ensure their independence, they should serve

staggered terms of at least ten years in length. Congress should be empowered to

remove a board member from office only if that member was convicted of a serious

offense or failed to uphold their oath of office, not because Congress disliked the positions taken by the member. As is the case with the Federal Reserve Board, the

SSRB should be given financial independence. This could be ensured by allowing it

to meet its budget by imposing a tiny charge on the earnings of its investments.

Under such an arrangement, neither Congress nor the executive branch could exercise influence by threatening to withhold resources.

A second tier of protection should be provided by limiting the discretion given to

the SSRB. The primary responsibility of the board should be to select, through competitive bids, several private sector fund managers, each of whom would be entrusted with investing a portion of the fund’s reserves. Depending on the amount

invested, somewhere between three and ten fund managers might be chosen. Contracts with the fund managers would be rebid periodically and the board would

monitor the managers’ performance.

A third tier of insulation from political pressures should be provided by authorizing fund managers only to make passive investments. They would be charged with

investing in securities—bonds or stocks—of companies chosen to represent the

broadest of market indexes, indexes that reflect all of the shares sold on the three

major exchanges. In other words, the trust fund’s investment would be in a total

stock market index such as the Wilshire 5,000 or Wilshire 7,000 index. If bonds

were included in the investment mix, the appropriate guide might be the Lehman

Brothers Aggregate (LBA) index. Unlike actively managed mutual funds, there

would be no discretion to pick and choose individual stocks and, therefore, no window through which political or social considerations could enter.

A fourth layer of defense should be provided by requiring that Social Security’s

investments be commingled with the funds that private account holders have invested in index funds offered by the managers chosen by the SSRB. These private

investors would object strenuously if politicians made any attempt to interfere with

the composition of the holdings of their mutual fund.

Fifth, to prevent the SSRB from exercising any voice in the management of private companies, Congress should insist that the several fund managers selected by

the SSRB vote Social Security’s shares solely to enhance the economic interest of

future Social Security beneficiaries.

To summarize, this set of five institutional restraints would effectively insulate

fund management from political control by elected officials. Long-term appointments

and security of tenure would protect the SSRB from political interference. Limitation of investments to passively managed funds and pooling with private accounts

would prevent the SSRB from exercising power by selecting shares. The diffusion

of voting rights among several independent fund mangers and the requirement that

the managers consider economic criteria alone would prevent the SSRB from using

voting power to influence company management. In short, Congress and the president would have no effective way to influence private companies through the trust

fund unless they revamped the SSRB structure. That would require legislation

which would precipitate a national debate over the extent to which government, in

its role as custodian of the assets of the nation’s mandatory pension system, should

interfere in the private economy. Framed this way, there would be strong opposition

to such legislation.

While nothing, other than a constitutional amendment, can prevent Congress

from repealing a previously enacted law, the political costs of doing so would be

high. Furthermore, if Congress is disposed to influence the policies of private businesses, it has many far more powerful and direct instruments to accomplish those

ends than through management of the Social Security trust funds. The federal government can tax, regulate, or subsidize private companies in order to encourage or

force them to engage in or desist from particular policies. No private company or

lower level of government has similar powers.

Conclusion

Allowing the Social Security system to invest a portion of its growing reserves in

private assets will increase the returns on the trust fund balances and reduce the

27

size of the unavoidable payroll tax increases and benefit reductions that will be

needed to eliminate the program’s long-run deficit. Concerns that political interests

might attempt to influence trust fund investment decisions are legitimate but institutional safeguards can be enacted into law that would reduce the possibility of such

interference to a de minimis level.

Mr. OXLEY. Thank you.

Mr. John?

STATEMENT OF DAVID C. JOHN

Mr. JOHN. Thank you. I am delighted to be here.

I am not going to speak about the government investment of the

trust fund. That actually has been handled and will be handled

subsequently to great extent. I am going to speak about the lesser

known, the lesser discussed element of the President’s plan, which

is the USA accounts.

We salute the President for including an element that does allow

Americans to increase their rate of return. The average worker

does need more to show for a lifetime of work than just memories

and a small monthly check.

There are, however, a couple of problems with the way it has

been proposed at this point. Problem No. 1 is that it does not have

stable source of funding. While I am an economist myself, or at

least I pretend to be on occasion, I am well aware that a 15-year

economic forecast is slightly less valuable than a 15-year weather

forecast. And I am not going to plan any picnics based on it.

If you look at the CBO forecast for the cumulative budget sur- plus from fiscal year 1999 to 2008, in August it stood at $1.54 trillion. Now, last month it stood at $2.65 trillion, which is a 72 percent increase. That can go down as well as it goes up, and if you

look at the technical notes in the back of the CBO numbers, you

will see that there actually is room for that kind of a decline.

This is too important a program to fund just out of a surplus, because what will we do at the inevitable time when the surplus

ends, or when the surplus does not meet the requirements. We are

faced with one of two situations. Either we tell the average worker

we are sorry, we are not going to be able to meet these goals that

we have set up for ourselves; or No. 2, that we have created another new expensive entitlement program for our children to end

up paying for.

Instead, it would make much more sense to perhaps start these

with the budget surplus, and then move them, whether it is on a

contingency basis or a permanent basis, and to carve out of a portion of the Social Security taxes that an individual now pays. It basically could be called perhaps Social Security Part B, Social Security Plus, and that is up to the press secretaries and the

marketeers to put together. But it is something that could be put

together relatively easily.

Second, there is a question while the administration has not

given us any indication of how they are going to structure these,

what they have talked about is $100 plus some sort of a match.

Now, Mark Sanford earlier mentioned the whole question of what

do you do with a lower-income individual. If you look at 401(k)

studies, you find that there is a direct correlation between income

level and the ability to make a matching contribution. When it

comes right down to it, your average worker is much more interVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00030 Fmt 6633 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
28

ested right now in paying the kids’ doctor bills than necessarily

putting away something for 40 years in the future. Instead, as I

say, a carve-out perhaps with a minimum amount of $500, $250,

whatever Congress sets up, would be much more appropriate.

Now, the next remarks will apply to both the USA accounts and

to any form of an individual account within Social Security.

How do you regulate? There is a direct correlation between the

administration costs of any account and how complex the account

is, and the types of investment return that it offers, investment options that it offers. For instance, a simple return like the TSP

which has three investment options, one of which is the stock index

fund, is probably the lowest possible cost, although TSP’s administrative costs are artificially low because it does not include any

costs of collecting the money.

There is a question about the size of funds. What is the maximum size of a mutual fund? This is something that has been

under discussion for a number of years. Nobody is quite sure what

it is at this point, but we are pretty sure that there is one.

If you look at TSP, for instance, TSP’s stock index fund is about $30 billion in assets. That $30 billion is about a third of a $91 billion fund. If you have one fund, if you have the investment option

that is done by TSP, at some point you are going to reach this maximum.

Now, how do you deal with that possibility? When it comes right

down to it, a stock index fund is a stock index fund is a stock index

fund. It really does not matter assuming that you are investing in

the same index who offers it. It would be very possible to allow a

number of different companies to offer it whether it is to an employer or to an individual worker.

If you look at the United Kingdom, they have a way where the

government collects the taxes, holds it for a year in a government

trust fund paying government bond rate, and then distributes it.

There is a paper by Fred Goldberg which has just been published

by the National Bureau of Economic Research which also discusses

this option.

Australia has another version where the money is sent directly

by the employer and then any sort of compliance is checked at tax

time. This is somewhat similar to what we do when you change

your IRA from one individual to another, or one provider to another. It would be fairly simple to allow choice.

Now, in order to allow choice we would have to have a certain

level of licensing. It is going to have to be objective, much the same

as the SEC’s licensing of a mutual fund now or a bank license or

a credit union license or something along that line. We are not necessarily interested in Joe’s Bar and Pension Plan. We are interested in something that is far better than that.

Here are four objectives or four criteria which might be some of

the ones that the subcommittee would consider.

No. 1 would be capital adequacy for fairly obvious reasons. We

are not interested in having someone’s provider be subject to sudden reverses.

No. 2, managerial expertise. Again, fairly obvious.

No. 3 is a clear and advanced disclosure in writing of all types

of fees that would be associated with this account. Notice here I am

29

not saying anything about regulating the fees. Again, you are talking about what is essentially the same type of mutual fund being

provided by a number of different people, and it would be quite

possible to go through and check the fees in advance and make a

choice depending on that.

And last, but not least, a clear regular statement, annual or

quarterly. This particular one happens to be an Australian statement that is offered by DeZerk Fund, which very clearly lists how

much money has gone in, how much tax has been paid, what the

return is and what the fees are. This again is perhaps something

that is fairly simple to structure. I would recommend it.

Now, of course. there would be a need to regulate and a need to

examine these entities on a fairly regular basis to make sure that

they are continuing to comply, and as with current structures in

banking and others, in the event that there is a failure you will

have to be able to transfer the accounts to another level.

I look forward to any questions you might have.

[The prepared statement of David C. John follows:]

PREPARED STATEMENT OF DAVID C. JOHN, SENIOR POLICY ANALYST FOR SOCIAL

SECURITY, THE HERITAGE FOUNDATION

I appreciate the opportunity to appear before you today to discuss the market impacts of the President’s Social Security proposal. While I am the Senior Policy Analyst for Social Security at the Heritage Foundation, the views that I express in this

testimony are my own, and should not be construed as representing any official position of the Heritage Foundation.

This hearing is particularly important because of the subcommittee’s expertise in

the workings of financial markets. The success or failure of both the President’s

Universal Savings Account proposal and any personal retirement account component of Social Security will largely depend on their structure and how they are regulated.

This morning, I will focus on three major areas. First, my testimony will briefly

discuss the potential dangers of having the government invest part of the Social Security trust fund in the equity markets. Second, the President’s Universal Savings

Account plan will be considered, and third, I will examine ways to structure individual accounts to reduce administration costs and provide adequate consumer protections.

However, I would like to begin by giving credit where credit is due. While I have

some strong criticism of aspects of the President proposal, it has several positive

features.

By recognizing the importance of allowing Americans to increase the rate of return on their Social Security retirement taxes, President Clinton has taken a major

step towards increasing the retirement security of working Americans. A conservative portfolio divided evenly between stocks and super-safe government bonds

would yield returns of 5 percent, far more than Social Security’s current average annual return on retirement taxes of 1.2 percent.

Also, the White House recognizes that personal retirement accounts are feasible,

cost effective, and safe. They know that it will be fairly simple to solve the logistical

problems associated with creating personal retirement accounts, and that these accounts can be structured to be both inexpensive and low risk.

Government Investment of the Social Security Trust Fund

The President’s proposal to have a government agency invest portions of the Social Security trust fund raises serious questions about political interference in investment decisions. Allowing a government agency, no matter how it is structured,

to invest Social Security funds in equity markets sets up a situation where the longterm needs of future retirees could be subordinated to short-term political goals.

Federal Reserve Board Chairman Alan Greenspan says that it would be almost

impossible to insulate those investment decisions from political interference. To

prove his point, the Reverend Jesse Jackson told the House Ways and Means Committee recently that Social Security funds should not be invested in tobacco and liquor companies or gun manufacturers. Also, there are news reports that the AFLCIO is threatening to pull its pension funds from any funds manager that supports

30

establishing individual retirement accounts as a part of Social Security. This is a

clear example of the pension needs of union members taking second place to that

organization’s political agenda.

Unfortunately, history proves the potential for political interference from both

sides of the political spectrum. The Texas State Board of Education recently sold

1.2 million shares of Disney because it disapproved of the content of certain Disney

films. In another instance, Minnesota lost $2 million in pension investments when

it sold its tobacco stocks.

Political influence is possible even if stock investments were limited to index

funds containing 500 or more stocks. Index funds can be developed using any criteria, and their composition changes over time because of mergers, bankruptcies,

and new technologies.

It would be extremely easy to develop an index fund of 1000 stocks that left out

tobacco companies, gun manufacturers, companies that had aroused the ire of organized labor, or those who had supported the wrong candidate in the last election.

There is even a chance that such a fund would earn almost as much as traditional

market index funds. However, it could just as easily earn much less. In politics

there is always the temptation to live for today instead of for the future, and tomorrow’s retirees should not see their Social Security held hostage to the next election.

Universal Savings Accounts

While I applaud the concept of allowing workers to have a new way to invest for

their retirements, USA accounts do nothing to save Social Security, and could become an expensive new entitlement program.

The White House says that these accounts will be financed by the surplus, but

former Congressional Budget Office head June O’Neill warned that the era of budget surpluses could be fairly short. While we all hope that the projections of lasting

budget surpluses will be accurate, any long-term economic forecast is volatile. Just

last August, CBO projected the aggregate surplus for fiscal years 1999 through 2008

to be $1.54 trillion. The January 1999 aggregate projections for the same period

were $2.65 trillion, a 72 percent increase. Over the next few years, these forecasts

could just as easily drop.

When the inevitable economic slowdown hits, deficits are very likely to return. At

that point, either federal contributions to the USA accounts will stop, or the government could convert them into another expensive entitlement program for our children to pay for.

The retirement security of American workers is far too important to base on our

hope for a future surplus. While it might make sense to start funding the USA accounts with the surplus, Congress should then shift to funding them with a proportion of the existing taxes that workers already pay to Social Security. That way,

once the surpluses end, these accounts can continue to grow, and with them, the

retirement incomes of American workers.

In addition, rather than creating a whole separate program, it would make much

more sense to make these accounts part of Social Security. The new ‘‘Social Security

Part B’’ would make it easier to consider these accounts as part of a comprehensive

solution to deal with Social Security’s existing problems. As Comptroller General

David Walker has pointed out, the President’s overall approach to Social Security

does nothing to change the program’s projected cash flow imbalance. At some point,

Congress will have to take steps to deal with this problem.

Finally, how these accounts are structured is extremely important. While the Administration has not announced specific plans, it appears that the government

would transfer $100 annually into each American’s account. Workers below a certain income level also being eligible for a government match of money they deposit

in the accounts, with those at lower income levels receiving a greater match of their

deposits. This is superficially attractive, but somewhat misguided. Lower income

workers have very little excess income that could be saved for future retirements.

Studies show that even when matched, contributions to existing retirement plans

are directly related to the income of the contributor. The lower the income of the

worker, the lower the probability that this person will contribute to their retirement

plan.

Simply put, for these workers, paying the kid’s doctor bills or the mortgage today

is much more important than saving for an event far in the future. They simply do

not have the extra money. As a result, including an income match will result in a

subsidy to middle class taxpayers without really benefiting those who need a higher

retirement income the most.

31

Structuring and Regulating Personal Retirement Accounts

This part of my testimony applies to both Universal Savings Accounts and a personal retirement account segment within Social Security. How these accounts are

structured and regulated is as important a decision as whether they exist in the

first place.

Structuring the accounts: In order to reduce administrative costs and potential investor confusion, initially, it would be best to only offer three investment options.

These could be a broad-based stock index fund, a bond index fund, and some sort

of government bond fund, perhaps using the new inflation-indexed Series I United

States Savings Bonds.

This decision is important for two reasons. First, studies have proved that administrative costs are directly related to the complexity of the account and to the level

of services offered. Stock index funds, which are computer traded, have extremely

low administrative costs. Overall, an account that offers only a few, simple investment options, one of which is a stock index fund, will provide the best tradeoff between potential returns and low administrative costs. As the Australian experience

has shown, this type of account can be offered for an annual administrative cost of

0.7 percent of assets or less.

Second, this structure reduces risk. Your brother-in-law’s hot stock tip is not usually the best road to retirement security. An index fund gives the returns associated

with the equity markets without the hazard and expense of picking individual

stocks. As time goes on, additional investment options can be added, some of which

could have greater risk.

Allowing the Choice of a Funds Manager: Regardless of which funds manager is

offering it, equity funds tied to a specific stock index are all pretty much identical.

Over time, these retirement savings accounts will attract hundreds of billions of dollars worth of savings and retained earnings. This pool of money will almost certainly be too large to be managed by any one funds manager. For that reason, rather than having everyone invest in one big stock index fund, as is currently the practice in the federal Thrift Savings Plan (TSP), it would be better to allow individuals

to purchase their stock or bond index funds from an approved list of funds managers.

Moving Funds to the Manager: There are several ways to send retirement savings

to a funds manager. In the United Kingdom, retirement taxes are collected by the

government and kept for a year in a government bond fund while income data is

being collected. Once it is clear how much is due to each person, the taxes and accumulated interest are sent to that individual’s funds manager and credited to his or

her specific account. Several of the Social Security reform plans that are before Congress now use a similar mechanism.

This method could be used for both Universal Savings Accounts and an individual

account component of Social Security. It has the advantage of utilizing Social Security’s existing method of collecting individual income data, while still allowing the

greatest number of private funds managers to be involved in the actual investment

process.

Regulating Funds Managers: It is not in anyone’s interest to have ‘‘Joe’s Bar and

Pension Fund’’ managing retirement savings. Only established funds managers who

can meet several strict, but objective, standards should be allowed to accept this

money.

The Securities and Exchange Commission (SEC) has both an admirable history

and the expertise to regulate funds managers, and either it or a similar agency

should have this responsibility. There are four standards that potential funds managers should meet. They are:

• Capital Adequacy: The manager should have sufficient capital invested in the firm

to ensure stability and the ability to survive market fluctuations. • Professional Expertise: Only qualified and experienced professionals should be allowed to manage these retirement savings accounts. • Disclosure of Fees: All fees and costs must be clearly disclosed in writing before

any money is accepted. • Regular Statements: All account owners must receive regular statements in clear

and simple language that discloses the status of their accounts, including the

amount of contributions, the rate of return for each investment option, and the

exact amount of any fees that were paid.

Funds managers should be regularly examined to ensure that they continue to

meet these qualifications and any other rules that the SEC finds to be necessary.

However, there is no need to apply the overly restrictive ERISA regulations to these

accounts. In addition, there could be a requirement that the principle (but not investment gains) would be covered against loss by a private insurance policy that

would be payable only at retirement. This would provide both an additional level

32

of security and reduce the possibility that individuals will become anxious because

of temporary market dislocations.

Conclusion

Mr. Chairman, it is time for all Americans to receive the benefits of our economy.

Over the last 12 months, the S&P 500 went up 23.3 percent. The NASDAQ composite went up 36.6 percent. Corporate bonds yield 6.4 percent a year, and the government’s Series I Savings Bonds yield 5.05 percent. However, Social Security, the

average worker’s retirement fund, has annual returns of only about 1.2 percent a

year.

It is only fair to allow every worker, no matter what his or her income level to

share these returns. Americans should have more to show for a lifetime of work

than just memories and a small monthly check.

The Heritage Foundation is a public policy, research, and educational organization operating under Section 501(c)(3). It is privately supported, and receives no

funds from any government at any level, nor does it perform any government or

other contract work.

The Heritage Foundation is the most broadly supported think tank in the United

States. During 1997, it had more than 210,000 individual, foundation, and corporate

supporters representing every state in the United States. Its 1997 contributions

came from the following sources:

• Government—0% • Individuals—47% • Foundation Grants—21% • Corporations—4% • Investment Income—24% • Publication Sales and Other—4%

No corporation provide The Heritage Foundation with more than 1% of its 1997

annual income. The top five corporate givers provided The Heritage Foundation

with less than 2% of its 1997 annual income. The Heritage Foundation’s books are

audited annually by the national accounting firm of Deloitte & Touche. A list of

major donors is available from The Heritage Foundation upon request.

Members of The Heritage Foundation staff testify as individuals discussing their

own independent research. The views expressed are their own, and do not reflect

an institutional position for The Heritage Foundation or its board of trustees.

Mr. OXLEY. Thank you, Mr. John.

We will welcome back Mr. Glassman.

STATEMENT OF JAMES K. GLASSMAN

Mr. GLASSMAN. Thank you, Mr. Chairman, members of the committee. I Am honored to be here today, and I commend you for

holding this hearing to address this profoundly serious subject.

It is appropriate that the title of the subcommittee is Finance

and Hazardous Materials because I think this proposal to invest

taxes in the stock market falls under both rubrics. It is hazardous;

it is dangerous. As Alan Greenspan, the chairman of the Federal

Reserve Board, said on Capitol Hill in July, government investing

would, quote, ‘‘have far-reaching dangers for a free American economy and a free American society.’’

The President says only a small portion, actually a little more

than one-fifth, of each year’s transfers to the Social Security trust

fund will go to stocks. But the sums, the total sums are enormous.

By 2014, according to the actuaries, the U.S. Government will own

$921 billion worth of stock in American corporations.

To put that figure into perspective, California’s Public Employee Pension plan, the largest in the Nation, has assets of $150 billion.

The pension plan sponsored by General Motors, the largest corporate plan, has $100 billion. The largest mutual fund is $80 billion. And currently, $3 trillion is invested in mutual, in stock mutual funds in this country.

Social Security actuaries calculate that between 2001 and 2020,

the government will own on average 3.7 percent of the total value

33

of the shares on the stock market. Ownership of stock by the government first raises an important matter of political philosophy. At

a time when much of the rest of the world has been turning ownership of State-owned enterprises over to the public in the form of

stock issues, and also moving toward private accounts in replacement of part, at least part of Social Security, the President’s proposal moves the United States in exactly the opposite direction.

I do not want to sound overly dramatic or inflammatory, but, by

definition, this plan is a step toward the dictionary definition of socialism, which is government ownership of a means of production.

Now, most large firms on the major exchanges have broadly diverse ownership, which is one of the strengths of the American corporate system. Take, for example, Merck and Company, the pharmaceutical house. It has only two shareholders with a stake of

more than 1 percent—Fidelity which has 2.3 percent, and Barclay’s

Bank, which is a major manager of index funds, at 1.5 percent.

Assuming that the Federal Government’s ownership stake is

spread across all corporations equally, it would hold 3.7 percent of

the stock of Merck, or 50 percent more shares than the largest

owner currently holds.

By the same analysis, it would become the largest owner of

shares in Exxon Corporation, the second largest owner of J.P. Morgan and Company, and the largest institutional owner, after the

three individual founders, of Microsoft Corporation.

The administration proposes to insulate the government from the

direction of companies whose stock it owns by setting up a neutral

board. But as Chairman Greenspan told Congress, I do not know

any way you can essentially insulate government decisionmakers

from having access to what will amount to very large investments

in American private industry. And certainly the experience of State

and local governments is not encouraging.

A few years ago the huge California State pension plan, Calpers,

brought its ownership weight to bear in pushing out the CEO of

General Motors. In the 1980’s, 30 States prohibited the investment

of government employee pension funds in companies that did business in South Africa. In a study of 50 State pension plans between

1985 and 1989, Roberta Romano of Yale concluded that public pension funds are subject to political pressures to tailor their investments to local needs.

And drawing on a reference work by James Packard Love, the

Cato Institute’s Michael Tanner recently concluded that 23 percent

of State and local government employee pension systems have prohibitions against investment in specific types of companies, and 42

percent have restrictions targeting some portion of investments to

projects designed to stimulate the local economy or create jobs.

So let’s just use some common sense here. Imagine what might

be called a passive system of investing tax dollars only in the companies that comprise the standard Forbes 500 stock index. This

seems to be one of the ideas that is on the table. This is an index

that is weighted according to market capitalization. In other words,

the bigger companies have more weight. The largest stock in the

S&P is—guess what?—Microsoft, which is currently being prosecuted by the Justice Department for alleged antitrust violations.

34

Imagine the government being the largest institutional shareholder

in a company that the government is suing.

Next, consider the No. 2 stock in the S&P, General Electric,

which owns, among other things, the National Broadcasting Company, NBC. Should the Federal Government be the second largest

shareholder in a huge media company?

Consider Philip Morris Companies, which represents 1 percent of

the S&P. That would be a $9 billion investment by the Federal

Government by the year 2014. Of course, Philip Morris is America’s

top purveyor of cigarettes. Should the hard-earned money of taxpayers support a firm that makes what many politicians believe to

be death-dealing products?

To choose the S&P is to give excessive weight to large companies.

Now, there is also a proposal instead to use the Wilshire 5000,

which is a broader index. But the Wilshire is also capitalization

weighted, which means, again, large companies get most of the

money. Is it fair to America’s smaller firms, does it make political

sense, does it make social sense to have this kind of an investment

strategy?

And why invest in listed companies at all? Few of them are run

by members of minority groups or by women. And these are precisely the companies that do not need the extra capital that the

government would provide.

Now, is this a new idea? I believe that it is, government investing in the stock market. You have heard previously and you heard

from the President that the government would only be doing what

a private or State government pension would do. This is disingenuous. No State runs a pension system for all of its citizens. Instead,

what States do is they make provision for the retirement of their

employees who voluntarily agree to accept employment from the

State.

Social Security, on the other hand, is universal and mandatory.

It uses tax dollars of every worker, whether that person works for

the Federal Government or not.

Let me just conclude by saying that in the end, the main threat

from government investing in the stock market is the inevitable political pressure that will be brought to bear. For the government

to use tax dollars to buy shares of private American corporations

is to take a giant step in precisely the wrong direction. It is also

unnecessary.

If higher returns on retirement contributions are needed, and I

believe they are, individuals are fully capable of seeking them in

a system that replaces part or all of Social Security with private

investment accounts that Americans would own themselves.

Thank you, Mr. Chairman and members of the committee.

[The prepared statement of James K. Glassman follows:]

PREPARED STATEMENT OF JAMES K. GLASSMAN, DEWITT WALLACE-READER’S DIGEST

FELLOW IN COMMUNICATIONS IN A FREE SOCIETY, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

GOVERNMENT INVESTING IN THE STOCK MARKET

‘‘DANGERS FOR A FREE AMERICAN ECONOMY AND A FREE AMERICAN SOCIETY.’’

Mr. Chairman, members of the committee:

35

My name is James K. Glassman. I am a columnist on financial, economic and political topics for the Washington Post. My column appears in many other newspapers

throughout the country and the world, including the International Herald Tribune.

I am also host of ‘‘TechnoPolitics,’’ a weekly program on PBS TV that frequently addresses the interaction between finance and government. In addition, I am a monthly commentator on PBS’s ‘‘Nightly Business Report’’ and a columnist for Intellectual

Capital, an electronic magazine on the Internet.

With my collaborator Kevin Hassett, an economist at the American Enterprise Institute who was formerly a senior economist at the Federal Reserve Board, I am currently completing a book on the stock market, to be published in October by Times

Books, a division of Random House. While I am not a trained economist, I have been

writing about finance and public policy and the relationship between the two for

nearly 30 years.

Since October 1996, I have been the DeWitt Wallace-Reader’s Digest Fellow at the

American Enterprise Institute, a research institution in Washington. Much of my

work at AEI has focused on investment aspects of Social Security.

Thank you for allowing me to address the committee this morning.

Nearly One Trillion in Stocks

The quotation below the title of this testimony is a quotation from Alan Greenspan, chairman of the Federal Reserve Board. It underscores the serious nature of

the Social Security proposal offered by President Clinton earlier this year. That proposal would profoundly change the relationship between the government and the

private sector, the engine of prosperity and hope for all Americans.

In his budget message on Feb. 1, the president proposed investing what he termed

a ‘‘small portion’’ of the federal budget surplus over the next 15 years ‘‘in the private

sector, just as any private or state government pension would do, so that we can

earn higher returns and keep Social Security sound for 55 years.’’

Specifically, according to a Feb. 12 memorandum to the chief actuary of the Social

Security Administration:

‘‘The president’s plan calls for transfers to be made from the General Fund

of the Treasury of the United States to the Old-Age, Survivors, and Disability

Insurance (OASDI) trust funds for each year 2000 through 2014. The amount

of the transfer each year would be specified in law as a percentage of the

OASDI effective taxable payroll. In each year 2000 through 2014, 21 percent of

the transfer would be used to purchase stock and 79 percent would be used to

purchase special interest-bearing obligations of the Treasury. All dividends

would be reinvested in stock until the market value of all stock held by the

OASDI trust funds reached 14.6 percent of total OASDI trust fund assets.

Thereafter, the percentage of total trust fund assets that is held in stocks would

be maintained at 14.6 percent.’’

While the president says that only a ‘‘small portion’’—actually a little more than

one-fifth—of each year’s transfers to the trust fund will go to stocks, the sums are

enormous. By 2014, according to the actuaries, the U.S. government will own $921

billion worth of shares of American corporations.

To put this figure in perspective: California’s public employee pension plan, the

largest in the nation, has assets of about $150 billion, and the pension plan sponsored by General Motors, the largest corporate plan in the country, had assets of

about $100 billion. The largest single mutual fund—Vanguard Index 500—has assets of about $80 billion.

The Social Security actuaries calculate that, between 2001 and 2030, the government will own, on average, 3.7 percent of the total value of the shares on the stock

market.

Defining Socialism

Ownership of stock by the government raises deep and troubling issues.

The first is a matter of political philosophy: At a time when much of the rest of

the world has been turning ownership of state-owned enterprises over to the public,

in the form of stock issues, the president’s proposal moves the United States in the

opposite direction.

I do not want to sound overly dramatic, but, by definition, the plan is a step toward the dictionary definition of socialism: government ownership of the means of

production.

Thus, Congress must first answer this question: Should the federal government

have an ownership stake in private corporations?

My own answer is no, but this is an issue of first principles that all Members

must decide themselves.

36

Second, even if you accept that the government should own shares of private companies, should it own so much?

Most large firms that are traded on major exchanges have broadly diverse ownership—which is one of the strengths of the American corporate system. For instance,

Merck & Co., the pharmaceutical house, has only two shareholders with a stake of

more than 1 percent: Fidelity Management, the largest mutual fund house in the

world, at 2.3 percent, according to Technimetrics, Inc., and Barclays Bank, a major

manager of index funds, at 1.5 percent. Assuming that the federal government’s

ownership stake is spread across all corporations equally, it would hold 3.7 percent

of the stock of Merck—or 50 percent more shares than the largest owner currently

holds.

Let’s look at some more examples. General Electric is America’s largest industrial

firm and the largest company on the New York Stock Exchange, with a market capitalization of $337 billion. Fidelity is its top owner, with a 4.0 percent share. Assuming the current stakes remain the same, the federal government would become the

second-largest owner, at 3.7 percent, well ahead of Barclays at 2.9 percent and

Bankers Trust at 1.7 percent.

It would also become the largest single owner of shares in Exxon Corp., the second-largest owner of J.P. Morgan & Co., the New York-based bank, and the largest

institutional owner of Microsoft Corp. (but with a smaller stake than each of the

company’s three founders).

What does stock ownership mean?

In the American corporate system, stockholders are like voters in the political system. They elect representatives—in this case a board of directors—who in turn select managers to run the company. But the essential decisionmaking power in a corporation resides in the stockholders on a one-share, one-vote basis.

Is Insulation Possible?

The administration proposes to ‘‘insulate’’ the government from the direction of

the companies whose stock it owns by setting up a neutral board. This board would

evidently vote the stock.

But, as Chairman Greenspan has told Congress, ‘‘I don’t know any way you can

essentially insulate government decisionmakers from having access to what will

amount to very large investments in American private industry.’’

Certainly, the experience of state and local governments is not encouraging. A few

years ago, the huge state employee pension plan in California, Calpers, brought its

ownership weight to bear in pushing out the CEO of General Motors.

More often, political influence is expressed through specific rules and restrictions.

For example, in the 1980s, 30 states prohibited the investment of government-employee pension funds in companies that did business in South Africa.

In a study of 50 state pension plans over the period 1985 to 1989, Roberta Romano of Yale University concluded that ‘‘public pension funds are subject to political

pressures to tailor their investments to local needs, such as increasing state employment, and to engage in other socially desirable investing.’’ She added that investment dollars were directed not just toward ‘‘social investing’’ but toward companies

with lobbying clout.

After all, when he was Labor Secretary, Robert Reich urged private pension funds

to invest in ‘‘economically targeted investments.’’

Drawing on a reference work by James Packard Love, the Cato Institute’s Michael

Tanner recently concluded that ‘‘23 percent of [state and local government-employee] pension systems have prohibitions against investment in specific types of

companies, including restrictions on investment in companies that fail to meet the

‘MacBride Principles’ for doing business in Libya and other Arab countries; companies that are accused of pollution, unfair labor practices, or failing to meet equal

opportunity guidelines; the alcohol, tobacco, and defense industries; and even companies that market infant formula to Third World countries.’’

Also according to the Love book, ‘‘approximately 42 percent of state, county, and

municipal pension systems have restrictions targeting some portion of investment

to projects designed to stimulate the local economy or create jobs.’’

One result of the politicization of pension investing in the states is that, as Olivia

Mitchell of the University of Pennsylvania found in a study of 200 state and local

pension plans during the period 1968 and 1986, ‘‘public pension plans earn[ed] rates

of return substantially below those of other pooled funds and often below leading

market indexes.’’

No wonder Greenspan told the Senate Banking Committee last July: ‘‘I know

there are those who believe [government investments] can be insulated from the political process. They go a long way to try to do that. I have been around long enough

to realize that that is just not credible and not possible.’’

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Owning Microsoft, Philip Morris

Just use common sense. Imagine what might be called a ‘‘passive’’ system of investing tax dollars only in the companies that comprise the popular Standard &

Poor’s 500-Stock Index, which roughly includes the 500 largest stocks listed on U.S.

exchanges, weighted according to their market capitalizations—or the number of

shares they have outstanding times the price per share.

The largest stock in the S&P is Microsoft, which is currently being prosecuted by

the Justice Department for alleged antitrust violations. Should the government be

the largest institutional shareholder in a company that the government is suing?

That would be quite a conflict of interest. Government shareholders might want to

vote to settle the lawsuit, or agree to break up the company—even if such a step

were not in Microsoft’s interest.

Microsoft represents 3.5 percent of the value of the S&P. So, assuming that ratio holds, by 2014, of the government’s $921 billion in estimated stockholdings, a total

of $32 billion—or nearly $300 per American family—will be invested in Microsoft.

Or consider the number-two stock on the S&P index: General Electric, which

owns, among other things, the National Broadcasting Co. Should the federal government be the second-largest shareholder in a huge media company? Under the same

S&P formula, Washington would own $29 billion of GE stock in 2014.

Perhaps the trustees on the government investment board could duck the Microsoft and GE problems, but what about a company such as Philip Morris Cos., Inc.,

which represents about 1 percent of the S&P (a $9 billion investment by 2014). Philip Morris, of course, is America’s top purveyor of cigarettes. Should the hard-earned

money of taxpayers support a firm that makes what many politicians believe to be

death-dealing products.

My guess is that someone will quickly introduce a bill in Congress to forbid investment in companies that sell tobacco products. That will be followed by bills that

restrict investing in firms that sell alcohol or run casinos or that operate plants that

exploit cheap foreign labor and on and on.

But imagine if, by some miracle, politicians did not restrict ownership, and the

federal government ended up with a large stake in Philip Morris. Then, whenever

the notion of taxing cigarettes or increasing regulations would arise in Congress, the

specter of a conflict would be raised. The legislation might make sense socially, but

it would reduce the company’s profits and thus hurt America’s retirees.

Bias in Choosing an Index

Of course, no investment policy is truly passive. You can put money into an index

fund, but you have to choose an index.

To choose the S&P 500 is to give excessive weight to large companies. Currently, there is no firm on the index with a market capitalization below $400 million, only

40 firms on the index that are listed on the NASDAQ exchange and only two that

are listed on the American exchange. The S&P 500 includes only one biotech firm

and only 13 computer hardware and software companies. It is hardly representative

of the U.S. economy as a whole.

Does it really make sense for the earnings of all working Americans to be invested

in fewer than 10 percent of all listed public companies and far less than 1 percent

of all U.S. firms?

It would be impossible for any investing policy to prevent discrimination against

particular regions of the country. Rep. Christopher Cox has pointed out that an S&P

investing strategy ‘‘would expressively disadvantage Orange County [Calif.]. Our region is teeming with high-tech startups and small-to-medium-sized firms, but is

home to only seven Fortune 500 corporations.’’

There are other indices. The payroll dollars could be invested in the Wilshire 5000

index, comprising every listed stock on the three major exchanges—7,200 of them.

Wilshire investing, however, is technically difficult since such small amounts would

go into some stocks. Vanguard, the mutual fund house with the largest public

Wilshire fund, called Total Stock Market Index Fund, actually invests in only 3,118

stocks, using a computer model to take care of the rest. But should payroll dollars

be entrusted to such a model?

Also, the Wilshire, like the S&P 500, is market-cap-weighted, which means that

large companies get most of the money. Is that fair to America’s smaller firms—

and does it make sense as an investment strategy?

And why invest in listed companies at all? Few of them are run by members of

minority groups or by women. And these are precisely the companies that don’t need

the extra capital that the government would provide.

Even if you could launch a successful index investing strategy, it would hardly

be passive since each year, as my colleague, Carolyn Weaver of the American Enterprise Institute, points out, ‘‘billions of dollars would be pouring into companies withVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00040 Fmt 6633 Sfmt 6621 X:\HSECOM\55156.TXT txed01 PsN: txed01
38

out regard to who is polluting what, who is selling what damaging products to children, who has been convicted of violations of the law or is being sued by the federal

government, who is operating in a country with offensive human rights policies or

dangerous nuclear weapons policies, or... who is in dispute with which union, or

who is moving jobs abroad or selling products made with child labor.’’

Advocates of government investing try to argue that it is no big deal. As President

Clinton said, the federal government would simply be doing what a ‘‘private or state

government pension would do.’’ That is disingenuous. No state runs a pension system for all of its citizens. Instead, states make provision for the retirement of their

employees, who voluntarily agree to accept employment from the state. Social Security, on the other hand, is universal and mandatory. It uses the tax dollars of every

worker, whether he or she works for the federal government or not.

Not the Thrift Savings Plan

Advocates also point to the federal retirement plan, called the Thrift Saving Plan

(TSP), as another example of benign government investing in stocks on behalf of

employees.

But the TSP, which has only $50 billion in assets, is a defined-contribution plan,

which means that employees direct where their retirement savings will go and that

they actually own the accounts. When it established the TSP in 1986, Congress explicitly addressed concerns about political manipulation of funds by observing that

it was the ‘‘inherent nature’’ of a defined-contribution plan that precluded tampering.

That inherent nature was private ownership. As House and Senate conferees stated in H.R. Conference Report No. 99-606 (1986): ‘‘Unlike a defined benefit plan...a

thrift plan is an employee savings plan. In other words, employees own the money.

The money, in essence, is held in trust for the employee and managed and invested

in the employee’s behalf until the employee is eligible to receive it. This arrangement confers upon the employee property and other legal rights to the contributions

and earnings. Whether the money is invested in government or private securities

is immaterial with respect to employee ownership. The employee owns it, and it cannot be tampered with by an entity including Congress.’’

Contrast this arrangement with the administration’s plan. Payroll tax dollars that

go into the Social Security Trust Fund, a general pool of money, controlled by government trustees, would be invested in the stock market—for the general welfare

of the fund not for the particular welfare of an individual owner.

This is truly government money, as opposed to the money of an individual with

the government acting as a fiduciary.

In fact, it makes me wonder: If stock-market investing by the government is so

lucrative, why not have the Treasury issue more bonds at 5 percent and invest the

proceeds in the stock market at 11 percent? The answer is obvious: Private investing is not a government function.

By pointing to the TSP, advocates of government investing remind us of an excellent model for a system of private accounts that could replace the current Social Security system. Under the TSP, federal employees have three choices: a stock mutual

fund, run by a Barlcay’s and based on the S&P 500 and two bond funds. These

choices are too limited, but they are a start.

I would be happy to see Americans divert payroll tax dollars into TSP-style accounts that they would own themselves.

The Risks of Stocks Can’t Be Changed

But what about the risk of the stock market?

This used to be a major argument against Social Security reform that uses private

accounts. For those familiar with extensive scholarly research on the stock market,

it was never a realistic objection.

The nature of Social Security investing is that it is long-term. But the stock market has never suffered a decline, even after inflation, over any period of 17 years

or longer. Bonds have. The standard deviation—a measure of volatility or risk—for

stocks is lower than for bonds or even Treasury bills—over periods of 30 years or

longer.

But the argument that stocks are risky hardly seems a viable argument now that

President Clinton wants to invest tax dollars in the market.

Still, it is said that government investing in the stock market is somehow less

risky than individual investing. In truth, the risk that exists in the stock market

exists for all investors—individual as well as government.

It is true that government, through the taxing power, has the resources to provide

a backup, or safety net, to individuals. But that would be true even if individuals

themselves did the stock-market investing.

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And, of course, the backup would be provided not by ‘‘the government’’ but by taxpayers who supply the government with their tax dollars. So, if a market disaster

occurred, it would be individual Americans who would foot the bill, either way.

Is government a better investor than individuals? It’s possible, but I wouldn’t bet

on it. Research shows that state and local government-employee pension funds certainly lag the market as a whole. Whose index fund investment would perform better? An individual’s? Or the government’s? Obviously, their performance would be

the same.

My own guess is that, with rare exceptions, individuals would do better—for

themselves and their families. They know their own risk tolerance and their own

needs. They would likely be more careful, not less—since so much more is at stake.

Think of it this way: Who would do a better job buying your house for you? You

yourself or a government agency? Retirement-funding decisions are not much different.

Inevitable Political Pressure

But, in the end, the main threat from government investing in the stock market

is the inevitable political pressure that will be brought to bear. For that reason, Professor Romano, after her extensive study, recommended transferring control of

state-employee pension assets from public boards to individual employees in order

to reduce, if not eliminate, ‘‘the opportunity to apply damaging political pressure on

decisions concerning those assets.’’

Alan Greenspan goes farther. He worries that a system of government investing

would ‘‘have far-reaching potential dangers for a free American economy and a free

American society.’’

For the government to use tax dollars to buy shares of private American corporations is for this country to take a giant step in precisely the wrong direction. It is

also unnecessary. If higher returns on retirement contributions are needed—and

they are—individuals are fully capable of seeking them in a system that replaces

part or all of Social Security with private investment accounts that Americans

would own themselves.

Thank you, Mr. Chairman and members of the committee.

Mr. OXLEY. Thanks to all of the panel, and we appreciate your

testifying.

Let me begin with a round of questions. In a general sense, when

Social Security was first enacted back in the 1930’s, Social Security

was essentially meant as a supplement to one’s retirement and

that it would be a piece of one’s retirement but not all of it.

Over the years, in your estimation has that changed? Are we now

as Americans considering Social Security as the bedrock of retirement? And if that is indeed the case, what are the implications for

that on the basis of the yawning chasm of deficits in the Social Security system, Mr. Reischauer?

Mr. REISCHAUER. Mr. Chairman, let me just talk a bit about the

history. When Social Security was enacted in 1935, a tiny minority

of American workers had pension plans from their employer. The

major sources of retirement income were personal savings and extended family support. And so Social Security really was awful

large.

In ensuing years, we have articulated the notion of the threelegged stool, that Social Security should be one component of a retirement income that consisted of an employer-sponsored pension

and private savings. It is, however, an unfortunate fact that only

about half of American workers are covered by employer-sponsored

retirement plans. So many are left with just Social Security and

whatever they can put away in an IRA or in non- tax-favored saving vehicles.

We should do, I think, everything we can to encourage employers

to provide pension plans, and there were several pieces of legislation which Congress has been working on to do this, to simplify

40

and lower the costs of such pension plans for small employers who

are the primary problem here, and do things to encourage individuals to save in the way the President’s USA account would do.

Over the course of this period, Americans have relied less on Social Security than they did in the past, but at the same time, 17

percent of retirees have no other means of income besides Social

Security, and it provides over half of the income for two-thirds of

the retirees.

Mr. OXLEY. Have those numbers remained relatively constant?

Mr. REISCHAUER. The fraction of the population with a private

pension plan has not changed much for the last decade, unfortunately. I would expect the fraction—but the fraction of retiree income coming from pension plans actually has been increased, no

small measure because of the benefits brought by ERISA.

Many were covered by pension plans in the 1950’s and 1960’s,

but never received benefits because they were eased out of a job or

their company went bankrupt before they got to that golden period.

And by changing investment requirements, law approvals, we really have greatly improved that situation, so the fraction of the retired population with pensions has been increasing and the aggregate dollar level of their benefits has been increasing quite rapidly

as well—which, by the way, is one of the unexpected reasons—one

of the reasons for the unexpected growth in revenues that we have

enjoyed that has helped us develop these surpluses.

Mr. OXLEY. Mr. John?

Mr. JOHN. Well, I agree as far as proportion and who is covered.

There is also a question of what income level is covered. If you look

at the 45 to 50 percent of American workers who are covered by

a private pension plan, it tends to be the upper income group. Likewise, if you look at savings, your average American family has

about $1,000 in liquid assets that they can live on, which is fine

if you are planning on living 2 weeks after you retire. I personally

hope to live a little bit longer than that.

When it comes down to it, for your average working American

Social Security ends up being the predominant portion of their pension plan. And, unfortunately, as you pointed out in the rate or return discussions, these are the people who are, unfortunately,

being hurt the most, because they have the lowest rate of return.

If you look at someone who had a 401(k) over the last 12 months,

if they went into the S&P 500 they went up 23.3 percent. If they

went into the Nasdaq, it was 36 percent, corporate bonds 6.4 percent. Even the Series I savings bond was up 5 percent. Well, when

it comes down to it, your average family is 1.2 percent rate of return, and a minority family, in particular a low-income AfricanAmerican family, you actually go into the negatives, very seriously

to the negatives.

Mr. OXLEY. Mr. Glassman?

Mr. GLASSMAN. I really think that what is most shameful, in

fact, about the Social Security system is that it deprives low-income

Americans of the opportunity to participate in the stock market.

Over the last 16 years the Dow has gone from under 800 to over

9,000, but the people who have benefited from this have tended to

be upper-middle- and upper-income people, because as Congressman Sanford said earlier, low-income Americans do not have the

41

savings to put into the stock market. And under the President’s

plan, it is doubtful that they will be able to participate to anywhere

near the degree that they would under a private account system.

So, really, we really need somehow, and I think there are lots of

plans on the table, to get lower-income Americans to be able to invest for the long term in a safe way, their money in the stock market.

Mr. OXLEY. Thank you.

Mr. Greenwood?

Mr. GREENWOOD. Thank you, Mr. Chairman. What is the standard to rethink if we have a proposal by—to what extent do we in

increased consideration of the impact of government savings on the

stock market, and is that appropriate or is it not?

Mr. GLASSMAN. Well, Congressman, I think that in a general

sense you probably already do that. I mean, probably in the back

of your minds at least is the idea that, well, we do not want to take

unwise steps that might hurt the economy and therefore hurt the

stock market.

My main concern is ownership of individual stocks. For example,

if the government owns $9 billion worth of stock in Philip Morris,

will that then make you hesitate about enacting laws that might

be harmful to that company that you own 1 percent of? And even

if there is some kind of insulation as far as ownership is concerned,

you might be concerned that the Social Security trust fund would

be affected, or it would be affected by your ownership of Microsoft.

So I am more worried about individual stocks than about what

steps you might take that would—I mean, concerns that you might

have about hurting the stock market as a whole.

Mr. JOHN. As a former staffer, let me answer that in slightly different way. Suppose we put the Social Security trust fund in the

stock market, and the Wall Street Journal has a little piece at the

bottom of one of the pages that tells you what the value of the Social Security trust fund is today and what it was yesterday.

Now, I vaguely remember floods of letters any time there was

any discussion of a reduction in the value of the Social Security

trust fund, would it be able to meet all requirements, et cetera. If

you have got a number that is in there, I would suggest that you

are going to raise anxiety to a certain level.

Mr. REISCHAUER. Let me agree with Jim Glassman for a rare

time, and say that the stock market is a reflection of the future

strength of our Nation’s economy, and you as policymakers are concerned about the ongoing health of our economy and are doing everything you can to strengthen that future.

We are looking—from this discussion, it sounds like Social Security is a day tripper, that we are worried about what preserves the

worth today versus 2 days from now.

This is an investment for a lifetime. It is probably very unlikely

that the trust fund balance, given the demography that we project,

is ever actually going to be run down.

You are looking at affording a 75-year horizon here. There will

be no need to put in the newspaper what the trust fund is worth.

There is no reason to look at the value of the trust fund on a daily

basis with it invested in bonds, either.

42

I would just like to make one comment about some of the numbers that Mr. Glassman has been using, and he said he was concerned about owning $9 billion worth of Microsoft or a particular

company. That is not the right way to look at it. The way to look

at it is, what fraction of the portfolio of Social Security is going to

be in that stock, and the answer is a tiny fraction. A fraction that

is representative of its percentage in the total valuation of stocks

in the country. And $9 billion might sound like a lot of money to

those of us looking at it one way, but looking at it in the context

of all of the stocks owned by the trust fund, it is not particularly

relevant.

Just to be fair, let me take a swipe at Mr. John as well, who

keeps comparing the return on Social Security, 1.2 percent, with

the returns one could get from the Nasdaq last year or something.

Of course, one would want a longer period than that, and I am sure

he would agree.

But what these comparisons are doing or suggesting really are

incorrect. The trust fund reserves last year did not make 1.2 percent. They made a return of a little over 5 percent, I believe, and

that is the correct comparison. What did the Treasury pay on the

reserves?

The return to Social Security participants is affected by the fact

that three out of four dollars that we send into this system goes

to pay for our parents, our grandparents, our great uncle’s benefits.

Somebody is going to have to pay for those. If we take the money

out of the system now and put it in Mr. Glassman’s private account, we are going to have to raise taxes somewhere else to pay

for our grandparents and parents, or else they are going to be living with us.

Mr. OXLEY. The gentleman’s time has expired.

The gentleman from Arizona, Mr. Shadegg.

Mr. SHADEGG. What is the disadvantage of having that through

tighter control? There has been some pretty good discussion about

government investing, so tell me what you see as a disadvantage

for this?

Mr. REISCHAUER. Well, then we are really comparing two very

different systems, and we would want to look at a lot of other dimensions. We are comparing something that is probably a hybrid

defined benefit, defined contribution system with a defined benefit

system. And to the extent we move to private accounts, risk would

be shifted from society, which bears the risk under defined benefit

programs, in part to individuals. And their benefit would be uncertain, the portion of it that came from their private account.

To the extent we move to individual accounts, we would also

have to change our notion of social assistance, which is provided by

Social Security. This is a program which provides, in a sense, extra

benefits for those who have low wages during their lives, those who

have not participated in paid employment and are spouses of somebody who did, those who have been married for 10 years and divorced, and these are redistributions that take place within our

system now and are terribly important to keeping people out of

poverty in their old age that would not be possible to the extent

that we relied on individual accounts.

43

Mr. SHADEGG. This blend is a mixture of the current system plus

partially funded individual accounts.

Mr. Glassman, perhaps you could respond to that.

Mr. GLASSMAN. Well, let me just comment on this concept of risk.

Somehow the advocates of government investing in the stock

market have this idea that government investing in the stock market is somehow less risky than individual. The risk exists. It does

not matter who invests in the stock market, whether it is you or

me or the government. It is exactly the same.

Mr. REISCHAUER. And I agree with Mr. Glassman for a second

time today.

Mr. GLASSMAN. Come on, Bob. We agree many times, don’t we?

But it is true that the government could, through the taxing

power—the government has the resources to back up individuals or

its own investments, but it has that, anyway. It does not matter

who is making the investment.

Mr. SHADEGG. And that is contemplated in any system that authorizes private investment?

Mr. GLASSMAN. I myself am a little bit worried about a direct insurance program because I think that leads to riskier investing. It

sort of creates a moral hazard problem, but, certainly, we know politically there would be that safety net. You could go to a system

such as what you just described, where it is a partial privatization

where there would be a floor that might be lower than the floor—

it would certainly be lower than Social Security now, but it would

provide that safety net.

So can I use 1 second of my time to respond to my good friend,

Mr. Reischauer?

As far as the proportion of the portfolio that Microsoft would represent, it is a big number. If you used the S&P 500 index, it would

be 3.5 percent of the portfolio, and not $9 billion. By the year 2014,

it would be $32 billion.

So we are not talking about small sums here, and even if you

used the Wilshire index, it would be over 2 percent. So these are

not small sums or small investments in individual American companies. That is my only point.

Mr. SHADEGG. My last question for you, all panel members: I understand what you mean by people at a lower income level not participating in the market and therefore not being able to take advantage of the growth of this economy.

I happen to believe that if you create a system which includes

the ability for at least some people at the younger age begin to put

money aside in the private account, it could have the dynamic that

is not actually discussed. It would illustrate to those people that

the market really does work.

Has that factored in?

Mr. GLASSMAN. I was going to say, this has been the experience

in Chile at least, which has had this kind of system since 1981.

Mr. JOHN. It has also been the experience in the United Kingdom

and to an extent in the experience in Australia.

Mr. REISCHAUER. I have a question to these two gentlemen,

which is I thought the question was, is there an indication that by

providing private investment through the mandatory pension system, low-wage workers or median-income families have gotten a

44

taste for investment and increased their saving. I am not aware of

any study that suggested that is the case in Chile or in Australia.

Mr. SHADEGG. That is in fact my question, and what my other

question would be, since two of you did say yes, there is evidence

to that effect, could you submit it to the committee?

Mr. GLASSMAN. Yes, I would be happy to.

Mr. GILLMOR. The gentleman’s time has expired.

The gentleman from Massachusetts, Mr. Markey?

Mr. MARKEY. Thank you, Mr. Chairman, very much.

As I mentioned earlier in my opening statement, Mr. Bartlett

and Mr. Pomeroy are going to introduce a bill later on today to insulate the investment fund that could be created under the President’s proposal from political interference.

Let me just go down what we are going to propose in order to

deal with the problem.

One, we establish an independent agency to oversee the investment, governed by a board, appointed for 10 years, staggered

terms.

Two, we ban the board or the executive director of the fund from

doing any individual stock picking.

Three, we ban them from picking any stock index of a fund based

on the political, social or religious considerations, and we direct

them to instead focus on maximizing returns and minimizing administrative costs.

Four, we require that the actual investing be done by professional money managers.

Five, we limit any one money manager to controlling 1 percent

or less of any of the total common stock of a company on the index,

so that the many managers that would be selected would have

independent investing authority and not anyone with more than 1-

percent control of any company.

Six, we direct that the managers mirror-vote their shares in the

same percentage as all of the other shares are voted, so that the

fund remains neutral in any corporate governance matter.

So, if the vote is 51 to 49 by all of the shareholders, that is how

the vote has to be coming from the government-owned shares, and

in that way, there is no influence whatsoever.

So let me pose this to the panel. Why wouldn’t that insulate?

Why wouldn’t that protect against the kind of political interference

you are concerned with?

Mr. Glassman?

Mr. GLASSMAN. Well, it is a law and it can be changed. If it is

a constitutional amendment, it might be able to sustain objections.

What happens if there is another South Africa, as 30 States have

put restrictions on government employee pension fund investments

in South Africa?

I am with Chairman Greenspan on this. I just have my doubts

that any fund can resist the political pressures that exist up here.

You have been here for a long time. You know what kind of political pressures exist.

Let me just raise a second issue, which is this matter of index

investing. Any index that you choose is an investment choice or a

political choice, really. If you choose the S&P 500 you are choosing

very large corporations. Even if you choose the Wilshire 5000,

45

which is an index comprising every listed stock, 7,000 of them, that

is market-cap weighted. So that is weighted toward large companies.

I am not sure exactly what kind of index you could use. Would

you equally put money into all 7,000 companies? That would be a

lot of money for a little tiny company. I would like to start one tomorrow. It just raises some very difficult technical issues.

If you do set up such a board and if you do believe that it could

be insulated, I would give managers actually much more discretion

than you would want to give them. I think it is almost impossible

to simply say you can only go into index funds because those are

decisions. In fact, they may be bad investment decisions. Lately,

index funds have been terrific, but they might not be good in the

future. I just have some doubts.

Mr. MARKEY. But if you pick the Wilshire 5000, you are capturing every firm, whether it be high tech or smoke-stacking. Everyone is in. Again, the objective of the fund would be not to pick

the winners and losers in the marketplace, apart from the goal of

insuring the retirees with the highest-possible return.

If there are pension capitalists or others in my district who want

to invest in the hundreds of thousands of software and computer

high-tech firms that are in my district, they are still free to do so.

It will lift up those companies, but for the purposes of what we are

trying to achieve, which is to catch that spread between the 7 percent that the little shareholder of 40 or 50 years would choose as

a return as opposed to the 2.5-percent yield from the bond market,

I think it deals with a political influence question and it deals with

the spreading of risk. It deals with the gambling question because

there will be long-term investors. We try to reduce all of the concerns which people have justifiably raised and at the same time

have people be able to get the benefit of a safe and comfortable

long-term investment in the market.

I understand your concern, but, again, Henry Gonzalez introduced a bill to repeal the independence of the Federal Reserve

every year for 30 years, and it did not go anywhere. I suppose any

one of us could introduce a bill to curb the independence of the

FERS investment board, those who invest, but no one has ever

done it.

If we on a collective basis agree unanimously to pass a piece of

legislation to this effect, theoretically anyone could come back and

undo it. I just think it would be a very difficult political act,

though, to engage successfully.

Mr. GLASSMAN. Just one comment about the Federal Reserve. I

think if you ask Alan Greenspan this question, he would probably

admit, if he were candid, that the Federal Reserve is indeed subject

to political pressures. I mean it is. He comes up here and testifies

on Capitol Hill. He cannot tell you, ‘‘No, I am not going to come.’’

I mean, obviously he and the other Governors operate—maybe

these pressures are subtle, but they certainly exist.

Let me just make a point about the Wilshire. You say that you

cannot have more than 1 percent in any stock, and I think that

makes sense, but just off the top of my head, Microsoft, which is

the largest company in the Wilshire, I am almost positive represents somewhere between 2 and 2.5 percent of that index.

46

So that is the kind of problem—I do not want to be too technical,

but I think that is the kind of problem you get into.

Mr. REISCHAUER. Well, weren’t you suggesting that no fund manager could go with more than 1 percent? So, if you have six or

seven fund managers, it would allow you to have 6 or 7 percent.

Mr. GLASSMAN. Well, do you think that 6 or 7——

Mr. MARKEY. The board would hire Vanguarg and Fidelity and

five other fund managers, but none of them could invest more than

1 percent, although the cumulative goal could be more than 1 percent in any individual company.

Again, if the concern was the political influence that the one

manager could have, we would remove that down to no more than

1 percent, although the retirees would get the benefit of the widest

possible investment strategy.

Yes, sir.

Mr. JOHN. Just a couple of very quick points, if I may. One is

you say that the government would vote according to the rest of the

stockholders with that. How do you know that in advance? I mean,

essentially, what you are doing is not voting those shares.

Mr. MARKEY. We would send instructions to the transfer agent

to vote in the same percentage as the other——

Mr. JOHN. So they would not vote until after the rest of the votes

were announced.

Now, No. 2 is that if you are developing your own stock index

here, which hypothetically you could be, I could develop a stock

index and give you a wonderful reason for doing it that did not invest in any companies that included tobacco stocks, liquor manufacturers, nuclear powerplants or anyone who gave to the Democratic National Committee in the last year. All of that is hypothetically possible.

I just point out that in 1974, Congress once and for all took care

of any political influence problems in the campaign finance laws,

and at that point, it developed what was seemingly a seamless situation.

Mr. MARKEY. Like I said, Mr. Bartlett has a zero ADA rating and

I have a 100-percent ADA rating. We are agreeing to agree that we

can find all the words that are necessary to make it clear in the

language of the legislation that we are talking about, generally recognized indexes and not some subset that might be created.

Mr. GILLMOR. The gentleman’s time has expired.

The gentleman from California, Mr. Cox?

Mr. COX. Thank you, Mr. Chairman.

I am very interested in the legislative proposal advanced by my

colleague, Mr. Markey, and other colleagues in Congress. It causes

us to address the question of whether the Federal Government

should invest in the stock market is a good idea or not. We ought

to ask ourselves, it seems to me, why we are here and why Social

Security needs fixing.

We are here because the so-called trust fund, the Social Security

trust fund is invested exclusively in government liabilities. It is a

wonderful thing to have a Treasury fund. You are not in the Federal Government, but the one person—there is a fundamental distinction between a liability and asset that we are missing here. The

reason we are here today is that rather than put real assets behind

47

the Social Security system and set up on a pay-as-you-go basis, demographics made that work marvelously well throughout the 20th

century. Demographics are not going to make that work. That is

why we are told by the Social Security that if we do not do something fast, the 35-year-old worker is going to have to pay 18-percent higher payroll taxes or have his benefits cut by 25 percent.

Government did not do what government promised. That is our

problem. So the question is how much government control do we

want in these investments. What would be the fundamental problem with investing in index funds if the Federal Government did

control it? How does the individual screw that up?

I checked Mr. Reischauer’s report, and I found out that the problem is not that people cannot be trusted to invest in index funds,

but, rather, that there would then be political pressure on Congress

to change the law so that they could control the accounts, so they

could take their money out sooner. That same political pressure

could be used on Congress to change this law or to change any law

or to change the current laws that we have, which would say it is

all insulated from political involvement.

I just want to know, Mr. Glassman, you said that it might be

sensible to have the Federal Government own U.S.—in truth, whatever he is talking about is buying a fractional of ownership, not

even the 5 percent of the SEC that has control.

So isn’t it true that what we are really talking about here is not

socialism, but fascism, that it is private property for government

purposes, that private property at the government direction, private property used for government purposes?

Mr. GLASSMAN. Well, let me duck question.

I think that if that is your characterization, you and I agree on

many things. So I have to think about that, though, but I do believe that you have to begin with first principles. I think the question, whether it is index funds or not index funds, that is later on.

The first question you have got to ask yourself is, is it proper,

is it within this country’s tradition, does it fit in the way the rest

of the world is moving, for us to take payroll taxes, for the government to invest payroll taxes in the stock market?

I just cannot stress enough the profound change that this represents in the role of the U.S. Government, and whether you call

it socialism or fascism or whatever it is, it does not seem to me to

comport very well with American traditions, and I think constitutional traditions.

We have always separated as much as we could the government

from the private sector, and the government will become a major

owner of American corporations.

I mean anyone who does not think 3 percent stockholding is a

lot, look at what Calpers did to General Motors, okay? Maybe they

did the right thing, but this is the power that can be wielded by

a stockholder of only 2 or 3 percent in a large corporation.

Mr. OXLEY. The gentleman’s time has expired.

Mr. Shimkus?

Mr. SHIMKUS. Thank you, Mr. Chairman.

The terminology is very important. I am not a lawyer. So I am

not an expert in the legal aspects of the language, but it is not correct to say rate of return on Social Security today. Rate of return

48

would assume that there is an account by which you can then calculate—there is a principal and then there is the interest amount,

and then you would calculate it.

Today’s Social Security is a tax which has promised entitlements

which the courts have ruled may not be paid. Is that correct? Am

I talking the proper English here?

Mr. JOHN. Actually, you are correct, but what you can do to approximate that is to measure all of the taxes that are paid as opposed to all of the returns that on the average an individual can

expect.

Mr. SHIMKUS. I understand that, but the problem with that is we

continue to deceive the public by doing that.

We continue to state to the public that there is a rate of return

on their investment, and that they have something there, when in

reality what they are is paying taxes to the current recipients in

the hopes of having future taxpayers pay down the sum amount in

retirement.

Mr. JOHN. To an extent, I agree with you, and one of the things

that has not been discussed to any great extent is that if future

taxes only brings in enough to pay 72 percent of benefits, which is

what is projected by the Social Security Administration, then these

are very high-risk activities.

The one advantage that you do have with a rate of return is that

it allows you to compare opportunity costs; in other words, what

could you do with that money.

Roughly three-quarters of the American people, their highest tax

is Social Security tax in one form or another, and what we have

tried to do by using rate of return is to point out to them that they

could do better under a slightly different structure.

Mr. SHIMKUS. Let me address the President’s proposal, and, Mr.

John, if you could answer first.

It is my understanding in the President’s proposal of investing

and receiving returns that the question is that the incoming payroll

tax receipts will fall short of the outgoing Social Security benefits

in 2013.

Does the President’s reform proposal for saving Social Security

make any reforms to address the upcoming 2013 shortfall?

Mr. JOHN. According to the new Comptroller General, David

Walker, no, it does not.

Mr. GLASSMAN. I agree with that. It does not.

When you get to the year 2013, there will be a whole bunch of

bonds left in the trust fund, and giving people bonds, Social Security beneficiaries, to take to the grocery store to buy their groceries

is not going to work very well. So those bonds have to be cashed

in. So where is the money going to come from? Well, it can only

come from either tax revenues or through further debt.

What the administration is saying is by kind of paying down

some of the debt or by getting some revenues from investment in

the stock market, it will be easier to borrow the money down the

road if we need to borrow it, but the cash will not be there, is the

answer.

Mr. REISCHAUER. Well, let me just disagree with the two of them,

and that is that there is a small difference. That is, the equity inVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00051 Fmt 6633 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
49

vestment would create a flow of revenues into the trust fund that

would boost revenues and add maybe a little bit to that time.

Mr. SHIMKUS. You are referring to a year or two versus the real

plan is to move the chart or actually move the 2035 date to, what,

2075 or to push it. The outlays are still going to occur within the

2013 framework. There is no real addressing the inherent——

Mr. REISCHAUER. But to be fair to the President, he did not suggest this was the whole enchilada. He said what I am doing is presenting one piece of a larger package. Now, he has not come forth

with the remaining piece of that package, and I think you can say,

‘‘Next move, Mr. President.’’ but this was not intended to be the

whole story.

Mr. JOHN. There is another problem with this, which is even if

you buy the President’s assumptions, suppose you subtract out the

OMB deficit projections and you put in the CBO deficit projections.

What you come up with is a fact, again leaving everything else the

same, that you have spent several trillion dollars and hypothetically you have bought 8 years, as opposed to moving to substantially more than that. That includes government investment,

and when you subtract out government investment, that buys precisely 2 years.

Mr. OXLEY. The gentleman’s time has expired, and I thank you.

The gentleman from Pennsylvania, Mr. Greenwood?

Mr. GREENWOOD. Mr. Chairman, I would like to begin with Mr.

Reischauer, and the others may respond as well.

I apologize for not being here during your testimony, but I have

read your testimonies.

Looking at the critical job that you did in terms of describing

how a series of firewalls could be built, I will call them firewalls,

in order to insulate these investments from political influence, it is

credible, but it is also credible, looking at these examples.

I would just like each of you to respond to how fireproof these

firewalls really would be.

Mr. REISCHAUER. Having worked up here for over 12 years, I certainly defer to your judgment on the potential for this body to foment mischief in this area, but I think we are really getting ourselves overly worked up over this issue.

The principle of hands-off the environment, I think, would be established in the debate, and would be supported. I have no doubt

that individual members will stand up from time to time and say

Levi Strauss has closed a factory in my area and moved jobs offshore. I think that we should remove that from Social Security investment, but a lot of that would be more for posturing purposes

than for actual meaningful legislative action.

I think there would be a constituency on the other side, a constituency that would be very strong among the aged and among

workers that would say, politics, stay out of this. I do not agree

with everything, with all of the investments, but that is not the

way this thing was set up.

I could be wrong. Jim would argue that my judgment here is

naive, but I think——

Mr. GREENWOOD. If I may interrupt, and I apologize for doing

that, the argument that you have made, that has not been the experience with Thrift Savings and other funds. It is a persuasive arVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00052 Fmt 6633 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
50

gument, and I think the question would be the order of magnitude

and visibility of this fund to change.

Mr. REISCHAUER. I think that works both ways on both sides.

There is a big constituency of regular Americans who just say you

stay out of this, which maybe is not the case when you are dealing

with State employees, all of whom are unionized.

Mr. GLASSMAN. I just want to respond to the Thrift Savings Plan

issue, which is addressed in my written statement.

Advocates bring this plan up all the time, saying you have this

insulation. The Thrift Savings Plan is a completely different animal from what we are talking about here.

It is a defined contribution plan, which means that the employees themselves, Federal employees themselves, direct where their

savings will go, and they actually own the account. The government is just a fiduciary.

I do not want to read the whole thing, but in the conference report in 1986, when the Thrift Savings Plan was set up, this issue

was addressed, and the observation was made that it is in the inherent nature of a defined contribution plan and that you do not

tamper with it. That is why it was set up as a defined contribution

plan. As I said, it is in my statement. I really think that that distinction should be made.

I would also say, and I do not know whether Mr. Reischauer

would agree with me, but the Thrift Savings Plan actually makes

a very nice foundation for a system of moving toward private accounts.

With the Thrift Savings Plan, you get to choose yourself where

you are going to put the money. The government does not make the

choices. It is your money. You choose. This is the way the 401(k)

plans work.

The fact that the government has stayed out is natural in a situation where individuals own accounts. Individuals will not stand

for this, and that is why I think that is the direction we should

move in rather than toward what the President proposes.

Mr. JOHN. I would like to agree with that, actually, and completely, but just to point out that a couple days after the President’s plan was announced, there was a hearing in the Ways and

Means Committee where Reverend Jesse Jackson announced that

he thought that it was a fine idea for the government to invest in

private-sector items as long as it did not have anything to do with

tobacco, guns or liquor.

Now, within the last few weeks, we have had a number of reports. The AFL-CIO has been sending out letters to everyone who

invests in their pension plans, saying that in the event that you

publicly take a position in support of any form of privatization of

Social Security, we are going to pull our money. They also announced at their convention down in Florida about a week ago that

they are going to be monitoring how their pension managers vote

on AFL-CIO resolutions. Now, here is a quick case of where the

pension needs of their members are being subordinated to shortterm political goals.

Mr. OXLEY. The gentleman’s time has expired.

Did you have something, Mr. Reischauer?

51

Mr. REISCHAUER. I just have a footnote on Mr. Glassman’s answer, and it is that the defined contribution, the TSP-type framework, does not get around this question completely because what

we do for Federal workers is we present them with three options,

and the question is who defines those options.

Well, you could have a situation in which the Congress said one

of the options will be, as it is now, the Standard & Poor’s 500, less

Levi Strauss, Microsoft, Philip Morris, whatever is objectionable.

So, unless you allow a broad selection of investment alternatives,

you still have this problem, not to the same degree maybe, but you

still have it.

If you go to a broad set of investment options, you then have a

problem of administrative cost and compliance, and these things

are all interwoven with each other and it makes it very difficult.

Mr. GLASSMAN. Right. Can I just say I agree with that analysis.

It certainly is possible the Congress could pass a law that would

interfere with individual ownership.

In fact, you could pass a law right now to stop all Americans

from investing their own money in Philip Morris if it wanted to,

I suppose. That would probably go through the courts and might

be overturned, but let me just read from the conference report.

It says: ‘‘This arrangement confers upon the employee, property

and other legal rights of the contributions and earnings. Whether

the money is invested in government or private securities is immaterial with respect to employee ownership. The employee owns it

and it cannot be tampered with by an entity, including Congress.’’

Now, maybe the conference report is a little strong. It says ‘‘cannot be tampered with.’’ It probably could be, but the chances that

it would be, I think, are a great deal less than the chances that

what the President has proposed will be tampered with. That is all.

Mr. OXLEY. Mr. Markey?

Mr. MARKEY. Thank you, Mr. Chairman.

Mr. Glassman, first of all, I want to say thank you for helping

in our time of need.

Mr. GLASSMAN. Thank you, Congressman.

Mr. MARKEY. In the beginning of the statement, you say that

Congress must answer this question, should the Federal Government have an ownership stake in private corporations. You say by

no means, but this is an issue of first principles that all members

must answer for themselves.

My question is, does Calpers, does the Massachusetts Teachers

Retirement Fund—does that raise the same first principle question

in terms of being stakeholders in the market, and should we reconsider whether or not we want States investing in the private market as a matter of course? How would you stand on that?

Mr. GLASSMAN. Well, I think State employee pension plans, and

I stress employee, are a completely different kind of situation.

There is no State that I am aware of that gives pensions to its

citizens on a broad-based basis the way the Social Security does.

These are State employee pension plans, and I think that makes

it completely different.

You have a State employee who is voluntarily deciding, okay, I

will accept employment from the State under these conditions. And

the State, it is true, this is State money, it is payroll tax dollars,

52

but I think there is a pretty clear distinction between State employee pension plans and Social Security, which is essentially a

universal and a mandatory, by the way, pension plan. That is all.

Mr. MARKEY. But it still does have that State element.

Mr. GLASSMAN. I agree, I agree. I have to say, I do not think

these things are clear-cut, and my own opinion is that it is fine to

have State employee pension plans, although I agree with Roberta

Romano who studied these, Roberta Romano from Yale Law School,

who studied all 50 pension plans and concluded—I do not have it

here, but she concluded in fact that because there is so much political interference in these plans that they should become defined

contribution plans.

Mr. MARKEY. Is that in your submission as well?

Mr. GLASSMAN. Yes, it is.

Mr. MARKEY. You have a sample?

Mr. GLASSMAN. Yes.

Mr. MARKEY. Then let’s move to the other issue. If we do move

it over to a system where we have individual accounts and we subtract sort of a percentage of the contribution now to that trust fund

and give it back to individuals, how do we handle the issue of the

present-day retired pool, plus those who are approaching that age,

in terms of the guarantee of the benefit which they are now entitled to? Is this a required tax increase? How do we deal with that

transitional period?

Mr. GLASSMAN. Well, first of all, I think Congress should pass a

law that simply says that all persons who currently receive Social

Security benefits will continue to receive those benefits at the current rate for the rest of their lives, as well perhaps as people in

their fifties or are 55.

I think it is very important to put those people’s minds at rest.

It is really unfair for them to be worried about the discussions that

are going on here, because these are discussions really about people

in their twenties, thirties, and forties, not about people who are

currently retired or about to become retired.

Those people should be taken care of by whatever means necessary, and if that includes a tax increase, then it will include a

tax increase. I am not against that, although I am not sure that

it is necessary.

Some people say it will, some people say it will not, but if it

means a 1-percent or 2-percent increases in payroll taxes, I think

that is a small price to pay for the increased returns that individuals have, the increased responsibility that they will gain from investing in the stock market, and frankly for the increased kind of

personal freedom that they will gain in making their own decisions

about their own livelihoods, just as they do in most other areas,

like buying a house or having children.

These are just not the realm of government in my opinion.

Mr. MARKEY. Could I ask Mr. Reischauer on the issue of whether

or not a tax increase will it be required?

Mr. REISCHAUER. Well, the answer is in the details of the plan,

and most of the plans that have been put forward either require

borrowing, large amounts of borrowing from the public or a tax increase or they use, at least for a time, the projected surpluses

53

which will buildup and then have to make a decision on whether

to borrow or increase taxes.

Mr. MARKEY. Would this be trying to avoid a tax increase or a

borrowing?

Mr. JOHN. Well, hypothetically we examined it, and there are

about four different ways that you can fill the hole when it comes

right down to it.

You can use the surplus, where the alternative would be tax

money. You can hypothetically reduce spending on other programs.

You can sell government assets, or you can borrow money.

Now, the problem that you are going to face is that starting in

2013, no matter what, you have got a significant gap that you have

got to deal with. So the question is, are you going to deal with the

current gap or are you going to deal with the future gap, and which

one is larger.

Now, one of the things that we did a little research on is that

hypothetically you could come up with say a 2-percent carve-out or

something along that line, which would substantially reduce your

long-term liability.

Mr. MARKEY. Thank you, sir.

Mr. OXLEY. The gentleman’s time has expired.

Let me wrap this up. First of all, thank all of you for informing

us on this difficult issue.

Mr. Glassman, I read your testimony last night and agreed with

almost all of it, but I wanted to know particularly from you or Mr.

John, if you were to advise us as to how to best set up an individual retirement system out of Social Security or supplement Social Security as well, how would you go about it?

Some have suggested that the Federal employee retirement system is a good place to start because, as you indicated, Mr. Glassman, it is privately held, relatively low fees, and you get a choice

of risk within a fairly narrow parameter. You go everywhere from

a C-fund which is the biggest risk, down to the G fund, the government securities.

Is that a good place to start as we try to practice alternatives?

If it is not, what would be more appropriate?

Mr. GLASSMAN. Well, I think that is a good place to start.

I think that the Thrift Savings Plan actually does a disservice to

the people who are in it now because it does not give them enough

alternatives. Now, I understand they are going to have a SmallCap

fund and so forth. There really should be more than one stock fund

as an alternative, but that certainly is not a bad way to do it.

I think it is important to start quickly, and start to allow people

to kind of get a taste for investing in savings, especially the vast

numbers of Americans who do not do it now.

Mr. OXLEY. Could I interrupt just a second?

Mr. GLASSMAN. Sure.

Mr. OXLEY. We should talk about it. It is true that we are talking about people in their twenties, thirties, and forties.

Mr. GLASSMAN. Right.

Mr. OXLEY. My son is 26. He is now an investor on the Internet,

as are a lot of his contemporaries.

54

As least as I see it, the younger people or even some of the babyboomers are getting to be relatively sophisticated investors. Half of

the households in this country own computers.

Mr. GLASSMAN. Yes.

Mr. OXLEY. So it is kind of a generational thing, is it not?

Mr. GLASSMAN. Yes.

In general, you hear a lot of talk about day-trading and people

trading on the Internet. There obviously is some of that, and that

is not, in my opinion, investing. That is speculating or gambling,

and not a good thing to do with your retirement dollars, but you

could certainly set up a system that required mandatory contributions. You would have to keep your money in. You would not be

able to make those kinds of day-trades.

As far as your question is concerned about sophistication, there

is absolutely no doubt, and I see it in my own readers, that there

has been increased sophistication about stock market investing

over the last 10 years. Mainly, that sophistication revolves around

the notion of buying good companies and holding onto them for a

long time. That is what we are seeing. During the last stock market break, it was the small investors who stayed in and who

bought, and the so-called professionals who bailed out.

So, yes, there is increased sophistication. There should be more

increased sophistication. I agree with the chairman of the SEC,

who issued some warnings about just going very quickly into stock

market investing, investing part of Social Security in the stock

market, and I agree with that. I think we should start small. We

should have limited choices, but really bring the vast majority of

Americans into the private sector. Let them partake of what is

going on in this country.

Mr. OXLEY. Mr. John?

Mr. JOHN. I would agree with that.

The one slight difference I would make is that rather than having one choice—I mean the overall size of TSB at the end of the

year 1997 was $60 billion or so. If you take 2 percent of the OASI

funds and put them into some sort of a mandatory savings account,

you are talking about something on the order of $60- to $80 billion

a year, not counting buildup. At some point or another, it does

make sense to start maybe with three investment options. As I say,

that holds down administrative costs rather directly, but rather

than saying everyone must put their money in say the Barclay’s

Equity Index Fund or something along that line, if I had the option

to choose an index fund, as long as it had a minimum of 500 stocks

or so and I could buy that regardless of whether it is from the credit union downstairs or Merrill Lynch or Goldman Sachs or Prudential Insurance Company. This would all you to spread out, and you

would not have the problems of huge sums being dumped into one

index bond or two index bonds or something along that line.

Mr. OXLEY. You would both agree though that an index fund is

the way to go?

Mr. GLASSMAN. I think several index funds should be the way to

go, different index funds, and let me also associate——

Mr. OXLEY. Do you think people should buy index funds?

Mr. GLASSMAN. Yes, absolutely, people should have the option.

55

Let me also just associate myself with what Mr. John just said.

I think I would much prefer a system where private companies,

strong private investment firms will be able to offer these investment products rather than just a few, although there is this issue

of administrative costs, and that has to be resolved one way or the

other.

Mr. OXLEY. Let me ask you this. A lot of people say that they

are not sophisticated enough to make those kind of investments,

they are likely to lose their savings, that we ought to just raise

taxes. What is your reaction to those who say we ought to trust

people to make these decisions that involves their family, their personal best interests?

Mr. REISCHAUER. Oh, I think we very definitely should, and we

do. We give workers in American who have 401(k) plans lots of

ability to make those choices. We offer IRA’s and other tax-advantage savings vehicles which people can——

Mr. OXLEY. That is indeed part of the fabric.

Mr. REISCHAUER. The real question is, do you want to put all of

your eggs in a single basket.

I think you are undoubtedly right when you say there is a

generational shift going on, that younger generations have more sophistication and more knowledge, but let’s not kid ourselves.

Look at the figures that Arthur Leavitt included in his talk up

at The Kennedy School about the American people’s sophistication.

The vast majority do not know the difference between a stock and

a bond, and we are talking about 80 or 90 percent do not know

what a load is on a mutual fund. There is tremendous ignorance

still out there.

Mr. Glassman mentions that there has been a tremendous surge

of interest in financial market information. We have had 4 years

of over 20-percent growth in the stock market. This has become

something like a sport or a recreation activity.

If we were to go back to more normal returns, where it went up

15 percent, down 3, it averaged 7 or 8 over a long period of time,

you might find a lot of people who seem to express a lot of interest

in these issues, and I am one of them. I am an avid reader of your

column every week.

There are a huge number of Americans who want this, in a

sense, taken care of for them. This is the basic foundation of retirement income. It is not the whole kit and caboodle, and what we

want to do is make sure we have that basic foundation secure and

predictable and adjusted for inflation. It is very difficult to do those

three things with the component that would be in private accounts.

Mr. OXLEY. With that, let me again thank you all for an excellent

morning of testimony.

The subcommittee is now adjourned.

[Whereupon, at 12:30 p.m., the subcommittee was adjourned.]

(57)

THE MARKET IMPACT OF THE PRESIDENT’S

SOCIAL SECURITY PROPOSAL

WEDNESDAY, MARCH 3, 1999

HOUSE OF REPRESENTATIVES,

COMMITTEE ON COMMERCE,

SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS,

Washington, DC.

The subcommittee met, pursuant to notice, at 10 a.m., in room

2123, Rayburn House Office Building, Hon. Michael Oxley (chairman) presiding.

Members present: Representatives Oxley, Tauzin, Gillmor,

Greenwood, Cox, Largent, Bilbray, Ganske, Shimkus, Wilson,

Shadegg, Fossella, Ehrlich, Bliley (ex officio), Towns, Deutsch, Stupak, DeGette, Barrett, Luther, Markey, Hall, and Dingell (ex officio).

Staff present; David Cavicke, majority counsel; Linda Dallas

Rich, majority counsel; Brian McCullough, professional staff; Robert Simison, legislative clerk, and Consuela Washington, minority

counsel.

Mr. OXLEY. The subcommittee will come to order.

Before we begin the hearing, the Chair wishes to make a brief

announcement. The Chair wishes to remind members that today’s

hearing marks the committee’s first effort to broadcast a live audio

feed over the committee’s Internet site. Our staff and constituents

may listen to today’s proceedings simply by accessing the committee’s website. I believe that this is another important step in making our proceedings more accessible to the people we serve.

The Chair is pleased to convene a second in the subcommittee’s

series of hearings on Social Security reform.

We are fortunate today to have before us the Chairman of the

Board of Governors of the Federal Reserve System, the Honorable

Alan Greenspan. Chairman Greenspan has raised concerns that go

to the very heart of this subcommittee’s interest in the issue of Social Security reform and the impact that government investment

would have on our capital markets.

We are also honored today to be hearing testimony, addressing

this issue, from the Deputy Secretary of the Treasury, the Honorable Lawrence Summers, who will be joining us later this afternoon, at 1:30 to be precise.

At the subcommittee’s hearing last week, we heard a wide range

of views as to the impact of government-controlled investment on

the capital markets. But on some very fundamental issues, there

was, and remains, strong bipartisan consensus.

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There is consensus that, as a primary matter, our Social Security

System is in dire need of reform. I believe there is a strong consensus against cutting benefits or raising taxes. Accordingly, there

appears to be agreement that the best way to accomplish the necessary reform is to increase the return generated by the tax dollars

that currently go into the Social Security Trust Fund. There even

seems to be agreement that the best way to do that is to invest

those dollars in the stock market.

Significantly, there appears to be a consensus that it is vital to

our free capital markets that investment decisions relating to investment of Social Security dollars be protected from political pressures that would lead to reduced returns, corruption, or worse.

Robert Reischauer, Senior Fellow of the Brookings Institution,

testified that he believed that, ‘‘If there were no effective way to

shield trust fund investment decisions from political pressures, the

advantage of higher returns that a diversified investment strategy

would yield would not be worth the price that would have to be

paid.’’

Where there appears to be a difference of opinion is on the question of whether it is possible to provide such a shield. This is the

fundamental question that we will explore at today’s hearing.

A number of the witnesses at last week’s hearing echoed the

view of Chairman Greenspan that it is not possible to insulate government decisionmakers from influencing the investment decisions

made with respect to Social Security Trust Fund dollars in a plan

such as that proposed by the President. Others suggested that the

Federal Thrift Savings Plan and the pension plan of the Federal

Reserve are evidence of the feasibility of providing such insulation.

Some provided suggestions as to procedures and plans that could

be put into place to ensure that political considerations could not

possibly influence investment decisions. At stake is nothing less

than the efficiency and success of our capital markets because their

efficiency and success derive from the freedom that underpins

those markets.

I believe this Congress has an historic opportunity to provide a

tangible, enduring boon to the quality of life of American workers

by reforming Social Security to ensure a better retirement for all.

I look forward to finding and developing the areas of common

ground that will enable us to create bipartisan reform that will accomplish this monumental achievement.

Mr. Chairman, I thank you for appearing before the subcommittee today. I note that the subcommittee will adjourn following the questioning of our first witness and reconvene at 1:30

for the testimony of Secretary Summers.

The Chair’s time has expired and I will be pleased to yield to my

good friend, the ranking member, gentleman from New York, Mr.

Towns.

Mr. TOWNS. Thank you very much, Mr. Chairman. I also thank

you very much for holding this hearing.

At this time I would like to yield to the gentleman from Massachusetts for a statement.

Mr. MARKEY. Thank you, Mr. Towns, very much and thank you,

Mr. Chairman. I commend you for calling this second oversight

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hearing on the market impact of the President’s Social Security

proposal.

If we are going to invest a portion of the Social Security Trust

Fund in the stock market, we basically have three choices. First,

we could establish privately managed accounts. Second, we could

create individual accounts that are centrally managed through a

government-sponsored entity like the Federal Thrift Savings Plan.

Third, we could maintain the defined benefit nature of the Social

Security program while investing a portion of the Social Security

reserves in broad index funds using a Thrift Savings Plan-like investment structure. This third approach is what the President has

endorsed and what the bipartisan legislation that I have introduced with Representatives Bartlett and Pomeroy would implement.

Our bill contains six principal safeguards that will insulate the

Social Security Investment Funds from the risk of political influence or social investing.

One, we establish an independent agency to oversee the investments, governed by a board appointed for 10-year staggered terms.

Two, we bar the board or the executive director of the investment

fund from doing any individual stock picking or voting of shares.

Three, we bar the board—our executive director—from picking

any stock index fund based on political, social, or religious considerations and direct them, instead, on maximizing returns and minimizing administrative costs.

Four, we require that the actual investing be done by professional money-managers who have substantial private assets under

management.

Five, we limit any one money-manager to controlling 1 percent

or less of any of the total common stock of a company that is on

the indexes selected for the fund.

Six, we direct that the managers mirror vote their shares in the

same percentage as all of the other shares voted so that the fund

remains neutral in any corporate governance matter.

Today, we will be hearing from one of the most thoughtful and

influential critics of the President’s approach. I look forward to

hearing from Chairman Greenspan on this issue. There is no one

whom I respect more. I look forward, as well, to hearing from Secretary Summer this afternoon.

But, as we debate the merits of this proposal, I am reminded of

something that my mother always said to me, which was that the

most important question to answer in every single instance in life

is, compared to what? So, let’s take a look at the privately managed

private account alternative.

The French have a saying that when you want to get to the bottom of any mystery, ‘‘Cherchez la femme.’’ Here, if I want to find

out what is really driving interest in private accounts, you simply

need to ask, ‘‘Cherchez la fee.’’

You don’t have to search very long here to discover that the fees

associated with privately managed individual accounts are quite

substantial, consuming 20 percent of the funds in an account over

the coarse of a 40-year work career and an additional 10 to 15 percent in converting that individual account into an annuity. That is

billions of dollars that could have supported the retirement of Main

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Street instead of supporting vacation homes for Wall Street brokers.

And, what of the government-managed private account options?

The basic structure and governance of such a program would be

similar to the Bartlett-Markey bill. You would still face the risks

of political interference in corporate governance matters or social

investments. The aggregate size of the investments being made

would be about the same, and you would still have to face the cost

and complications of converting these accounts to annuities.

What other additional political risks might such private account

schemes face? When Congress originally created IRAs, they were to

be used only for retirement savings, but now IRA funds can be diverted to purchase a home or to pay educational expenses. Will we

be any more successful in insulating Social Security private accounts from the inevitable political pressures to make these fund

available for similar purposes?

Moreover, if there is a recession, will Congress be able to withstand the demands from the public that they be allowed to withdraw funds from the individual accounts to alleviate their immediate economic distress? And, what happens to those individual accounts when their beneficiaries reach retirement age? Will we mandate their conversion into annuities? If so, what happens to those

who gamble away their savings with bad investments, simply have

the bad fortune to retire during a sustained bear market?

For such individuals, converting one’s recently depleted investment account into a annuity, would condemn the retiree to receive

a substantially smaller monthly annuity check than those who had

the good fortune to retire and annuitize during boom times. Will

we be facing new generations of stock market notch babies, demanding that Congress make them whole because they were forced

to invest during bad stock market times?

Mr. Chairman, when we begin to examine the consequences of

these alternatives, I believe that, ultimately, we have to return to

the President’s approach because it gives that guarantee which is

going to be so necessary for all of the retirees in our country.

I thank you. I know you gave me an extra minute or so, and I

appreciate it very much. I yield back my time.

Mr. OXLEY. The gentleman’s time has expired.

The Chair now recognizes the gentleman from Virginia, the

chairman of the full Commerce Committee.

Chairman BLILEY. Thank you, Mr. Chairman.

Today, we will continue with our examination of the market impact of the President’s Social Security proposal. Solvency of the Social Security System is vitally important. And, I commend the

President by beginning the debate by coming forward with a proposal to deal with the impending problem of Social Security.

A number of estimates by the CBO and the bipartisan Task

Force on Social Security indicated that, absent reform, Social Security will begin paying out more than it takes in sometime around

2013. Obviously, the earlier we deal with the structural issues

causing this problem, the easier it will be to fix them.

The President has recognized that the budget surpluses we have

worked so hard to produce in the last Congress, the surplus from

current workers now paying into the Social Security System, gives

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us an opportunity to work to save Social Security and improve the

retirement of all Americans.

The President has also recognized, as did the members of the Advisory Council on Social Security, that there is a role for investment in the stock market as part of any reform of Social Security.

Simply put, the rate of return to investors in the stock market has

been about 13 percent a year over the past 40 years. This return

is much more attractive than the anemic, or sometimes negative,

returns that participants in Social Security receive from their contributions.

If the return from the market can be extended to all Americans

we can substantially improve the lives of Americans as they retire.

I believe that this committee, which has historically looked to promote capital formation, will play an important role in protecting investors and insuring that increased market participation by Americans will be safe and fair.

There are four basic principles that I will use to evaluate any Social Security proposal.

First, there can be no diminution of benefits to current retirees.

We have made an agreement with millions of Americans who depend on Social Security, and we must keep it.

Second, any changes to the Social Security System that involve

private investment should be completely voluntary. If a person

doesn’t want to participate, he or she should be able to stay in Social Security as it currently exists.

Third, any system of private investment must have appropriate

safeguards. We are not going to have Social Security money put in

risky derivatives, cattle futures or other speculative instruments.

Fourth, any Social Security reform must increase the rate of return to the participants. I understand that for many young people

the expected return for their lifelong contributions will be negative;

for others, less than a paltry 1 percent per year. People can do better in passbook savings accounts. We should look to find a way for

the benefits of the market to be shared, prudentially, with all

Americans.

The committee will be active in the area of Social Security reform. We will work to improve the retirement of all Americans and

see that any private investment is done safely.

I am pleased today to welcome Federal Reserve Chairman Alan

Greenspan, and I look forward to hearing his views on the President’s Social Security proposal and how it could affect the United

States equity markets. I would also like to extend a welcome to

Deputy Secretary Lawrence Summers who will be testifying before

the subcommittee later this afternoon.

Mr. Chairman, I applaud your efforts for holding these ever so

important hearings concerning the future of Social Security and

yield back the balance of my time.

Mr. OXLEY. The gentleman yields back. The Chair now recognizes the gentleman from New York, Mr. Towns.

Mr. TOWNS. Mr. Chairman, I would like to, at this point, recognize the ranking member of the full committee, John Dingell from

Michigan.

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Mr. DINGELL. Mr. Chairman, I want to thank my good friend

from New York and I want to thank you. Mr. Towns. It was an act

of great courtesy and I thank you.

Mr. Chairman, I commend you for these hearings. I believe that

it is important that we should go into this question. The President

has indicated that his approach is going to produce higher rates of

return for Social Security and ultimately for retirees. The proposal

raises a number of concerns relative to government involvement in

the stock market and in corporate governance that need to be examined and addressed if the Congress is to go down that path.

This committee has long jurisdiction and long experience in the

securities market. It is imperative that this committee make this

inquiry and begin the debate sooner rather than later.

I want to say a word of welcome to my very special friend, Mr.

Greenspan, and tell him how delighted we are to have him here

this morning and look forward to the benefit of his help and his

wisdom. He has an extraordinary record of public service going far

back, and it is one which he has accomplished great things for the

benefit of the country. We owe him a great debt for what he has

done in his great career of public service. We are also happy to welcome him here this morning because he is going to add great

amounts of light and wisdom to the discussion before this committee.

The administration has not yet submitted a legislative proposal.

My good friends and colleagues, Mr. Markey, Mr. Barlett, and Mr.

Pomeroy, have introduced a bill, H.R. 871, to effectuate the President’s plan and to establish safeguards to meet the objections and

concerns that have been raised. This bill deserves serious consideration.

Mr. Chairman and my colleagues, I am willing to be educated on

this matter, but I must note that I am leery of privatization of Social Security. Much of the discussion of that topic so far, especially

the concept of scrapping the present system for Social Security protection in favor of individual savings accounts, seems to me to have

a number of major problems, the first of which is the stock market

is not a guaranteed up escalator or elevator which is going to take

us all to great economic success. And, not everyone understands

how to deal with the controls or, indeed, has the means to enter

into this.

One of the premises is that most Americans are well-employed

middle-class persons who don’t save enough. This is far from the

truth. There are large numbers of households which are in the

stock market through mutual funds and other investment devices,

but this is not representative of large numbers of families of the

working poor who are struggling to keep a roof over their heads

and put food on the table and to clothe and educate their families.

Saving is a luxury that many in this country cannot afford in any

significant amount.

It is a testament to this society that we have established and

maintained a Social Security System that spreads the risk amongst

all Americans and makes sure that our senior citizens, especially

the elderly poor, have a financial safety net to look forward to and

to fall back upon.

63

I would urge all to be very careful in making significant changes

in Social Security that can impair public confidence in Social Security or, indeed, put at risk persons who are dependent on that in

their retirement years. I would observe that many who might appear to be afloat at this time might find that economic reverses will

leadve them in a situation where they will not have the protections

that they expect they will have except through Social Security.

I look forward to hearing what the witnesses will say. and also

look forward to seeing the rest of the President’s plan. I believe

that this committee can, and should, work with the Ways and

Means Committee, and others of our colleagues and committees, to

see to it that we handle this matter well.

In closing, I would like to submit for the record, and ask unanimous consent so to do, a letter that I have received from the State

legislators, counties, cities, and mayors, and their finance officers.

This letter indicates that they disagree with comments that have

been made about the performance of State and local pension plans

and request that they be heard on the matter. I hope that the subcommittee will give them an opportunity to clarify the record and

I do hope that, Mr. Chairman, the subcommittee will put this in

the record for the benefit of all of our colleagues.

[The letter follows:]

NATIONAL CONFERENCE OF STATE LEGISLATURES; NATIONAL ASSOCIATION OF COUNTIES; NATIONAL LEAGUE OF CITIES; UNITED STATES CONFERENCE OF MAYORS; GOVERNMENT FINANCE OFFICERS ASSOCIATION; NATIONAL ASSOCIATION OF STATE RETIREMENT ADMINISTRATORS; NATIONAL COUNCIL ON TEACHER RETIREMENT; NATIONAL CONFERENCE ON PUBLIC EMPLOYEE RETIREMENT SYSTEMS

March 1, 1999.

The HONORABLE JOHN D. DINGELL

United States House of Representatives

Washington, D.C. 20515

DEAR REPRESENTATIVE DINGELL: We understand the House Commerce Subcommittee on Finance and Hazardous Materials will be holding a hearing on the

direct investment component of the President’s Social Security reform proposal on

Wednesday, March 3, 1999. We have also been advised that State and local government pension plans may be characterized in this hearing as allowing ‘‘political interference’’ in their investment decisions.

We have no position on the President’s proposal. However, we strongly disagree

with the current comments implying we earn a lower rate of return due to alleged

politicization of investment decisions and policies that focus on social factors other

than the best interests of the plan participants. We strongly believe that public pension plan assets are invested in a prudent manner that ensures that plan participants receive the benefits to which they are entitled and also in a manner that reduces the costs for taxpayer support of the plans.

Should the Subcommittee find it necessary to raise the issue of the investment

performance of State and local government pension plans, we respectfully request

the Subcommittee invite independent experts to testify on the rates of return obtained by public pension plans as compared to their private sector counterparts over

the past several years. Such testimony will show that the rates of return achieved

by public and private plans over these periods are quite similar. Furthermore, it will

provide the Subcommittee with information based on current data.

In his recent appearances before Congress, Federal Reserve Board Chairman Alan

Greenspan has provided several committees with information on the performance of

state and local investments based on information from the 1960s through the 1980s.

Chairman Greenspan has suggested that this information shows the rates of return

for public sector plans trailing by two to three percentage points the return rates

of private sector plans. Chairman Greenspan suggests that some of the disparity

might be ascribed to political interference in the management of the State or local

pension plans. This is incorrect. Even the Chairman has conceded in recent discussions that that much of this disparity would be eliminated were these returns adVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00066 Fmt 6601 Sfmt 6621 X:\HSECOM\55156.TXT txed01 PsN: txed01
64

justed for risk in light of the fact that State and local pension funds are often invested more conservatively than private plans.

We believe virtually all of this lag is attributable to the investment restrictions

imposed on public funds but not on corporate plans. As these restrictions have

gradually been lifted, public funds’ performances have grown to become comparable

with private pension funds. Current data shows that public retirement funds are efficiently managed financial institutions with well diversified portfolios that have

achieved impressive rates of return.

If the Subcommittee does wish to pursue the issue of State and local government

pension investment practices, we would appeal for a full, fair and complete hearing

record. We respectfully request that the Subcommittee invite independent experts

to testify on the rates of return obtained by public pension plans as compared to

their private sector counterparts over the past several years.

We would suggest that you call Laurette Bryan and/or John Gruber, Senior Vice

Presidents of State Street Bank. Their testimony will be factually rooted in the actual rates of return experienced and provided by scores of the nation’s public and

private pension plans to their institution as well as Chase Manhattan Bank,

Citiank, Mellon Bank, Northern Trust Company, U.S. Trust, Bank of New York,

NationsBank and 11 other banks. These banks support the Trust Universe Comparison Service (TUCS), which produces rates of return and other data that are

used as the industry standard by which pensions measure their performance. (We

have attached a summary of these independent findings for your review).

We appreciate your consideration. If you have any questions or would like additional information you may contact our legislative representatives:

Gerri Madrid/Sheri Steisel, NCSL, 202/624-8670, 8693

Neil Bomberg, NACo, 202/393-6226

Doug Peterson, NLC, 202/626-3020

Larry Jones, USCM, 202/861-6709

Tom Owens, GFOA, 202/429-2750

Jeannine Markoe Raymond, NASRA, 202/624-1417

Cindie Moore, NCTR, 703/243-3494

Ed Braman, NCPERS, 202/429-2230

65

66

Mr. DINGELL. Again, Mr. Chairman, I thank you for this. This is

a very important undertaking and it requires calm consideration,

and I am sure that Mr. Greenspan will lead off well and guide us

well in his presentation. I thank him for being here.

Mr. OXLEY. And, without objection, the material will be entered

in the record at the request of the gentleman from Michigan.

The Chair now recognizes the vice chairman of the subcommittee, the gentleman from Louisiana, Mr. Tauzin.

Mr. TAUZIN. Thank you, Mr. Chairman, and good morning, Mr.

Greenspan. I certainly want to thank you, again, and commend

you, as others have, for both holding these hearings, Mr. Greenspan, for your agreeing to appear and to help us through this issue.

The President’s proposal to earmark a substantial portion of the

budget surplus for investment in the stock market is, obviously,

conceptually a very interesting idea. Nonetheless, the prospect of

the Federal Government holding an equity position in a variety of

our Nation’s companies raises a number of serious concerns that I

hope we hear more about today.

Thus far, for example, I think we haven’t heard enough about

how the President’s plan might affect America’s capital markets

and investor protection. Specifically, I am curious to know whether

public investment in capital markets might curtail the current outstanding performance of the stock market. So, the stock market is

a place where individuals in our society compete with one another

in their investment decisions. Mr. Markey, my mother had some

good advice to me, too. She always told me that when the Federal

Government showed up in Chackbay with a sign on the corridor

saying they were there to help us, we should be very leery. She

also had a great Cajun expression that we often referred to, and

it goes ‘‘Shacanasan goghe,’’ which literally means—it is an expression of independence—‘‘to each his own.’’ That you make your own

investments and you take your own chances in this great market

we have and in this life we live.

I am not fully convinced that the government’s investments in

the surplus can be managed independently of political influence, regardless of how many goals we might establish or so-called independent investment boards we may create. I am deeply concerned,

as Mr. Markey pointed out, about the changing political moods in

this country. Indeed, will it be that in a couple of years from now,

after we have allowed this to happen, that the law has suddenly

changed to make sure that this independent board cannot invest in

certain companies which the government at that time has a distaste for—or a dislike of their products?

I also wonder whether the Federal Government, as a fiduciary

investing the surplus, will be held accountable to taxpayer investors for managerial malfeasance, just as broker dealers are now

held accountable to their investment clientele. To that extent, I ultimately question whether our securities laws are going to be adequate in this new world of government investors competing with

private investors and the complex mix of decisions that might be

made for, and on behalf of, the taxpayers in general as private individuals are competing in that same market for their own interests.

These are just some of the primary concerns I have with the proposal, but I am, frankly, interested and willing to learn a great

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deal more and to understand and appreciate the concerns that I

understand have already been expressed by Mr. Greenspan.

Mr. Greenspan, I have always looked upon you as one of the best

in our government. I am just pleased that you are here, sir. And,

I am anxious to learn from your testimony today. Thank you for

coming.

Mr. OXLEY. The gentleman yields back. The Chair now recognizes the gentleman from New York, Mr. Towns.

Mr. TOWNS. Thank you very much, Mr. Chairman. I really appreciate you holding this hearing.

I would like to thank you very much too, Chairman Greenspan,

for coming.

Preserving the Social Security is the No. 1 domestic priority. I

am heartened that there be bipartisan support for that goal. For

almost 60 years, Social Security has been protected. The economic

social security of American’s retirees, disabled individuals, and

children of deceased workers.

The Federal Old Age and Survivors Insurance Fund is the only

popular economic and social program in the United States history

because of its success eliminating widespread poverty among the

elderly. Whatever reforms are adopted must not undermine the

safety of our senior citizens.

I represent a district in New York. New York is the home of Wall

Street, The New York Stock Exchange, the world premiere stock

market, and most of this country’s major investment banks, brokers, dealers, and money-managers. The Security Industry Association has testified in favor of Social Security privatization.

I am pleased that the subcommittee is holding this hearing and

beginning the process of the issues raised by the President’s plan.

In his State-of-the-Union Address, the President proposed that 62

percent of the unified budget surpluses over the next 15 years be

transferred to the Social Security Trust Fund in order to increase

the ability of that fund to meet promised Social Security obligations. The President further proposed that about a fifth of the

transferred surpluses be invested in equities to achieve higher returns for Social Security, helping to extend the life of Social Security Trust Fund to 2055.

This action does, however, raise understandable concerns about

the possible extension of political influence on investment decisions

and the risk that this might pose to the economy and the trust

fund. Any system of connective investment can, and must, address

these concerns.

I am taking no position on the President’s plan at this time. It

would be helpful to have a concrete legislative proposal on the

table; I would feel a lot more comfortable. But, in any event, I look

forward to hearing from Chairman Greenspan, of course, this

morning and, later on, Secretary Lawrence Summer, later on this

afternoon.

Whatever the outcome of this debate, experts agree that investing in the stock market, while helpful, is no panacea for what ails

Social Security. In that regard, Mr. Chairman, I am hopeful that

we will begin a dialog with the Ways and Means Subcommittee on

Social Security earlier than later in this process. An effective soluVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00070 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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tion is going to require us to work together and to draw our combined expertise.

Now, I understand some of the concerns, but I can’t think that

we also have to recognize that we just cannot stand around and

continue to just sort of wiggle our thumbs. We have to begin to do

something, else we will have a very difficult problem.

Thank you, and I yield back.

Mr. OXLEY. The gentleman yields back.

The Chair now recognizes the gentleman from Iowa, Mr. Ganske.

Mr. GANSKE. Thank you, Mr. Chairman.

Mr. Chairman, it appears to me that the President’s Social Security proposal does not level with the American people. The President’s budget forecasts a total of $4.5 trillion over the next 15

years. Of this surplus, $2.7 trillion already belongs to the Social Security Trust Fund because it comes from excess payroll taxes dedicated to pay for the future needs beyond the year 2012, when Social Security benefits will exceed income. For the remaining $1.8

trillion, the only true surplus, the President proposes to devote $1.7

trillion to new spending. But then, the President also plans to set

aside 62 percent of the $4.5 trillion surplus, or $2.8 trillion, to extend the Trust Fund solvency from 2032 to 2055. So, the President’s budget makes commitments and promises of $2.8 trillion,

plus $1.7 trillion, plus $2.7 trillion, for a total of $7.2 trillion. But

with only $4.5 trillion surplus, you can’t do them all. It just simply

does not add up. So, Mr. Chairman, maybe later today, Mr. Summers will be able to clarify that for us.

Now, the President’s complex accounting, I think, undermines

the efforts to save Social Security by lulling policymakers and citizens into a false sense of accomplishment.

A second element of the President’s plan calls for the Federal

Government to invest Social Security funds in the stock market.

Under his plan, approximately $1.2 trillion of the trust fund would

be used to buy up 4 percent of the stock market. Experts estimate

this ownership share could compound to 20 percent, almost one

fifth of the market. Turning the government into the largest shareholder in American business I think is a bad and dangerous idea.

I think it could destroy the market, and it could hurt millions of

investors across the country.

Our witness today, Mr. Greenspan, has testified saying that investing a portion of the trust fund assets and equities would, ‘‘arguably put at risk the efficiency of our capital markets and thus our

economy.’’ He goes on to say that, ‘‘even with Herculean efforts, I

doubt it would be feasible to insulate, over the long run, the trust

funds from political pressures, direct and indirect, to allocate capital to less than productive use.’’ And, experience proves him correct.

At least 42 percent of State, county, and municipal pension systems have rules governing controlling types of allowable investments. In fact, then-Governor Clinton in Arkansas backed such social investment policies.

So, I think turning the government into the largest owner of

American business would be a bad thing. It has been condemned

by a wide range of financial and economic experts. Members of

Congress, and both parties have expressed their concern, including

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such experts as Senator Moynihan of New York. Senator Moynihan, along with Senator Kerry of Nebraska, has a Social Security

proposal that would allow an individual to invest 2 percent of the

payroll tax into a retirement account similar to the Federal Employee Thrift Savings Plan.

I will be interested in asking Mr. Greenspan, and this afternoon,

Mr. Summers, to comment on the viability of the Kerry/Moynihan

proposal.

I yield back, Mr. Chairman.

Mr. OXLEY. The gentleman yields back. The gentleman from

Michigan, Mr. Stupak.

Mr. STUPAK. Thank you, Mr. Chairman.

Mr. Chairman, this is our second hearing on investing Social Security in the market, and I thank you for holding these hearings.

I know we are going to have more as we move on. I think it is noteworthy to note, Mr. Chairman, that for once, the Congress is talking about surpluses, in fact, we are talking about surpluses in the

Federal Government which may total $4.3 million over the next 15

years.

We are at this point because, back in 1993, many of us helped

to pass and put together, a deficit reduction package. Mr. Greenspan was, certainly, instrumental in giving us advice on that deficit

reduction package. And, we took a step and we said it was going

to be a tough vote, but we will do it to try to get the economy moving, get this country going in the right direction, and it worked.

Now we are able to talk about surpluses.

And, I would add that only Democrats voted for that plan, but

we are not now—as Democrats—are going to be the only ones to

vote for the President’s plan. In fact, because of the long, painful

process we had to go through to get this country talking about surpluses, I am very cautious about this plan. I am undecided on what

to do.

So, I look forward to hearing from our witness, Mr. Greenspan,

today because I certainly respect his opinion on fiscal matters. I

may disagree with him on the steel dumping issue that is currently

going on in this country, but I guess what it shows is that reasonable people can, respectfully, disagree. And, I hope that when we

make our decision at the end of the day about investing our surpluses in Social Security, whether it be in the private market or

not, that we base it not upon disagreements, but, rather, on the information made available to us from all segments of our society,

from all segments of the financial institutions and their representatives.

So, I certainly look forward to your testimony today, Mr. Greenspan, and that of Mr. Summers, the Deputy Secretary of Treasury,

on what impact the President’s proposal will have if we invest part

of the surplus in the private financial market. So, I look forward

to hearing from you, and I thank you for your service to this country and for your sound fiscal advice and we will talk about steel

dumping some other time. Thank you.

Mr. OXLEY. The gentleman yields back.

The gentlelady from New Mexico, Mrs. Wilson.

Mrs. WILSON. Thank you, Mr. Chairman. I also want to thank

Chairman Greenspan for testifying today.

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I believe that this series of hearings, both in this subcommittee

and others on the Hill, are very important as we are now engaged

in a national discussion about how to make sure that Social Security is going to be there on time, and in full, for those who depend

on it today as well as those who depend on it tomorrow.

I am also very pleased that so many on both sides of the aisle

have committed themselves to preserving, protecting, and strengthening Social Security. Many of those in the Congress, myself included, have not seized upon one right answer to champion. At this

point in our deliberations, I think that is good. Although, I think

everyone should take Mr. Markey’s French advice in searching for

the answer to any situation: ‘‘Cherchez la femme,’’ which means:

‘‘look for the woman.’’ I don’t think it is exactly what the French

probably had in mind, but maybe Congresswoman DeGette and I

can co-sponsor the solution to Social Security.

We are still studying the options, asking the questions, comparing notes, and listening to our constituents. I am committed to

working toward a bipartisan solution guided by some basic principals with respect to Social Security.

First, the solution which we come up with must be fair to all

generations, those that depend on it today, as well as those who

enter the workforce today.

Second, Social Security should remain a social insurance program; it is the safety net. While over a long period of time individuals should be given more options about how their money is invested. In the State of New Mexico, which I represent, 60 percent

of those who get Social Security checks have only Social Security

checks to rely upon.

Third, we have to protect Social Security funds from being used

for other government expenditures.

And, finally, the Federal budget surplus, now estimated at al- most $1.5 trillion over the next 10 years, should be used first and

foremost, to make sure that Social Security is solvent.

I have some serious reservations about allowing the Social Security Administration to invest directly in the stock market. Under

such an arrangement, the Federal Government could quickly become the largest single owner of American businesses. And, no

matter how many Chinese walls we place between government

ownership and the corporate boardroom, I believe that this would

put the government in a position of both owning and regulating

companies, and that may not be good for America.

I do believe that we should consider some of the ideas about partial personalization of Social Security for those who want it and

who are early in their working life. A small percentage of Social Security contributions could be put into an account with their name

on it, similar to the Federal Employees Retirement System. And,

as Mr. Greenspan has testified before on other committees, any investment strategy must include enough incentive for each American to monitor his or her own investment, and the ability to have

some control over that investment.

Social Security should remain a social insurance program, the

safety net for retirees, and for dependents who depend on Social

Security checks being there in the post box on time, and in full. I

believe that by working together for the common good that we can

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develop a plan, a bipartisan plan, to make sure that it will be there

for those who depend on it.

I yield the balance of my time.

Mr. OXLEY. The gentlelady yields back. The gentlelady from Colorado, Ms. DeGette.

Ms. DEGETTE. Thank you, Mr. Chairman and thank you, again,

for holding this hearing which, as you heard, is a second in what

we hope are an ongoing series of hearings on this proposal to invest

a portion of the Social Security Trust Fund in the stock market.

I agree with all of my colleagues that it is important how we are

going to preserve Social Security for future generations and keep

it strong. One of the intriguing proposals is to invest a portion of

the retirement funds in the stock market. It is also one of the more

dangerous proposals, possibly. And, like everyone else here, I am

cautiously looking at different options.

I am very pleased to have the wisdom of Chairman Greenspan,

and also, Secretary Summers, as we decide what the proper mix is

and how will we accomplish this, both in the short and long run.

I really do understand the impetus between proposals to invest

a portion of the Social Security Trust Fund in the stock market or

even to set up private investment funds. Frankly, the markets have

never been higher and, for this next generation below me, they

have never known what it means to have a bear market. Suddenly,

the 2.8 percent projected return on bond investments seems dismally low compared to higher market rates-of-return from equities.

While we all hope that the market continues on its historic high

indefinitely, history tells us to act cautiously. We must carefully

evaluate any proposed changes to the Social Security program—in

part, to maximize our investment in the Nation’s retirement plan.

While public investment is appealing now, is it truly the only

choice or the best choice for the Social Security Trust Fund, as well

for the National economy?

One area of testimony I am looking forward to hearing is what

happens to the rest of the economy, even if we just invest a small

proportion of the trust funds in this way. Additional factors like

government influence on markets and the impact of the mass of influx of 150 million retirees, investments would have to be carefully

considered.

I hope today’s hearings and the hearings in the weeks to come

will shed some light on President Clinton’s plan, and I also hope

that today’s testimony will further enlighten us on any plan that

proposes investing money that the Federal Government has committed to every worker.

I would especially like to congratulate our chairman, as well as

Mr. Dingell, for seeing the light that this important issue is one of

the many issues that do remain in this subcommittee’s and this

committee’s jurisdiction, and look forward to an ongoing conversation.

I yield back the balance of my time.

Mr. OXLEY. The gentlelady yields back. The gentleman from Illinois, Mr. Shimkus. The gentleman from Oklahoma, Mr. Largent.

Mr. LARGENT. Thank you, Mr. Chairman. I want to submit my

entire statement for the record.

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Mr. OXLEY. Without objection, all of the opening statements will

be made a part of the record.

Mr. LARGENT. I would just say briefly, the one line that scares

all of our constituents the most is when you say, ‘‘Hi, I am from

the Federal Government and I am here to help you.’’ And, I think

they are probably equally concerned when we say ‘‘Hi, I am from

the Federal Government and I am here to protect your Social Security check.’’

I am interested to hear the testimony of our witnesses today. I

would like to hear their comments on the obvious conflict of interest of having the government be, not only the regulator, but the

largest participant in the stock market and what the outcome of

that may be. I am also interested to hear the witness’ testimony

on the President’s proposal that he has put forward.

I have to say, briefly, Mr. Chairman, that I am excited that we

are dealing with a debate and an issue as important as Social Security. Although I would say it is easy to talk about it, it is more

difficult to do something about it.

I would say to all of the folks that are in our listening audience

today that are generation X’es, if you truly believe that you are

more likely to see life on another planet than ever see a Social Security check at your retirement, that you have an ability to participate in this debate by doing two simple things: registering to vote

and voting. I would encourage you to do that.

Thank you, Mr. Chairman.

[The prepared statement of Hon. Steve Largent follows:]

PREPARED STATEMENT OF HON. STEVE LARGENT, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF OKLAHOMA

Mr. Chairman, I want to commend you on holding these series of hearings to examine what may be arguably the most important issue Congress tackles this year—

Social Security reform. I am extremely interested to hear what Chairman Greenspan and Deputy Secretary Summers thoughts are on the President’s plan to invest

a sizable portion of the projected $4.5 trillion budget surplus in the stock market,

and what impact may result from having Uncle Sam as the major stockholder in

corporate America?

I don’t think there is much of an argument that it will take future retirees considerably longer to recoup what they have paid into the system as compared to current

Social Security recipients. For example, according to the Congressional Research

Service, workers who earned average wages and retired in 1980 at age 65 took 2.8

years to recover the value of what they and their employer paid in Social Security

taxes plus interest. Fast forward twenty five years from now—it will take someone

who retires in 2025 just over 26 years to recoup what he or she has paid into Social

Security.

That leads to the obvious question as to why we are here today. Is it sound public

policy to pass a law which would allow a portion of an envisioned budget surplus

to be invested in the capital markets for the sake of a greater return on one’s Social

Security investment? Since coming to Congress I’ve become quite familiar with

many laws, but probably the most important law I’ve learned is the law of unintended consequences. What may appear to have some merit in theory can prove to

be less than meritorious when put into practice.

My other concern with the President’s proposal, as I understand it, is that although his proposal decreases the publicly held debt, it would increase the total

debt, which in turn requires raising the debt ceiling. Let me explain, assume that

we have balanced budget except for Social Security which has a $100 surplus. Currently, under these circumstances Social Security would send the surplus to the

Treasury in exchange for special issue treasury bills, meaning that they are only

negotiable through Social Security.

These special issue treasury bills, which are essentially IOUs, are then deposited

into the Social Security Trust Fund. At the end of the year, under this scenario,

there is a $100 deficit in the unified budget. Under the President’s proposal, $38

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of the $100 surplus would be used for non-Social Security purposes such as Medicare, Defense and other so-called ‘‘high priority’’ spending programs. The remaining

$62 would be returned back to Social Security. Since Social Security does not need

the money because it is operating at a surplus, it reverts back to the Treasury in

exchange for $62 in T-bills. Treasury then uses the $62 to pay down the public debt. Under this scenario, the Social Security Trust Fund now has $162 in treasury bills, and this is where the accounting sleight-of-hand occurs. With a $100 surplus,

Social Security has purchased itself $162 in Treasury bills. What happens when it

comes time to repay the IOUs? Does Social Security receive $100 or $162. As far

as I know, the President has not specified.

Another problem with the plan is that, in the past, Social Security has been selfsufficient through funding from payroll taxes. If we adopt the President’s plan, we

will now have to potentially repay the Social Security IOUs from general funds.

Why you ask? In the scenario I have just laid out, when Social Security returns the

$62 in exchange for T-bills, it receives general revenue T-bills, and not special issue

T-bills as we have done in the past. General revenue T-bills are what is known as

‘‘first order’’ debt. It would be analogous to a bankruptcy proceeding in which all

the debts are ranked according to the order in which creditors must be repaid. General revenues are at the top of the list and must be paid out of general revenue.

By involving the general fund in Social Security, we create an opportunity for true

fiscal irresponsibility as Congress would now no longer have to make the tough

choices of raising payroll taxes or lowering benefits—we simply take on more general debt.

Mr. Chairman, I think the President’s proposal creates more problems than it

solves, but I’m interested in hearing what our witnesses have to say about how we

should proceed with preserving the solvency of Social Security.

Mr. OXLEY. The gentleman yields back. The gentleman from Wisconsin, Mr. Barrett.

Mr. BARRETT. Thank you, Mr. Chairman. First of all, I want to

thank you for holding these hearings. This is actually the first

hearing I have been to under your leadership and it has been a

life-long dream of mine to serve on your subcommittee. So, I am

very pleased to be here with you today.

I want to say that this issue is the most important domestic

issue, obviously, that we face as a Nation. And, at the same time,

there is no issue easier to demagogue than Social Security. I think

everybody at this panel recognizes that if we are going to truly address the problems of Social Security, Democrats and Republicans

have to hold hands together and jump off whatever cliff there is.

I am hoping that the cliff is only about 2 inches high. But this is

something that we have to deal with on a bipartisan basis.

For that reason, I am pleased that the President has come forward with a proposal. I think, for a long time, both parties were

saying ‘‘After you,’’ ‘‘No, after you,’’ ‘‘After you,’’ because nobody

wanted to take the first step in what certainly could be a very hostile debate. But now we have something to debate, and I very much

look forward to hearing the thoughtful comments of Mr. Greenspan

because I think that he is going to allow us to move the debate forward. I am sure his comments, as well as Mr. Summers’ comments,

will, ultimately, lead this Congress to moving forward and actually

addressing what I considered to be the most important domestic

issue we face.

I yield back my time.

Mr. OXLEY. The gentleman yields back. The gentleman from Arizona, Mr. Shadegg.

Mr. SHADEGG. I thank you, Mr. Chairman, and I will submit my

full written statement for the committee, but I just merely want to

observe that today’s hearing brings me back to 4 years ago. I sit

here as a freshman on this committee this year because I just

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joined the committee, and it reminds me of 4 years ago when I

joined the Congress and was a freshmen. Like today, I then sat in

the front row in a committee hearing where our esteemed guest,

Mr. Greenspan, was going to testify. That time, it was the budget

hearing and we were all debating hotly, as we are today, the reform of Social Security. Then, we were debating the Republican

majority’s proposals for shrinking the size of government and for

cutting Federal spending. That particular hearing was my first

hearing on the Budget Committee.

I sat in the front row in front of Mr. Kasich and the debate went

on, rather intently, over the Republican proposals to slow the

growth of the Federal Government. And, the discussion went back

and forth from each side of the aisle. And, finally, we got toward

the end of the discussion and one of my colleagues from the other

side asked Mr. Greenspan, after expressing his deep concern about

the cuts that were being discussed—we all, of course, know they

weren’t really cuts; they were slowing the rate of growth of the government—but this colleague from the other side of the aisle asked

Mr. Greenspan if he was not, indeed, concerned that if the majority

was successful in reducing government spending in the fashion

they were then proposing, that there would be dislocation and damage to the economy?

Mr. Greenspan, who may recall this moment, sat back for a moment and looked at my colleague and said, ‘‘Son, I have been

around this town a long time and I lose little sleep worrying that

the Congress will cut spending too far or too fast.’’

I believe Mr. Greenspan was right then, and I think he is also

right about his concern about the notion of having the government

become the largest investor in the private stock market. I am anxious to hear his comments today, as I was then.

I would associate myself with the comments of my colleagues

here. This is, indeed, a very important issue, but an issue on which

we can make grave mistakes and we should be very cautious about

how we proceed.

I yield back the balance of my time.

[The prepared statement of Hon. John Shadegg follows:]

PREPARED STATEMENT OF HON. JOHN B. SHADEGG, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF ARIZONA

Thank you Chairman Oxley for your leadership on this issue and thank you

Chairman Greenspan for appearing before this subcommittee today to address our

concerns surrounding certain aspects of the President’s Social Security proposal.

The President has proposed using $2.8 trillion of the $4.5 trillion projected budget

surplus over the next 15 years to shore up Social Security. Twenty-one percent of

that $2.8 trillion—or $588 billion—will be directly invested in the stock market by

the federal government under the President’s plan.

For several years now, a great deal of attention has been given to the anticipated

decline of the Social Security system and proposals to save the system. As we all

know, an aging U.S. population combined with a shrinking workforce will result in

increased benefits to retirees but fewer tax receipts for the Social Security account.

Experts estimate that as early as 2013, just as the baby boomers begin to retire,

Social Security will become dependent upon other federal receipts, including the interest currently paid to the trust funds. And as early as 2026, Social Security will

be insolvent.

There are, essentially, three options for saving Social Security: increase taxes, decrease benefits, or increase the rate of return of Social Security funds. Considering

that I am a strong advocate of reducing the tax burden on the American people,

I could not, and will not, support any proposal to save Social Security that would

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result in a tax increase. Furthermore, I am not inclined to support lowering Social

Security benefits to today’s retirees, and those who will retire in future years. I

don’t imagine either group would support it as well. This leaves us with the option

of increasing the rate of return on Social Security funds. I look forward to hearing

Chairman Greenspan’s comments as to the effects of government investing in the

capital markets.

I strongly believe in the tenets of individual liberty and individual responsibility.

I have long supported legislation that reduces the size and scope of the federal government and returns power to the American people. For these reasons, I am inclined to support the use of personal retirement accounts to invest in the stock market and to provide for America’s retirees in the future. I am confidant that today’s

discussion will spark a renewed interest in a Social Security proposal that includes

the use of personal retirement accounts.

Although proponents of the President’s Social Security plan are confident that an

independent investment board could be insulated from political pressures, I have serious doubts about the government’s ability to maintain objectivity when investing

in companies that are not politically appealing, such as the tobacco companies. Furthermore, I am deeply concerned about government ownership of private corporations not only because this would be a dangerous step away from our capitalist economy, but also because of the potential and likely negative impact on the market

itself

Finally, current state and local pension funds have been cited as models for the

President’s proposal. I would simply point out one significant distinction between

these pension programs and the system that would be established under the President’s proposal: these state pension funds provide retirement benefits only to state

government employees and not to the residents of the entire state. However, the

President’s proposal would include every single American.

Again, I am anxious to hear from Chairman Greenspan, and later Dr. Summers

on the President’s proposal and the potential market impact of the federal government investing in the capital markets, including your thoughts on investor protections and corporate governance in those markets. I believe we can all agree that

many unanswered questions remain regarding the President’s proposal.

I look forward to discussing these points and yield back the balance of my time.

Mr. OXLEY. The gentleman yields back. The gentleman from

Texas, our good friend, Mr. Hall.

Mr. HALL. Mr. Chairman, I will put my statement in the record,

and I thank Mr. Greenspan. I think he is really one of the great

Americans. We are honored to have him here. I thank him for what

he has done and I thank him for what he has done for this country.

I yield back my time.

Mr. OXLEY. The gentleman yields back. The gentleman from Illinois, Mr. Shimkus.

Mr. SHIMKUS. Thank you, Mr. Chairman. I, too, want to welcome

the Chairman here, I do have great respect for you and what you

have done. It is one of the privileges of being a Member, getting

a chance to interact with folks who serve the country so well.

I unintentionally touched the Third Rail of politics in 1992, when

I was stressing the need to balance the Federal budget. Throughout

the rest of the campaign, I was demagogued as one who wanted to

steal the retirements of individuals. So, I also am excited. We really have come a great distance in the society to be able to have

hearings openly on how do we address the upcoming problems.

And, I am excited to be a participant in that debate.

The simple law of economics is supply and demand—and I will

be listening for two issues, hopefully, in the debate—one is the supply and-demand issues of investing into the capital markets by the

Federal Government and how that all shakes out; and another proposal, which may not get addressed today, but if we were to take

the Social Security tax revenue and pay down the national debt,

how would those supply and-demand aspects affect—you may not

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want to address—interest rates across the board; and, actually, the

longevity of a position, in which, we can then sit down and address

saving Social Security for future generations.

Again, Mr. Chairman, thank you for holding this hearing and

again, welcome to Chairman Greenspan. And, I look forward to the

rest of the hearing.

Mr. OXLEY. The gentleman yields back. The gentleman from

Pennsylvania, Mr. Greenwood.

Mr. GREENWOOD. Thank you, Mr. Chairman. I have been sitting

here contemplating the number of hours of his life Mr. Greenspan

has spent enduring opening statements, and it has inspired me not

to give one. I yield back.

Mr. OXLEY. That was brilliant.

The gentleman from California, Mr. Bilbray.

Mr. BILBRAY. Regretfully, Mr. Greenspan, I am not so merciful.

Mr. Chairman, I would just like to say that I am encouraged by

how many young, or younger, people I see in this room today. I

think, if you look around, you do not see the group that usually is

discussing Social Security. And, that is appropriate because we are

not talking about present recipients of Social Security; we are not

talking about senior citizens of today. We are talking about those

of us who will be senior citizens of tomorrow.

Mr. Chairman, we are not just talking about dollars and cents

when we talk about the future of Social Security. I think we are

talking about trust and credibility. I think the one thing that the

younger generations of America will acknowledge is there is not

much trust in the fact that Social Security will be there when we

want it, especially, with those who are younger, much younger,

than those of us who are baby-boomers.

I only have a question, again, that keeps raising to me. I am

from California. In California if a government official uses trust

funds for anything other than what the trust fund is for, it not only

raises concerns, it raises legal questions, and that includes the interest generated by the trust funds. Now I may be wrong, but at

least there seems to be a perception, for those of us who come from

the West Coast, and from a lot of young people, that Social Security Trust Fund has, since the 1960’s, been used as a slush fund.

And that the promise: ‘‘Don’t worry, trust us; we will get the money

back when you need it,’’ is something that a lot of young people

don’t really believe at this time.

Now, I know that, since the 1960’s, it has been technically legal

to use Social Security funds and the so-called surplus. It is interesting to hear how many fathers of success there is in Congress

where a 1993 tax increase taxed our way into prosperity. The Republicans can point out, since 1995, that there has been a control

of spending. But, that aside, is the fact that we can change the

laws here in Washington, but we can’t change the laws of nature,

which is, when you have the money, and you can spend it on something else, you usually do.

I think that we need to discuss that. I think that Mr. Greenspan

is here and has a lot more credibility than anyone else involved in

this issue. I think we tried to place too much responsibility on Mr.

Greenspan because he is one of the few people that people really

give some credence to his credibility. Maybe that is because he is

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the one guy who shot straight and continues to shoot straight in

this town. I think, the young people look to Mr. Greenspan, basically, to shine the light on the truth, get beyond the partisan posturing, and actually talk about what needs to be done.

I look forward to addressing this issue. I want to make sure that

we are not talking about a baby-boomer in the White House using,

what our generation called, ‘‘new math’’ to double-count and triplecount so-called surpluses so we can justify our strategies. I think

that all of us that are the baby-boomers bear the responsibility to

make sure the next generation gets as much benefits out of the Social Security System as we do. Our challenge, I think, here today

and in the future is to make sure those young people that are sitting in this crowd and out in the American people start developing

the kind of trust for the system that the system was meant to have

prior to the creative financing of the 1960’s that has continued for

over 30 years.

Thank you, Mr. Chairman. I yield back.

Mr. OXLEY. The gentleman yields back. The gentleman from

Maryland, Mr. Ehrlich.

Mr. EHRLICH. I would adopt the remarks from the gentleman

from Pennsylvania and just simply welcome the Chairman.

[Additional statement submitted for the record follows:]

PREPARED STATEMENT OF HON. PAUL E. GILLMOR, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF OHIO

Now that the proposal is out there of using the equity markets in one form or

another to help finance Social Security, we need to carefully examine the proper

roles of the public and private sectors. What does the government do better than

the private sector? What do the equity markets do better than the government?

Regarding the return on Social Security funds, it is clear that the private markets, over time, offer superior returns. In as much as the equity markets provide

better returns, we have an interest in exploring this option. That’s because each dollar of increased return the stock markets can provide for the Social Security trust

funds, represents one dollar less the government needs to raise taxes or reduce benefits.

While finding a better return on Social Security may temporarily stall the depletion of the trust funds, this fails to address the underlying question: How can we

get workers to save and invest more for themselves?

Recently, one 48 year old worker from Northwest Ohio called my office and stated

that he would be willing to give up everything he has paid into Social Security in

exchange for being allowed to invest his share of his payroll taxes. This individual

knows that, as a pay-as-you-go program, the money that he has put into Social Security isn’t actually being held for him when he retires. And that is why he is willing to give up everything he has paid in return for the opportunity to know that

he has his own individual account. There is a certain sense of security derived from

owning a personal account established from your own paycheck.

Besides the concerns about federal ownership of corporate America, this is one

reason why I think if we move at least some of the Social Security dollars into the

private markets, American workers, not the federal government, should privately

own such accounts.

One of our witnesses last week pointed that an individual’s Social Security taxes

are mandatory payments owned by the government. State pension systems, however, are for people who voluntarily work for the state. And plans like the Federal

Thrift Savings Plan allow federal workers to contribute various amounts to their

pension system. It seems to me that allowing workers to divert at least some of

their mandatory payments into individually owned accounts would provide for better returns and increase control and confidence in the system.

I know our distinguished panels will provide their expertise and insight into these

questions.

Thank you, Mr. Chairman.

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Mr. OXLEY. We now turn to our distinguished witness, the Honorable Alan Greenspan. Chairman Greenspan, again, welcome to

the committee. We appreciate your sincere interest in this issue

and we appreciate your patience during the opening statements.

STATEMENTS OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD

OF GOVERNORS, FEDERAL RESERVE SYSTEM; AND LAWRENCE H. SUMMERS, DEPUTY SECRETARY, DEPARTMENT OF

THE TREASURY

Mr. GREENSPAN. Thank you very much, Mr. Chairman. I very

much appreciate the opportunity to appear before you and the

other members of the committee.

Preparing for the retirement of the babyboom generation looms

as one of our Nation’s most difficult challenges, and I commend the

serious efforts being made here to address this important long-term

problem. Mr. Chairman, before discussing my views on the issue of

investing the Social Security Trust Fund in equities, I would like

to examine the more fundamental issues that any retirement reform will have to address.

The dramatic increase in the ratio of retirees to workers that

seems inevitable, as the babyboom generation moves to retirement

and enjoys ever greater longevity, makes our current pay-as-you-go

Social Security System unsustainable. Furthermore, the broad support for Social Security appears destined to fade as the implications

of its current form of financing become increasingly apparent. To

date, with the ratio of retirees to workers having been relatively

low, workers have not considered it a burden to share the goods

and services they produce with retirees. The rising birth rate after

World War II, which, in due course, contained the growth of the

ratio of retirees to workers, helped make the Social Security program exceptionally popular, even among those paying the taxes to

support it.

Indeed, workers perceived it to be a good investment for their

own retirement. For those born before World War II, the annuity

value of benefits on retirement far exceeded the cumulative sum at

the time of retirement of contributions by the worker and his or

her employer, plus interest. For example, the implicit real rate of

return on Social Security contributions was almost 10 percent for

those born in 1905, and was about 6 percent for those born in 1920.

I am talking about real rates of return, not as adjusted for inflation. The real interest rate, by contrast, on U. S. Treasury securities, has generally been below 3 percent.

But, births flattened after the babyboom, and life expectancy beyond age 65 continued to rise. Consequently, the ratio of the number of workers contributing to Social Security to the number of

beneficiaries has declined to the point that maintaining the annuity value of benefits on retirement at a level well in excess of accumulated contributions has become increasingly unlikely. Those

born in 1960, for example, are currently calculated to receive a real

rate of return, on average, of less than 2 percent on their cumulative contributions. Indeed, even these low rates of return for more

recent cohorts likely are being overestimated, because they are

based on current law taxes and benefits. In all likelihood, short of

a substantial infusion of general revenues, Social Security taxes

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will have to be raised, or benefits cut, given that the system as a

whole is still significantly underfunded, at least according to the intermediate projections of the Old-Age and Survivors Insurance actuaries. For the present value of current law benefits over the next

75 years to be fully funded through contributions, Social Security

taxes would have to be raised about 2.2 percent of taxable payroll

right now; to be fully funded in perpetuity, that is, to ensure that

taxes and interest income will always be sufficient to pay benefits,

Social Security taxes would have to be raised much more—perhaps

something on the order of four to 5 percent of taxable payroll.

The issue of funding underscores the critical elements in the

forthcoming debate on Social Security reform, because it focuses on

the core of any retirement system, private or public. Simply put,

enough resources must be set aside over a lifetime of work to fund

retirement consumption. At the most rudimentary level, one could

envision households saving by actually storing goods purchased

during their working years for consumption during retirement.

Even better, the resources that would have otherwise gone into the

stored goods could be diverted to the production of new capital assets, which would, cumulatively, over a working lifetime, produce

an even greater quantity of goods and services to be consumed in

retirement.

The only way we will be able to finance retirement incomes that

keep pace with workers’ incomes is to substantially increase the

national saving rate, increase the borrowing of foreign capital, or

increase the output that a given capital stock, financed through

this saving, can produce. The crucial retirement funding issues center on how to increase our national saving and how to allocate

physical resources between workers and retirees in the future. We

must endeavor to increase the real resources available to retirees

without blunting the growth in living standards among our working population.

In this light, increasing our national saving is essential to any

Social Security reform. Privatization proposals that begin to address Social Security’s existing unfunded liability would significantly enhance domestic savings; so would fuller funding of the

current Social Security program. But the size of the unified budget

surplus implied by such funding, many have argued, would be politically unsustainable. It would be in the trillions. I should say it

is in the trillions over time and especially as we get into the middle

parts of the next century. The President, recognizing this political

risk, has proposed changing the budgetary framework so as to support a large unified budget surplus. This is a major step in the

right direction that, if effective, would ensure that the current rise

in government’s positive contribution to national saving is sustained. The large surpluses projected over the next 15 years, if they

actually materialize, would significantly reduce the fiscal pressures

created by our changing demographics. Whichever direction the

Congress chooses to go, whether toward privatization or fuller

funding of Social Security, augmenting our national saving rate has

to be the main objective.

The administration has also proposed investing a portion of the

Social Security Trust Fund assets in equities, rather than in U.S.

Treasuries alone. Having the trust fund invest in private securities

80

most likely would increase its rate of return, although the increase

might be less than historical rates of return would suggest, and

certainly would be less on a properly risk-adjusted basis. But

where would that higher return come from, and what would happen to private funds available for consumption in retirement?

If Social Security trust funds are shifted from U.S. Treasury securities to private debt and equity instruments, holders of those securities in the private sector must be induced to exchange them, on

net, for U.S. Treasuries. Private pension and insurance funds,

among other holders of equities, presumably would swap equities

for Treasuries. It seems likely that a rise in the interest rate paid

on Treasuries, and perhaps an increase in equity prices and a reduction in the expected future return on equity, would be necessary

in order to induce private investors to reallocate their portfolios

from equities to U.S. Treasury securities. If this is indeed the case,

then the net increment to the government of investing the trust

fund in equities on an ongoing basis presumably would be less than

the historical rates of return suggest. That said, exactly what

changes in bond and stock prices would result from this type of

large-scale swap of U.S. Treasuries for equities is extremely difficult to predict.

But analyzing the macroeconomic effects of the portfolio reallocation is much less complicated. The transfer of Social Security assets

from U.S. Treasuries to equities would not, in itself, have any effect

on national saving. Thus, the underlying economic assets in the

economy would be unchanged, as would the total income generated

by those assets. Any increase in returns realized by the Social Security must be offset by a reduction in returns earned on private

portfolios, which represent, to a large extent, funds also held for retirement. Investing Social Security assets in equities is, then,

largely a zero-sum game. To a first approximation, aggregate retirement resources—from both Social Security and private funds—

do not change.

Only an increase in national saving or an increase in the efficiency with which we use our saving can help us meet the retirement requirements of the coming years. Indeed, improved productivity of capital probably explains much of why the American economy has done so well in recent years despite our comparatively low

national saving rate. For productivity and standards of living to

grow, financial capital raised in markets or generated from internal

cash-flow from existing plant and equipment must be continuously

directed by firms to its most profitable uses—namely, new physical

capital facilities perceived as the most efficient in serving consumers’ multiple preferences. It is this continuous churning, this

so-called creative destruction, that has become so essential to the

effective deployment of advanced technologies by this country over

the recent decades.

Looking forward, the effective application of our capital to its

most highly valued use is going to become, if anything, more important, as we strive to increase the resources available to provide for

the retirement of the baby boomers without, in the future, significantly reducing the consumption of workers. An efficient market

pricing mechanism for equities has been a key element in our superior allocation of saving into investment this past decade. Large inVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00083 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
81

vestments in equities by the Social Security Trust Funds could impair that process.

As I have indicated in earlier testimony, I doubt that it is possible to secure and sustain institutional arrangements that would

insulate, over the long run, the trust funds from political pressures.

These pressures, whether direct or indirect, could result in suboptimal performance by our capital markets, diminished economic

efficiency, and lower overall standards of living than would be

achieved otherwise.

The experience of public pension funds seems to bear this out.

Although relevant comparisons to private plans are difficult to construct, there is evidence that the average rate of return on State

and local pension funds tends to be lower than the return realized

on comparable private pension funds.

As I have also indicated in previous testimony, I do not deny that

the Federal Government can manage equities without political interference if they are held in defined contribution funds or small

defined benefit plans, such as the one run by the Federal Reserve.

Defined contribution funds, such as the Federal Government’s

Thrift Savings Plan, are effectively self-policed by individual contributors, who would surely object were their retirement assets to

be diverted to investments that offered less than market returns.

But government defined benefit plans, like Social Security, provide guaranteed annuities that are wholly insulated from poor investment performance. Annuitants look to the Federal Government

for their retirement incomes, not the performance of any trust

funds. Thus, beneficiaries have no incentive to monitor the performance of their investments. And, while the government’s small

defined benefit funds do not reach the asset size threshold to make

them a target, a multi-trillion dollar Social Security Trust Fund

presumably would.

It is possible that institutions could be created that would prevent the trust fund investments from being subject to political interference. But, investing the Social Security Trust Funds in equities does little or nothing to improve the overall ability of the U.S.

economy to meet the retirement needs of the next century. Given

this lack of evident benefit, it is unclear to me why we should take

on the risk of interference, which, probably short of a Constitutional amendment, cannot be eliminated. Even if concerns about

politically driven investment were not to materialize, what would

have been gained by such a huge shuffling of funds?

To the extent that a transfer of private retirement resources to

Social Security is deemed necessary to fund currently promised

benefits, why not do it directly through increased Social Security

taxes, or an allocation of general revenues to the Social Security

Trust Fund? Whatever the Congress does, it would be best not to

obscure the choice of real resource allocation with complex financial

structures that merely reshuffle claims to real resources, without

increasing them.

Of course, assessing the fiscal, financial, and economic state of

the American economy in the early twenty-first century is an enormously difficult undertaking. We cannot confidently project large

surpluses in our unified budget over the next 15 years, given the

inherent uncertainties of budget forecasting. How can we ignore

82

the fact that virtually all forecasts of the budget balance have been

wide of the mark in recent years? For example, as recently as February 1997, OMB projected a deficit for fiscal year 1998 of $121 billion—a $191 billion error. The CBO and others made similar errors. Likewise, in 1983, we confidently projected a solvent Social

Security Trust Fund through the year 2057. Our latest estimate,

with only a few changes in the program, is 2032.

It is possible, at some maintain, that the OASI actuaries are too

conservative, and that productivity growth could be far greater

than is anticipated in their so-called ‘‘intermediate’’ estimate. If

this is, in fact, our prospect, the Social Security System is in less

jeopardy than it currently appears. But proper fiscal planning requires that consequences of mistakes in all directions be evaluated.

If we move now to shore up the Social Security program, or replace

it, in part or in whole, with a private system, and subsequently

find that we had been too pessimistic in our projections, the costs

to our society would be few. If we assume more optimistic scenarios

and they prove wrong, the imbalances could become overwhelming,

and finding a solution would be even more divisive than today’s

problems.

Thank you, Mr. Chairman. I would appreciate my full text be included for the record.

[The prepared statement of Hon. Alan Greenspan follows:]

PREPARED STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF

THE FEDERAL RESERVE SYSTEM

Mr. Chairman and other members of the committee, preparing for the retirement

of the baby boom generation looms as one of our nation’s most difficult challenges,

and I commend the serious efforts being made here to address this important longterm problem. Before discussing my views on the issue of investing the social security trust fund in equities, I would like to examine the more fundamental issues

that any retirement reform will have to address.

The dramatic increase in the ratio of retirees to workers that seems inevitable,

as the baby boom generation moves to retirement and enjoys ever greater longevity,

makes our current pay-as-you-go social security system unsustainable. Furthermore,

the broad support for social security appears destined to fade as the implications

of its current form of financing become increasingly apparent. To date, with the

ratio of retirees to workers having been relatively low, workers have not considered

it a burden to share the goods and services they produce with retirees. The rising

birth rate after World War II, which, in due course, contained the growth of the

ratio of retirees to workers, helped make the social security program exceptionally

popular, even among those paying the taxes to support it.

Indeed, workers perceived it to be a good investment for their own retirement. For

those born before World War II, the annuity value of benefits on retirement far exceeded the cumulative sum at the time of retirement of contributions by the worker

and his or her employer, plus interest. For example, the implicit real rate of return

on social security contributions was almost 10 percent for those born in 1905, and

was about 6 percent for those born in 1920. The real interest rate on U.S. Treasury

securities, by comparison, has generally been below 3 percent.

But, births flattened after the baby boom, and life expectancy beyond age sixtyfive continued to rise. Consequently, the ratio of the number of workers contributing

to social security to the number of beneficiaries has declined to the point that maintaining the annuity value of benefits on retirement at a level well in excess of accumulated contributions has become increasingly unlikely. Those born in 1960, for example, are currently calculated to receive a real rate of return, on average, of less

than 2 percent on their cumulative contributions. Indeed, even these low rates of

return for more recent cohorts likely are being overestimated, because they are

based on current law taxes and benefits. In all likelihood, short of a substantial infusion of general revenues, social security taxes will have to be raised, or benefits

cut, given that the system as a whole is still significantly underfunded, at least according to the intermediate projections of the Old-Age and Survivors Insurance

83

(OASI) actuaries. For the present value of current law benefits over the next 75

years to be fully funded through contributions, social security taxes would have to

be raised about 2.2 percent of taxable payroll; to be fully funded in perpetuity, that

is, to ensure that taxes and interest income will always be sufficient to pay benefits,

social security taxes would have to be raised much more—perhaps something on the

order of 4 to 5 percent of taxable payroll.

This issue of funding underscores the critical elements in the forthcoming debate

on social security reform, because it focuses on the core of any retirement system,

private or public. Simply put, enough resources must be set aside over a lifetime

of work to fund retirement consumption. At the most rudimentary level, one could

envision households saving by actually storing goods purchased during their working years for consumption during retirement. Even better, the resources that would

have otherwise gone into the stored goods could be diverted to the production of new

capital assets, which would, cumulatively, over a working lifetime, produce an even

greater quantity of goods and services to be consumed in retirement.

The only way we will be able to finance retirement incomes that keep pace with

workers’ incomes is to substantially increase the national saving rate, increase the

borrowing of foreign capital, or increase the output that a given capital stock, financed through this saving, can produce. The crucial retirement funding issues center on how to increase our national saving and how to allocate physical resources

between workers and retirees in the future. We must endeavor to increase the real

resources available to retirees without blunting the growth in living standards

among our working population.

In this light, increasing our national saving is essential to any social security reform. Privatization proposals that begin to address social security’s existing unfunded liability would significantly enhance domestic savings; so would fuller funding of the current social security program. But the size of the unified budget surplus

implied by such funding, many have argued, would be politically unsustainable. The

President, recognizing this political risk, has proposed changing the budgetary

framework so as to support a large unified budget surplus. This is a major step in

the right direction that, if effective, would ensure that the current rise in government’s positive contribution to national saving is sustained. The large surpluses projected over the next 15 years, if they actually materialize, would significantly reduce

the fiscal pressures created by our changing demographics. Whichever direction the

Congress chooses to go, whether toward privatization or fuller funding of social security, augmenting our national saving rate has to be the main objective.

The Administration has also proposed investing a portion of the social security

trust fund assets in equities, rather than in U.S. Treasuries alone. Having the trust

fund invest in private securities most likely would increase its rate of return, although the increase might be less than historical rates of return would suggest, and

certainly would be less on a properly risk-adjusted basis. But where would that

higher return come from, and what would happen to private funds available for consumption in retirement?

If social security trust funds are shifted from U.S. Treasury securities to private

debt and equity instruments, holders of those securities in the private sector must

be induced to exchange them, on net, for U.S. Treasuries. Private pension and insurance funds, among other holders of equities, presumably would swap equities for

Treasuries. It seems likely that a rise in the interest rate paid on Treasuries, and

perhaps an increase in equity prices and a reduction in the expected future return

on equity, would be necessary in order to induce private investors to reallocate their

portfolios from equities to U.S. Treasury securities. If this is indeed the case, then

the net increment to the government of investing the trust fund in equities on an

ongoing basis presumably would be less than the historical rates of return suggest.

That said, exactly what changes in bond and stock prices would result from this

type of large-scale swap of U.S. Treasuries for equities is extremely difficult to predict.

But analyzing the macroeconomic effects of the portfolio reallocation is much less

complicated. The transfer of social security assets from U.S. Treasuries to equities

would not, in itself, have any effect on national saving. Thus, the underlying economic assets in the economy would be unchanged, as would the total income generated by those assets. Any increase in returns realized by social security must be

offset by a reduction in returns earned on private portfolios, which represent, to a

large extent, funds held for retirement. Investing social security assets in equities

is, then, largely a zero-sum game. To a first approximation, aggregate retirement

resources—from both social security and private funds—do not change.

Only an increase in national saving or an increase in the efficiency with which

we use our saving can help us meet the retirement requirements of the coming

years. Indeed, improved productivity of capital probably explains much of why the

84

American economy has done so well in recent years despite our comparatively low

national saving rate. For productivity and standards of living to grow, financial capital raised in markets or generated from internal cash flow from existing plant and

equipment must be continuously directed by firms to its most profitable uses—

namely new physical capital facilities perceived as the most efficient in serving consumers’ multiple preferences. It is this continuous churning, this so-called creative

destruction, that has become so essential to the effective deployment of advanced

technologies by this country over recent decades.

Looking forward, the effective application of our capital to its most highly valued

use is going to become, if anything, more important, as we strive to increase the

resources available to provide for the retirement of the baby boomers without, in

the future, significantly reducing the consumption of workers. An efficient market

pricing mechanism for equities has been a key element in our superior allocation

of saving into investment this past decade. Large investments in equities by the social security trust funds could impair that process.

As I have indicated in earlier testimony, I doubt that it is possible to secure and

sustain institutional arrangements that would insulate, over the long run, the trust

funds from political pressures. These pressures, whether direct or indirect, could result in suboptimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise.

The experience of public pension funds seems to bear this out. Although relevant

comparisons to private plans are difficult to construct, there is evidence that the average rate of return on state and local pension funds tends to be lower than the

return realized on comparable private pension funds, other pooled investments, and

market indexes. Of course, a significant part of this disparity would be eliminated

were these returns adjusted for risk, because public pension plans are often invested

more conservatively than private plans. But there is evidence that returns are lower

even after accounting for differences in the portfolio allocation between stocks and

bonds. For example, it has been shown that state pension plans that are required

to direct a portion of their investments in-state and those that make ‘‘economically

targeted investments’’ experience lower returns as a result. Similarly, there is evidence suggesting that, the greater the proportion of trustees who are political appointees, the lower the rate of return. A lower risk-adjusted rate of return on financial assets is almost invariably an indication of lower rates of return on the real

underlying assets on which they are a claim.

As I have also indicated in previous testimony, I do not deny that the federal government can manage equities without political interference if they are held in defined contribution funds or small defined benefit plans, such as the one run by the

Federal Reserve. Defined contribution funds, such as the federal government’s

Thrift Savings Plan, are effectively self-policed by individual contributors, who

would surely object were their retirement assets to be diverted to investments that

offered less than market returns.

But government defined benefit plans, like social security, provide guaranteed annuities that are wholly insulated from poor investment performance. Annuitants

look to the federal government for their retirement incomes, not the performance

of any trust funds. Thus, beneficiaries have no incentive to monitor the performance

of their investments. And, while the government’s small defined benefit funds do not

reach the asset size threshold to make them a target, a multi-trillion dollar social

security trust fund presumably would.

It is possible that institutions could be created that would prevent the trust fund

investments from being subject to political interference. But, investing the social security trust funds in equities does little or nothing to improve the overall ability of

the U.S. economy to meet the retirement needs of the next century. Given this lack

of evident benefit, it is unclear to me why we should take on the risk of interference,

which, probably short of a Constitutional amendment, cannot be eliminated. Even

if concerns about politically driven investment were not to materialize, what would

have been gained by such a huge shuffling of funds?

To the extent that a transfer of private retirement resources to social security is

deemed necessary to fund currently promised benefits, why not do it directly

through increased social security taxes, or an allocation of general revenues to the

social security trust fund? Whatever the Congress does, it would be best not to obscure the choice of real resource allocation with complex financial structures that

merely reshuffle claims to real resources, without increasing them.

A collateral issue is relevant to this debate. If the Congress were to decide to do

nothing to alter the path of receipts and outlays projected under current law, a large

buildup in the social security trust fund would occur, along with a significant onbudget surplus, according to the projections of CBO and OMB. The consequence

85

would, of course, be a significant decline in the current $33⁄4 trillion outstanding federal debt to the public.

But, if the unified budget is in surplus for a protracted period of years, it is at

least conceivable that the outstanding public debt would be eliminated. I might add

that this would be the first such occurrence for this nation, the previous low having

been $38 thousand in 1835 and 1836.

Currently, the rise in the holdings of U.S. Treasuries by the social security trust

fund is accomplished by the Treasury redeeming or buying back debt from the public, and selling it as special series nonmarketables to the trust fund. But, should

the debt to the public fall to zero, there would be no additional Treasury instruments available to the trust fund from that source. Were the Treasury, nonetheless,

to continue to sell debt to the trust funds, its cash balances at the Federal Reserve

would build up. At that point, under existing policy, there would be no choice but

to have the social security trust fund invest in private or quasi-private agency securities. I grant that, should these circumstances arise, the decision of how to handle

social security investments would become a more pressing question. However, it is

exceptionally difficult for me to focus seriously on so politically improbable, though

so intriguing, an event.

Of course, assessing the fiscal, financial, and economic state of the American economy in the early twenty-first century is an enormously difficult undertaking. We

cannot confidently project large surpluses in our unified budget over the next fifteen

years, given the inherent uncertainties of budget forecasting. How can we ignore the

fact that virtually all forecasts of the budget balance have been wide of the mark

in recent years? For example, as recently as February 1997, OMB projected a deficit

for fiscal year 1998 of $121 billion—a $191 billion error. The CBO and others made

similar errors. Likewise, in 1983, we confidently projected a solvent social security

trust fund through 2057. Our latest estimate, with only a few changes in the program, is 2032.

It is possible, as some maintain, that the OASI actuaries are too conservative, and

that productivity growth could be far greater than is anticipated in their ‘‘intermediate’’ estimate. If that is, in fact, our prospect, the social security system is in

less jeopardy than it currently appears. But proper fiscal planning requires that

consequences of mistakes in all directions be evaluated. If we move now to shore

up the social security program, or replace it, in part or in whole, with a private system, and subsequently find that we had been too pessimistic in our projections, the

costs to our society would be few. If we assume more optimistic scenarios and they

prove wrong, the imbalances could become overwhelming, and finding a solution

would be even more divisive than today’s problem.

Mr. OXLEY. Without objection, so ordered. Again, we appreciate

your being with us today.

The Chair will begin a round of questions for the Chairman.

As I understand your testimony, the two goals that you addressed were the long-term future of Social Security and to increase the national savings rate. And, you mentioned specifically

the Federal Government’s Thrift Savings Plan, which all Federal

workers since, I think, 1984, are required to participate in—or the

Federal Employees Retirement System—and the option of the Federal Government’s Thrift Savings Plan.

As you know, Mr. Chairman, that has a choice of, essentially,

three funds, the first one being the C Fund, the stock index fund,

based on the S&P 500. The second is the bond index Fund A bond

and X bond, and the third is a government securities provision that

basically provides a set amount, thereby giving Federal employees

who chose to participate essentially a choice of the risk that they

wish to take with their own money.

If we were crafting a proposal that would provide an increase in

the national savings rate as well as buttress existing Social Security for a number of years, would we be in the right neighborhood

if we were to use the Federal plan as an opportunity to explore how

we would craft a privatization of part of the Social Security System?

86

Mr. GREENSPAN. I would certainly think so, Mr. Chairman. Remember, however, we are talking about a defined contribution

plan. Its return will be high or low, depending on the success of

the investments. And, there is, of course, no guaranteed annuity at

the end of one’s working life as there is in a private annuity system

or in Social Security. So, in evaluating that, one must keep that in

mind. But if you are asking whether or not something of that nature is a model for individual retirement accounts or a quasi-privatization, I would say it is certainly the beginning from where one

should start to look.

Mr. OXLEY. I know when I have the opportunity to discuss this

with my constituents, which is quite often, and many of them

aren’t aware of the Federal system, I explain the Federal system.

Their response is, if it is good enough for Federal workers, why

isn’t it good enough for us? Particularly in regard to the babyboomers and the generation X’ers, who by every poll indicate that

they have very little faith that, when they are of retirement age,

they will be able to get Social Security in any form.

And, even if they were—because as you indicated in your remarks, the return would be less than 2 percent, and this is one of

the things that I think Congress really has to deal with—I think

you were very forthright in saying that there is very little chance

that you could craft a system whereby the Federal Government

would invest into the Social Security System without fear of political pressure. Also interesting, I think, is when you said that investing would not really increase the national savings rate. I think

it is something that I, frankly, have not considered, but was most

interested in pursuing.

Mr. Chairman, we had testimony last week, and also toward the

end of last year from James Glassman, who is an economist who

writes a regular column for The Washington Post. He indicated

that over the long term—that is, from 1929 until the present—the

most return on investment actually came from equities that averaged about over that period. That includes the Great Depression

and the stock market crash, and again we are talking long-term for

retirement for baby-boomers and for generation X’ers. That return

was 7 percent, which was far greater than bonds or very secure

government securities. Do you share that same confidence that

over the long-term—again, knowing the ups and downs of the market—that indeed the most secure investment and the highest return is an equity?

Mr. GREENSPAN. We have to start with the general notion of

where all of this earnings and interest comes from. These are

claims on real goods and services that are produced. What happens

when one looks at the historical record is what you do see is that

the so-called equity premium, meaning the persistence of the rate

of return in equities over riskless debt, seems always to be positive.

That is, people tend to be risk-averse and as a consequence of that,

they appear to be inevitably pricing debt in a manner in which

they would be willing to accept a lower real rate of return on debt

instruments which they consider less risky than equities. As a consequence of that, it is true over a long period of time that equities

do yield more than debt instruments. But remember that when you

shift the equities from one part of the system—namely, the private

87

system into the public system—you are not changing the overall

rate of return. You are just shuffling back between various different segments of the economy.

If you lower the degree of leverage in the economy—meaning, increase the amount of equity and decrease the amount of debt—then

the rate of return on equity will probably become somewhat less

because it will become an admixture of the previous interest payments with the equity returns.

Given the fact that the total gross operating profit—if I may put

it that way—is determined independently of whether, in fact, there

is a significant mix of equities or debt, I say that as a first approximation—a number of my academic colleagues will start to quibble—and I will grant them their quibble, but factually it is true,

but there is no free lunch out there. In other words, if everybody

decided to invest in equities and nobody in debt, than the rate of

return of equities would fall.

Mr. OXLEY. Well, do you like the idea or are you enchanted with

the idea of giving individuals a choice of risk much like the Thrift

Retirement System?

Mr. GREENSPAN. Yes, Mr. Chairman, I have always been in favor

of some form of privatization because I believe that it is easier to

raise the national savings rate through a private system than

through a government system. The issue is not the form of the savings or the instruments that are involved, but the availability of a

significant increase in savings to fund a necessary capital investment which will be required, because the demographics of our society are inexorably going to change in a manner, which means that

there are going to be significantly more retirees to workers, and

one should always conceive of all retirement systems, including Social Security, in terms of their physical characteristics. In other

words, are enough goods and services being produced to supply

both the retirees—whose numbers are going to be increasing very

dramatically—and, the workers?

It is very easy to shift resources from workers to retirees and always make retirees whole. The question is—you cannot do that

without impacting on workers unless the total pie increases. The

only way to increase the total pie is to increase activity.

Mr. OXLEY. Thank you, Mr. Chairman.

My time has expired. The gentleman from New York, Mr. Towns.

Mr. TOWNS. Thank you very much, Mr. Chairman.

Mr. Greenspan, in your testimony, you indicated that it may not

be possible to insulate the trust fund from political pressure. Why

do you feel so strongly about that?

Mr. GREENSPAN. I guess, Congressman, because I have been

around this town for a very long period of time.

And, I work for individual members of the governing class who

would have few compunctions in moving in that direction. And, I

would be most concerned about it. I must say that Congressman

Markey’s bill goes a long way to trying to get to resolve that problem—and I must say to you, it is a commendable effort. I just find

that there is something fundamental about the process which is

very difficult to get around. But, frankly, my most important concern is that I don’t think investing equities in the Social Security

Trust Fund does anything for the retirement system as a whole. It

88

is a shuffling of claims and doesn’t increase the real resources. If

it did, I guess one could argue it is worth taking the risk, the political risk, of what might happen. But I can’t see what the benefits

are and, therefore, I do not deny that we can probably construct

probably a very formidable barrier to prevent political interference.

I don’t think at the end of the day it is feasible without a constitutional amendment. But I don’t see what we are doing it for if there

is no real benefit to retirees.

Mr. TOWNS. Let me put it this way: If investment in the Social

Security Trust Fund in equities will do little to improve the overall

ability of this Nation to meet our future retirement needs, what investment policy changes should we be making in order to meet the

retirement needs of the 21st century?

Mr. GREENSPAN. Congressman, I would say anything which does

one of two things: increases the amount of national savings or increases the efficiency of the capital stock which that savings is invested in. Both of those will contribute to real resources.

The reason I would be terribly concerned about our current situation is that we have gotten along exceptionally well since the end

of World War II in funding retirement plans and basically making

retirees reasonably well off—to whatever extent that can be. It has

largely been the consequence of workers, either directly or indirectly, either allocating part of what they produce or claims that

were built up from previous retirees for private pension funds.

That is about to change. That is largely because population is

about to become dramatically less employed as we move a big bulk

in the population from the workforce where it is producing goods

and services to the retirement community where it is consuming

them. And, that is something we cannot change, short of a major

increase in immigration. And, I don’t sense in the Congress any inclination in that direction.

So, the fundamental issue is, no matter what we do, whether it

is in the private sector or in Social Security, it is essential that we

increase the aggregate amount of goods and services. That, in my

judgment, is only feasible through increasing the rate of return on

capital and/or increasing the savings which are invested in that

capital.

Mr. OXLEY. The gentleman’s time has expired.

Mr. TOWNS. Thank you much, Mr. Chairman.

Mr. OXLEY. The Chair now recognizes the gentlewoman from

New Mexico, Mrs. Wilson.

Mrs. WILSON. Thank you, Chairman Greenspan I found your

presentation most interesting and I have a couple of questions I

have to preface my remarks by saying I didn’t do very well in economics, so these questions may in some way seem simple to you.

I’m still struggling a little bit with them.

Mr. GREENSPAN. Let me just say this, Congresswoman: This is

an extraordinary difficult problem which the best economists have

not quite figured how it all works yet, and what all the implications are. So I think that everyone is struggling on this issue.

Mrs. WILSON. You said in your testimony that if we transfer Social Security Trust Funds from U.S. Treasury securities to private

debt, holders of the securities in the private sector must be induced

to exchange them on net for U.S. Treasuries. I understand your

89

point that that would be a no net increase in the overall retirement

system since most of those equities are invested for retirement. But

why must they be exchanged on that?

Mr. GREENSPAN. Well, that’s an important question. The best

way to visualize this is to think in terms how at any point in

time—let’s say the end of last year—that we have balance sheets

for all individuals and businesses at a point in time when they

owned various different types of assets. And you’ve got a Social Security Trust fund sitting up there and say on the December 31,

there’s a huge chunk of U.S. Special Treasury issues in the Social

Security Trust Fund—which by law you have to convert into marketable instruments. You take the marketable instruments and you

want to convert them into equities. And the question is, the only

way to do that is to swap them with somebody else. Nothing else

is happening at that point in time; it’s an instantaneous change.

So what occurs is that you’re trying to induce, within say 10 minutes, 15 minutes, 2 days, whatever the timeframe, a large block of

holders of equities, private pension funds, insurance companies, individuals to swap the government debt from the Social Security

Trust Fund for the equities that are held by private individuals.

There is no other way to do that.

Mr. WILSON. To follow up on that, not with respect to the existing Social Security Trust Fund and the Treasuries that are in it,

but for the revenue that comes in this year in Social Security taxes,

which are not—maybe they are but—but they’re not yet in Treasury notes, if there were individualized plans where that tax revenue was to be invested directly in the stock market, do you still

have the same problem of no net increase or is that an increase in

savings?

Mr. GREENSPAN. Maybe not. It depends on whether those actual

taxes or—let us just assume that if 2 percent of the Social Security

tax goes into a private account, the crucial issue is whether when

you move that 2 percent, whether the aggregate savings of the

economy is increased. If it is, then, the answer is yes, you do get

an increased overall return. If not, then it’s still a zero-sum gain.

The crucial question that must be answered gets down to that

level, and it is not easy to determine. As I said previously, I think

that I support such privatization because I do believe that process,

ultimately at the end of the day will increase total national savings, and if it does, it is a plus; if it turns out not to, then it is

a zero-sum gain.

Mr. OXLEY. The chairman’s time has expired. The gentleman

from Massachusetts, Mr. Markey.

Mr. MARKEY. Thank you, Mr. Chairman, very much.

I like to begin first, Mr. Chairman—by the way, I hope the President named you for another 4 years and I hope that you say yes.

You are a great man.

I want to clarify something here. If $400 billion, let us say, is put

into individual accounts and invested, as opposed to $400 billion

put into a centrally managed fund, say a Russell 2000, what is the

difference in terms of the impact on the savings rate?

Mr. GREENSPAN. From what you have told me, Congressman, it’s

indeterminate.

Mr. MARKEY. Indeterminate?

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Mr. GREENSPAN. Indeterminate; that in and of itself does not

change savings.

Mr. MARKEY. Right, and that’s my point. Whether it is——

Mr. GREENSPAN. Maybe the best way to respond to the question

I think you are asking is that—take the extreme form of privatization where you would get all of the Social Security Trust Funds

moving from the public sector to the private sector. And let us assume further that, because we need savings to fund the capital investment, we have to fully fund both systems because what fully

funding means is you are creating claims on future assets which

would be enough for future consumption of goods and services. And

that is true whether public or private. The sole criterion I think is

relevant here is which of the two systems has the higher probability of creating a larger amount of total national savings.

Mr. MARKEY. Okay.

Mr. GREENSPAN. And I would say that for reasons which I said

before—I will be glad to go over it, but I think the private system

looks better than the public.

Mr. MARKEY. So that becomes a debate then?

Mr. GREENSPAN. Correct.

Mr. MARKEY. Each have the potential of adding to private savings. So you contend if they are pooled over into individual retirement accounts, they are going to produce more income which will

as a result——

Mr. GREENSPAN. No, no not more income, I think the capacity to

have a fully funded private system is far higher—the probability is

far higher than a public system where you have the possibilities of

having to deal with very large surpluses which can be employed for

other means. Now, one of the reasons which I felt the President is

endeavoring to set aside 62 percent of the Social Security surplus

is the judgment he is making is that it is politically infeasible to

believe that we can keep that going. I happen to agree with him.

Mr. MARKEY. But this is the core of your notion—of your objection. The same amount of money invested by a central manager or

by individuals is going to get the pretty much the same result, although I would argue that you would get more with a centrally

managed because you would get rid of all those fees; you get rid

of the administrative woes——

Mr. GREENSPAN. Well——

Mr. MARKEY. [continuing] and even with—and let us be honest,

with the concerns of Arthur Levitt with regards to the percentage

of Americans who really even understand the stock market, you

wind up with, most likely, a huge percentage going into the hands

of private managers.

So my concern is that, if we keep a constant number of dollars

going into the private sector, then what I would ask you is, do you

agree or disagree with the Advisory Council on Social Security,

which has estimated that the administrative cost and fees of a privately managed individual account would average at least 1 percent per year and that would have to be taken right off the top of

anything that an individual would receive?

Mr. GREENSPAN. It depends how it is invested. If it is individual

stocks and it is done in the matter that is quite similar to say some

of the mutual funds, the fees do rise to that level.

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Mr. MARKEY. I appreciate that the Investment Company Institute report of last year, the average cost of an equity mutual fund

was 1.49 percent a year and Lipper Analytical reported that the average charge for a no load equity mutual fund equal 1.21 percent

of the amounts invested in the funds.

Mr. GREENSPAN. Sure, but the index funds can be managed for

very significantly less. If you are asking me whether, in fact, the

issue of the costs of management are an issue, the answer is, yes,

they are. I think there are two elements to that. One is anything

gained by the costs—in another words, does the investor get an additional service because they are paying more, and that is a question one has to make a judgment on. But there is no doubt that

a small, relatively small change in costs of administration accumulated over a very significant period of time does add up to a lot of

money, and I think that is a very relevant question to be put on

the table.

Mr. OXLEY. The gentleman’s time’s expired. The gentleman from

Louisiana.

Mr. TAUZIN. In the Chilean plan, in increasing the net savings

rate, was the additional factor in their plan allowing their citizens

that mandated a certain percentage to be invested—I think it was

10 percent of the income to be invested in the 14 or so plans. But

the additional feature that allowed them to invest considerably

more, I think as much as 15 percent more at tax-free savings in

these equity plans, was that, in your opinion, designed to increase

the net savings and, therefore, to achieve some the results you

think, whatever option we choose ought to achieve?

Mr. GREENSPAN. My recollection was that the Chilean plan came

out of what had previously been a chaotic——

Mr. TAUZIN. Yes——

Mr. GREENSPAN. [continuing] system and, in retrospect, it has

been, clearly, one of the models which a number of emerging nations have been looking toward to replicate their own programs.

The issue of equity investment per se does not necessarily change

the savings rate; it is often a transfer between particular areas of

the economy. But, I think the crucial question of what they called

the recognition bonds, which essentially, in our vernacular would

be, to take our contingent liabilities for benefits under current law

and put them into an official obligation of the United States

government——

Mr. TAUZIN. It is called gold bonds, I think.

Mr. GREENSPAN. In effect, they would be the equivalent of bonds

that would be paid to individuals. Actually, all you need is a claim

toward an annuity without even valuing the particular bonds. But

that process apparently did increase the savings rate, as best I understand it in Chile——

Mr. TAUZIN. Quite significantly——

Mr. GREENSPAN. [continuing] their general view toward their

ownership of their claim on their pension fund—apparently, according to some of my Chilean friends—was a badge of honor of some

form, and they managed to create what was, in their view, quite

significant success.

Mr. TAUZIN. But didn’t also—the additional features, is what I

am asking—whereby the Chilean worker was allowed to invest into

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his pension fund tax free far and above beyond the mandated investment requirements in addition to his gold bond, in addition to

his 10 percent contribution—I think they were allowed to put 15

percent more. Wasn’t that a very desirable feature in encouraging

the private investor not only to invest wisely his Social Security deposit, but also additional monies into the system?

Mr. GREENSPAN. Yes, Congressman, I would assume what I can’t

prove, that the ability to invest in equities in that particular context probably did raise the savings rate. It’s probably an exceptionally statistically difficult procedure to make that judgment definitively, but human nature being what it is, one must presume that

it probably did have a positive effect.

Mr. TAUZIN. I know we don’t have a lot of time, but you make

a statement in your written reports. You said an efficient market

pricing mechanism for equities has been the key element to a successful savings into investment in the past decade. You mention

large investment in equities by the Social Security Trust Funds

could impair that process. Could you elaborate, how might it impair the efficient price market pricing mechanism that currently

exists in the market?

Mr. GREENSPAN. Well I think it could do so in a number of different ways. One of the major ways is the diversion of funds into

economically targeted investments—which many State and local

funds are required to do. But there’s also the problem of whether,

if the Social Security Trust Fund were to invest only in indexed

stocks, for example, there would be fewer vehicles by which a number of venture capital type areas in our economy could be financed

if Social Security became a very large player in the stock market.

If it is small, obviously, my concern would be significantly less, but,

as I said to earlier questions, it is not clear to me what the overall

benefits are in the Social Security System of doing that. So I don’t

have a particular problem of making a judgment as to whether it’s

desirable or not.

Mr. OXLEY. The time of the gentleman has expired. The gentleman from Michigan.

Mr. STUPAK. Thank you, Mr. Chairman.

Mr. Greenspan, at the bottom of page 3 of your statement, you

indicate that the large surpluses projected over the next 15 years,

if they materialize, would significantly reduce the financial pressures created by our changing demographics. Whichever direction

the Congress chooses to go, whether toward privatization or fuller

funding of Social Security, augmenting our national savings rate

has to be the main objective. The President’s proposals on universal savings account, your opinion on that? I know that we’re on

Social Security, but I mean——

Mr. GREENSPAN. Yes, Congressman, as you know, the particular

program has not been fully specified—I mean, other than certain

general principles. I would apply the same principle I applied to everything else: If it increases savings, it is a plus; if it doesn’t, it is

a wash. I don’t think at this particular stage we know enough

about the details of the program to really make a sensible judgment. I will assume the President will be forthcoming at some

point with full details on that, and I think it will be far easier to

make some realistic judgment on that.

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Mr. STUPAK. The basic premise on the USA accounts is that, as

individuals save, the government would try to match—not necessarily match dollar for dollar—but at least contribute to that saving plan which would encourage hopefully more savings. That is a

sound basic premise.

Mr. GREENSPAN. Well, the problem, Congressman, is we are not

sure whether the savings put up by the individuals are new savings or merely diversions from previous savings into these new accounts. And, unless you can make that judgment I don’t think you

can conclude one way or the other whether or not the savings are

augmented.

Mr. STUPAK. So it would have to be new assets going into the

savings account?

Mr. GREENSPAN. Correct, it would have to be new savings. In

other words, in a sense, a better way of looking at it is that less

of one’s income would be consumed, and that is tough to monitor.

Mr. STUPAK. Since you are not keen on this privatization or any

investments here to fuller funding of Social Security over the next

15 years—we are talking again, if it materializes, $4.3 trillion surplus—how much of that surplus would have to go to Social Security

for fuller funding?

Mr. GREENSPAN. Oh, that and considerably more because we are,

as I indicated previously, underfunded in the Social Security Trust

Fund and under current services, meaning the projection of our

budgets under current law in respect to taxes and benefits, we end

up with a shortfall which the Social Securities actuaries in the intermediate assumptions, as I indicated, declare is equal to 2.2 percent of the tax base. The shortfall implicit in that 2.2 percent is,

indeed, the same order of magnitude as the $3 trillion-plus Social

Security Trust Fund assets which we get to before they begin to

liquidate. So it is already built into the underfunding issue, meaning there’s a lot more to go.

Mr. STUPAK. While we spent our time on Social Security, would

you not agree that Medicare should be addressed immediately, if

not sooner?

Mr. GREENSPAN. Well, Medicare is a tougher problem, undoubtedly. If we can find a way to address Medicare in a sensible way,

I would say it probably has priority over Social Security. But because Social Security is technically far easier to come to grips with

than Medicare, my own judgment is that it is probably wise to put

Social Security behind us and then try to focus more closely on

Medicare, which is so heavily involved in forecasts of technology

which we don’t have, in the same sense in making an evaluation

of the Social Security System.

Mr. OXLEY. The gentleman’s time has expired. The gentleman

from Arizona, Mr. Shadegg.

Mr. SHADEGG. If I understand your testimony, Mr. Greenspan,

you have indicated that simply shifting from the current investment by Social Security in debt instruments of the Federal Government to equity instruments in the private market in it of itself will

not enhance return for the overall investment portfolio, the retirement investment portfolio of the Nation, is that correct?

Mr. GREENSPAN. That is correct, yes.

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Mr. SHADEGG. And I presume from that, then, it is also true that

that benefit will not be achieved merely by allowing individuals to

invest in the private market, or am I mistaken about that? That

is, creating individual retirement accounts with some of the monies

flowing into the Social Security won’t solve the problem either, is

that right?

Mr. GREENSPAN. Unless you increase the savings rate in the

process, the answer is, yes, it doesn’t.

Mr. SHADEGG. And I believe what my colleague, Mr. Tauzin, was

trying to focus on, the fact that it would at least appear, or can be

argued, that in some of the countries where they have gone the private investment route, allowing individual investment in the private market has spurred a further savings—at least that was what

he was positing—thereby enhancing the overall investment in retirement funds and boosting the economy.

Mr. GREENSPAN. Yes, a number of the particular programs to

move toward privatization actually mandate additional savings

above and beyond the Social Security taxes, and one must presume

that, in doing that, you do increase the savings rate in the process.

Mr. SHADEGG. One of the things we can do to inject further savings in retirement or further private investment, the savings rate

overall, would be tax incentives to achieve that goal?

Mr. GREENSPAN. Well, there are lots of different ways of doing

it. One way, as I indicated earlier, is if you believe, as I do, that

it is far easier to get full funding through a private system than

a public system, now merely shifting funds, trust funds, and benefits, and in fact receipts from the Social Security System to the private system, will increase the national savings. But it is not the

fact that there is something magical about equities or debt; it is

wholly a question of what happens when the transfers occur. Here,

if one could argue that you could fully fund Social Security, then

the argument that you get superior savings in the private sector

I think would fail.

Mr. SHADEGG. Let me turn to another aspect. You said that you

weren’t confident that any investment scheme which would have

the government invest in the private market could be protected

without a constitutional amendment, and I share that concern. But

let me ask you a different concern. If we simply statutorily prescribe that government is now going to invest, as the President has

proposed, a portion of the Social Security surplus into the private

market, in equities instead of government debt, don’t we run a very

real risk that the moment the current surpluses disappear—say we

were to hit a steep economic downturn—wouldn’t there be a grave

danger, absent a constitutional amendment restructuring the system, that the government would simply repeal what it had done

and stop investing those monies in that surplus in the private market and, indeed, begin to spend in the current consumption as we,

in fact, have done, to date?

Mr. GREENSPAN. Well, Congressman, I think that’s the real issue;

that is, we have been living in a period in the last 7 or 8 years

where things have been going rather well. Both of these laws appear to have been repealed.

Mr. SHADEGG. Let us hope it is permanent.

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Mr. GREENSPAN. All the things that could have gone wrong

haven’t. It is perhaps difficult to remember what it is like when

things go bad. I think right now, for example, if Congressman Markey’s bill would have been put through and your fund would be created, my judgment is that it would probably work for a while. I

don’t see any particular pressure that would exert. The real issue

comes when things go wrong. When you are running a big deficit,

you have caps on expenditures; you have all sorts of claims on resources. Then all you need is 51 percent of the Congress, and the

President’s signature, and it changes everything.

Mr. SHADEGG. I see my time has expired. Let me just simply conclude. I think that is the essence of the problem and that we have,

historically, proven that if government can get its hands on it, it

will, in fact, spend the money. Therefore, the advantage of

privatizing this money is to create in the public the belief, or the

sense, or the actuality of ownership, making it, therefore, more difficult—hopefully impossible—for the government to reach out and

steal that money back. I would be interested in your comment on

that point.

Mr. SHADEGG. I think that is the correct argument.

Mr. OXLEY. The gentleman’s time has expired. The gentlelady

from Colorado.

Ms. DEGETTE. Thank you, Mr. Chairman.

Chairman Greenspan, one thing that we have been talking a lot

about on this subcommittee is the extraordinary move that the

baby-boom generation, and even our parents, have made to invest

their retirement money in the stock market. Average folks are investing in the market more than any time in the past. For example, right now about 4 percent of the market is held by Fidelity

funds—a fund that I invest in and probably so a lot of other members of this committee.

One thing that you have talked about today is the effect that

government investment of a portion of the Social Security Trust

Fund in the stock market will have on the market. Could you comment on what you think would happen once the baby-boomers start

to retire drawing off the Social Security Trust Fund, which would

hold about 4 percent of the market, and, at the same time, moving

their own investments out of equities—as our financial advisors tell

us we should. What happens when you have the convergence of

these events?

Mr. GREENSPAN. That is an interesting issue. A lot of people have

raised this question. If you buildup equities in the Social Security

Trust Fund and you have to liquidate the fund as you get to the

very large numbers of retirees, is it a significant negative on the

stock market? I suspect not. Let me say why.

Ultimately, the value of equities really reflects the values of the

companies, the real assets, that are producing goods and services

and earnings. And, who happens to own the claims should not have

a significant effect on the value of those claims. I don’t deny that

in the short run, if you get a substantial degree of liquidation of

equities, that the prices will go down, but they are unlikely to stay

down because they are not ultimately determined—let me put it

another way. The value of the corporation should be independent

of who owns it, and merely shifting around who owns it shouldn’t

96

effectively change its value. It will in the short run, because of a

lot of technical reasons, but there is no reason to expect that to be

the case over the long run.

Ms. DEGETTE. And you believe that would be true even with a

fairly extensive liquidation as we would see in people——

Mr. GREENSPAN. I am sorry, could you move your microphone a

little bit closer?

Ms. DEGETTE. I am sorry. And, you would think that that would

be true—the kind of extensive liquidation that we would see with

both the Social Security Trust Fund beginning to liquidate because

of the increasing people retiring and at the same time, people shifting their private investments away from equity?

Mr. GREENSPAN. I would think so. I mean, if the proposition

which I stipulated is correct, then the answer is obviously it would

have no effect. I am not saying I’m 100 percent accurate but I have

a suspicion that I’m more than 90 percent accurate. So, there may

be some effects, but it can’t be large.

Ms. DEGETTE. Now, I would like to follow up on the issue that

my colleague from Arizona was talking about. Couldn’t Congress

just go in and change the law, if they pass the Markey law or any

other law, couldn’t they just go in and do that? Well, we were sitting back here talking about how Congress could repeal the independence of the Federal Reserve Board—for example, we threaten

to, with great regularity around here. Practically speaking, if we

set up these higher laws, as we are discussing, do you think in 30

years—or however long it would be—that Congress would practically begin to repeal that?

Mr. GREENSPAN. Well, let’s remember one thing. And, there are

a lot of issues here about whether the Federal Reserve is being politically pressured or the like. I will give you a very strange answer. I think we should be. Because we live in a democratic society

and Congress has delegated to us the authorities which we have.

And, I think it would be inappropriate for Congress not to be telling us, or giving their judgments, as to what they think we ought

to do, and we, indeed, listen. And, I must tell you, on occasion, I

do hear things which do affect how we deliberate. And, I think that

is right. But we listen to everybody, and I think that the presumption that we should be blocking off Congress from either the Federal Reserve or this new organization, I think is a mistake. This

is a democracy. This is an appropriate structure of the way we

function.

I am less concerned that we will create inappropriate monetary

policies than I am that very specific, simple pieces of legislation

will emerge like do not invest any of these funds in industry X. If

industry X is in trouble politically, or otherwise, you will get an

overwhelming vote here on that issue. It is an easy vote in a sense.

It is not an easy vote to have significant inhibition on the Nation’s

central bank. So, I do think there are orders of magnitude which

are different.

Mr. OXLEY. The gentlewoman’s time has expired. The gentleman

from Iowa Dr. Ganske.

Mr. GANSKE. Thank you, Mr. Chairman.

Mr. Greenspan, you’re good with numbers. I want to ask you a

question about the budget as it relates to Social Security, and it

97

goes back to my opening statement because I’m not the only one

who has been confused by the President’s numbers. Many economists have said this is a very confusing and complicated statement

on the budget as it relates to Social Security. So let me just go

through some of these numbers again.

The President’s budget—maybe you can enlighten me on how

these numbers work out. The President’s budget forecasts a total

of $4.5 trillion over the next 15 years. Now of this surplus, $2.7

trillion, you could say, already belongs to the Social Security Trust

Fund because it is what is coming from the excess payroll tax.

With the remaining $1.8 trillion, the President then proposes $1.7

trillion in new spending. But then the President also says he wants

to set aside 62 percent of the $4.5 trillion surplus, or $2.8 trillion

to extend the Trust Fund solvency.

So, it looks to me like the President’s budget is making commit- ments and promises of $2.8 trillion, plus $1.7 trillion, plus $2.7 trillion, for a total of $7.2 trillion, but you only started out with $4.5

trillion. Now can you comment on this or clarify this for me?

Mr. GREENSPAN. Yes, I think that there has been an unfortunate

set of, I will say, bookkeeping going on here which—let me see if

I can clarify exactly what is happening. The Social Security Trust

Fund, which is the difference between receipts and outlays plus interest, is virtually all of the so-called off-budget part of the unified

budget. The postal system is the other thing which is small. If you

think in terms of the unified budget surplus being comprised of two

elements which are additive, one is the Social Security Trust Fund

and all other which we are now calling on budget. What is happening is that if you leave the total system to run, under current

law, you will end up with—let me just say, at the moment, we have

a very small deficit on budget and a very large surplus in the Social Security Trust Funds, so that the total unified budget surplus

is very close to the Social Security surplus at this particular point.

If you project the current services budget out into the next 10

years or so, what happens is the Social Security Trust Fund remains large and growing, but the on budget small deficit turns to

surplus and becomes very substantial, so that we have a surplus

cumulatively over the next 10 or 15 years, which is comprised of

two parts, one the total Social Security surplus and the on-budget

surplus.

Mr. GANSKE. Is that taking into account sticking with the 1997

Balanced Budget Act, the caps?

Mr. GREENSPAN. Yes, it is.

Mr. GANSKE. Okay, so if you break those caps, you don’t have

that?

Mr. GREENSPAN. Absolutely. I’m just talking about current law

and current practice, actually, but it is certainly the case that all

caps are in place in that particular projection. The President makes

a judgment that it is not possible to maintain that large unified

budget surplus politically, and so he says let us mandate that part

of the surplus will be locked in; the other is not. And he has effectively moved general revenues, which is the on-budget part, into

the Social Security Trust Fund, in addition.

If you would like, Congressman, what I may get for you, rather

than try to do this orally, is to give you a set of tables which recVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00100 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
98

1The Administration has not released estimates of the surpluses under their social security

proposal.

onciles precisely the numbers that you are working with on this.

The bottom line is that, if you look at what the program is, it is

dipping into some of the on-budget surplus and allocating it to Social Security along with the existing Social Security Trust Fund

surplus, these general revenue transfers augment the Social Security System, and move it from the year 2032, which is where we

would expect the Social Security Trust Fund to go bust, out to

2049. The additional transfers which occur as a consequence of

moving equity income in there move you from 2049 to 2055, and

the President has indicated that he would like additional additions

to the Social Security Trust Fund coming from agreements to either reduce benefits or increase taxes for the remainder of it.

[The following information was received for the record:]

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

WASHINGTON, D.C.

March 17, 1999

The Honorable GREG GANSKE

House of Representatives

Washington, D.C. 20515

DEAR CONGRESSMAN: During the March 3 hearing on the market impact of the

President’s social security proposal, we discussed whether the Administration was

‘‘double-counting’’ the surpluses. As I stated then, the Administration’s budget accounting is quite complicated, and it has led to a great deal of confusion. Fundamentally, however, ‘‘double-counting’’ is a misnomer. I enclose a short memo that attempts to clarify the issue, as promised.

Sincerely,

ALAN GREENSPAN

Chairman

Enclosure

THE ADMINISTRATION’S BUDGET

1. The direct effect of the Administration’s budget on national saving depends only

on the unified budget balances. The attached table provides an estimate of the

budget arithmetic.1 For simplicity of presentation, the table excludes the effects of

investing the trust fund assets in equities.

• The current services unified budget surpluses total $4.9 trillion over the next 15

years. • The Administration proposes spending $1.4 trillion on USA accounts, defense, and

other programs, leaving a net unified surplus of $3.5 trillion. 2. The Administration has also proposed transferring $2.8 trillion to the social se- curity trust fund, and $0.7 trillion to the Medicare trust fund.

• These transfers do not represent increased spending, and have no direct effect

on the unified budget balance or on national saving. • Transfers to the social security trust fund reduce the on-budget surplus but increase the off-budget surplus; transfers to the Medicare trust fund have no effect on either balance, because the Medicare trust fund is on-budget. • The transfers can be viewed as an earmarking of general revenues for social security and Medicare. As long as promised benefits are unchanged, the transfers

simply specify the sources of funds that will be used to finance the benefits.

3. The so-called ‘‘double counting’’ concerns stem from the fact that the proposed

transfers to the social security trust fund are larger than the available on-budget

surpluses.

• Under the Administration’s budget, the on-budget balances are in deficit over the

15-year horizon. But the on-budget deficits are more than made up for by offbudget surpluses. • The transfers to the trust funds have no direct economic effects. However, if they

affect political outcomes—for example, if the transfers reduce the likelihood of

large spending increases or tax cuts or influence other reforms of social security

or Medicare—then the transfers may have indirect economic effects.

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Budget Projections for 2000-2014

(Trillions of dollars, fiscal years)

Unified

budget

balance

Offbudget

balance

Onbudget

balance

Current services baseline (OMB) ............................................................................................ 4.9 2.7 2.2

Administration budget

Spending on USAs ................................................................................................................ -.5 -.5

Spending on defense and other ........................................................................................... -.5 -.5

Increased debt service ......................................................................................................... -.4 -.4

New Spending ....................................................................................................................... -1.4 -1.4

Transfer to social security trust fund .................................................................................. 0 +2.8 -2.8

Estimated interest on trust fund balance ........................................................................... 0 +1.0 -1.0

Estimated new budget balance .............................................................................................. 3.5 6.5 -3.0

Mr. GANSKE. Mr. Chairman, I ask unanimous consent for 2 additional minutes.

Mr. OXLEY. Would 1 additional minute be——

Mr. GANSKE. One additional minute.

Mr. OXLEY. No objection.

Mr. GANSKE. Let me see if I can summarize what I think you are

saying. Okay. Of that $4.5 trillion, $2.7 is Social Security.

Mr. GREENSPAN. I think that is correct.

Mr. GANSKE. Okay. So, in a sense, the President says, well, what

we are going to do is we are going to take 62 percent of that total

surplus——

Mr. GREENSPAN. Actually, he is taking 62 percent of the unified

budget surplus, which is where——

Mr. GANSKE. I am sorry, 62 percent of the unified budget surplus. Which happens to work out to be close to what the Social Security component would be—$2.7 versus $2.8, something like that.

So, in a sense, you are taking that Social Security part, you are

going to save what should have been saved for Social Security. But

then what he is saying—correct me if I am wrong on this—is that

we are going to, then, spend everything else that comes in because

he has spending of $1.7 trillion in his budget and that, then is, basically the difference between the $2.7 and the $4.5?

Mr. GREENSPAN. Well, let me put it this way——

Mr. GANSKE. Is that accurate?

Mr. GREENSPAN. I hesitate to answer because I want to be sure

that all the numbers—I don’t have the numbers in front of me to

put it together, but essentially something like that is happening.

It is not, as some people are saying, double-counting. It is not that.

If you think in terms——

Mr. GANSKE. But it would be accurate to say that, under the

President’s budget, that any other surplus that is projected there

is accounted for by spending?

Mr. GREENSPAN. Well, it is not spending; it is a movement of

funds out of general revenues. Now, it is not the same thing as

spending. What it is, basically, is to reduce the on-budget surplus,

and take that block of funds and add it to the Social Security Trust

Fund. Remember that since neither benefits, nor taxes, are

changed, the only way that you can move from the year 2032 to

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the year 2049 by building up Social Security Trust Fund is to effectively take it out of the on-budget general revenues.

Mr. OXLEY. The gentleman’s time has expired.

The gentleman from Wisconsin, Mr. Barrett.

Mr. BARRETT. Thank you, Mr. Chairman.

Just to continue this line of thought, from your perspective, the

dipping into the general fund, is that a solid idea or a bad idea?

Mr. GREENSPAN. Well, it depends, as Congressman Markey said,

in comparison to what? If you take the existing current services

budget, you will end up with a higher unified budget surplus than

is in the President’s program. Basically, because there is some

spending of the unified budget surplus. If you believe—and I suspect I would agree with the President on this—that it is unrealistic

to believe that we will maintain the unified budget surplus that is

projected under current law through tax cuts or spending, and if

you believe, as I do, that savings are crucial, then anything which

tries to maintain that surplus is a useful device.

I, personally, have been very uncomfortable about using general

revenues in the Social Security System. Indeed, most Social Security professionals are concerned because they are worried about the

discipline of the system and the fear of making it a welfare program. I would be more inclined, if you are going to adjust the system—as I said in earlier testimony, I would address the possibility

of effectively examining: one, the benefit structure and, two, the

CPI escalator issue, which Senator Moynihan has raised issues

about, I think quite correctly.

So, it really comes down to a question of, what are the benefits

and the costs of going in different directions? At root, the criterion

which I would tend to use is what tends to increase the savings

rate the most and what, basically, increases the capital assets in

this economy the most, because that is what is going to be necessary to fund a very sharp increase in the ratio of retirees to

workers.

Mr. BARRETT. Now I am even more confused, then. Because, you

are saying if the three options are that this money, this unified

surplus, that it would be unrealistic to think that it is going to stay

there, that we would either spend it, have a tax cut, or put it into

the Social Security Trust Fund, those seem to be, as Mr. Markey

said, compared to what? Looking at those comparisons, which do

you think is the best?

Mr. GREENSPAN. Well, if you told me that you could effectively

function with that large unified budget surplus over the next 15

years and not either spend it or cut taxes from it, I would say that

program is superior to the President’s program.

Mr. BARRETT. I am telling you we can’t.

Mr. GREENSPAN. Okay. You go back a step. If it turns out that

you can save part of it, then that is desirable to do. If it turns out

that you are going to spend it all, I would strongly support cutting

taxes.

Mr. BARRETT. Just so I know your ranking——

Mr. GREENSPAN. My ranking is, surplus, do nothing. Keeping the

largest surplus as possible would be my first ranking.

Mr. BARRETT. Okay, gotcha.

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Mr. GREENSPAN. Reducing the government debt, I think would be

very helpful in maintaining the economy and, more specifically,

creating the savings for the assets to help the retirees.

Mr. BARRETT. So that is preferable to the tax cut?

Mr. GREENSPAN. That is preferable to a tax cut.

Mr. BARRETT. And, a tax cut is preferable to spending?

Mr. GREENSPAN. Correct.

Mr. BARRETT. Okay. I know I don’t have much time——

Mr. GREENSPAN. That is my judgment, not anybody else’s.

Mr. BARRETT. Okay. I understand. I think your judgment is pretty well respected, so that is why I wanted to have your judgment.

You recognize that this is—for young people, they are not happy

with the system. How do we change the system to have young people have more confidence in this?

Mr. GREENSPAN. Well, Congressman, I think that we ought to be

looking at the issue not of immediate privatization, but to remember that the younger people coming into the workforce right now

have an expected rate-of-return into the Social Security System

which is significantly below what they could probably get in virtually any private plan. The problem, as you know, if you begin to

divert their funds to the private system, then their contribution to

the benefits of the older workers is reduced and you are running

into a terribly difficult problem of who finances that.

I, personally, think we could probably solve that problem by

some form of recognition bond issue, which is a complex issue—I

know the light is red and I can’t get into it. But I would be very

glad to send you a paper I presented to the Senate Budget Committee Task Force on Social Security in which this issue was

raised. And, I hope it will explain what, I think, could conceivably

be done.

[The following was received for the record:]

PREPARED STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF

THE FEDERAL RESERVE SYSTEM BEFORE THE TASK FORCE ON SOCIAL SECURITY, COMMITTEE ON THE BUDGET, UNITED STATES SENATE, NOVEMBER 20, 1997

I am pleased to appear here today to discuss one of our nation’s most pressing

challenges: putting social security’s Old-Age and Survivors Insurance program on a

sound financial footing for the twenty-first century. It has become conventional wisdom that the social security system, as currently constructed, will not be fully viable

after the baby boom generation starts to retire. The most recent report by the social

security trustees projected that the trust funds of the system will grow over approximately the next fifteen years. However, beginning in the year 2014, the annual expected costs of the Old-Age and Survivors Insurance program are projected to exceed annual earmarked tax receipts, and the subsequent deficits are projected to deplete the trust funds by the year 2031.

This imbalance in social security stems primarily from the fact that, until very

recently, payments into the social security trust accounts by the average employee,

plus employer contributions and interest earned, were inadequate to fund the total

of retirement benefits. This has started to change. Under the most recent revisions

to the law and presumably conservative economic and demographic assumptions, today’s younger workers will pay social security taxes over their working years that

appear sufficient, on average, to fund their benefits during retirement. However, the

huge liability for current retirees, as well as for much of the work force closer to

retirement, leaves the system as a whole badly underfunded.

This issue of funding underscores the critical elements in the forthcoming debate

on social security reform, because it focuses on the core of any retirement system,

private or public. Simply put, enough resources must be set aside over a lifetime

of work to fund the excess of consumption over claims on production a retiree may

enjoy. At the most rudimentary level, one could envision households saving by actually storing goods purchased during their working years for consumption during retirement. Even better, the resources that would have otherwise gone into the stored

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1See my remarks at the Abraham Lincoln Award Ceremony of the Union League of Philadelphia, December 6, 1996.

goods could be diverted to the production of new capital assets, which would, cumulatively, over a working lifetime, produce an even greater quantity of goods and

services to be consumed in retirement. In the latter case, we would be getting more

output per worker, our traditional measure of productivity, and a factor that is central in all calculations of long-term social security trust fund financing.

In sum, the bottom line in all retirement programs is the availability of real resources. The finance of any system is merely to facilitate the allocation of resources

that fund retirement consumption of goods and services. Unless social security savings are increased by higher taxes (with negative consequences for growth) or reduced benefits, domestic savings must be augmented by greater private saving or

surpluses in the rest of the government budget to ensure that there are enough

overall savings to finance adequate productive capacity down the road to meet the

consumption needs of both retirees and active workers.

The basic premise of our current largely pay-as-you-go social security system is

that future productivity growth will be sufficient to supply promised retirement benefits for current workers. However, even supposing some acceleration in long-term

productivity growth from recent experience, at existing rates of saving and capital

investment, a pick-up in productivity growth large enough by itself to provide for

impending benefits is problematic. Moreover, savings borrowed from abroad, our

current account deficit, cannot be counted on indefinitely to bridge the gap between

domestic investment and domestic savings.

Accordingly, short of a far more general reform of the system, there are a number

of initiatives, at a minimum, that should be addressed. As I argued at length during

the Social Security Commission deliberations of 1983, with only modest effect, some

delaying of the age of eligibility for retirement benefits is becoming increasingly

pressing. For example, adjusting the full-benefits retirement age further to keep

pace with increases in life expectancy in a way that would keep the ratio of retirement years to expected life span approximately constant would significantly narrow

the funding gap. Such an initiative would become easier to implement as fewer and

fewer of our older citizens retire from physically arduous work. Hopefully, other

modifications to social security, such as improved cost-of-living indexing, will be instituted.

There are a number of broader reform initiatives that, through the process of privatization, could increase domestic saving rates. Given the considerable stakes involved, these are clearly worthy of intensive evaluation. Perhaps the strongest argument for privatization is that replacing the current underfunded system with a fully

funded one could boost domestic saving. But, we must remember that it is because

privatization plans might increase savings that they are potentially viable, not because of their particular form of financing.

Moving toward a privatized defined-contribution plan would, by definition, convert

our social security system into a fully funded plan. But, the same issues and questions remain as under the current system. What level of retirement income would

be viewed as adequate, and should required contributions to private accounts (and

savings) be increased to meet this level? Is there an alternative to forced savings

to raise the level of contributions to the private funds?

Finally, if individuals did invest a portion of their accounts in equities and other

private securities, thereby receiving higher rates of return and enhancing their social security retirement income, what would be the effect on non-social security investments? As I have argued elsewhere,1 unless national saving increases, shifting

social security trust funds to private securities, while likely increasing income in the

social security system, will, to a first approximation, reduce non social-security retirement income to an offsetting degree. Without an increase in the savings flow,

private pension and insurance funds, among other holders of private securities, presumably would be induced to sell higher-yielding stocks and private bonds to the

social security retirement funds in exchange for lower-yielding U.S. Treasuries. This

could translate into higher premiums for life insurance, and lower returns on other

defined-contribution retirement plans. This would not be an improvement to our

overall retirement system.

Furthermore, the potential consequences of moving social security to a system

that features private retirement accounts need to be considered carefully. Any move

toward privatization will confront the problem of how to finance previously promised

benefits. That would presumably involve making the implicit accrued unfunded liability of the current social security system to beneficiaries explicit. For example,

participants at the time of privatization could each receive a non-marketable certificate that confirmed irrevocably the obligations of the U.S. Government to pay a real

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2 Calculating the accrued benefits would require an estimate of future national real wage

growth. 3 Note that these estimates of the value of the accrued liability differ in concept from the $3

trillion official OASDI unfunded liability. That number represents the difference between expected future tax payments and future benefits over a 75-year horizon, and also includes the

unfunded liability of the disability program. Even if the assets in the social security trust fund

were to be increased by the $3 trillion, the social security system would still not be in balance

over the long-term (i.e., in perpetuity).

annuity at retirement, indexed to changes in the cost of living. The amount of that

annuity would reflect the benefits accrued through the date of privatization.2

Under our current system, social security beneficiaries technically do not have an

irrevocable claim to current levels of promised future benefits because legislative actions can lower future benefits. In contrast, the explicit liability of federal government debt to the public is essentially irrevocable. A critical consideration for the privatization of social security is how financial markets are factoring in the implicit

unfunded liability of the current system in setting long-term interest rates.

If markets perceive that this liability has the same status as explicit federal debt,

then one must presume that interest rates have already fully adjusted to the implicit contingent liability. However, if markets have not fully accounted for this implicit liability, then making it explicit could lead to higher interest rates for U.S.

government debt.

For any level of real annuity at retirement, the corresponding current value of

recognition certificates would depend on a number of technical assumptions. These

assumptions have no impact on the real payouts from the retirement annuities but

determine the current notional value of recognition certificates, which is useful for

making broad economic comparisons. For example, factoring in a 2 percent real annual rate of discount and including other technical assumptions, the value of recognition certificates the U.S. government would need to issue to ensure that all currently accrued legislated future benefits are paid would be roughly $91⁄2 trillion. Alternatively, at a 1 percent real rate, the value would be roughly $12 trillion, and

at a 6 percent real rate, the value would be about $41⁄2 trillion.3 Because, under

a wide range of assumptions, the magnitude of this liability remains very large relative to the current outstanding federal debt to the public—$31⁄2 trillion—the market adjustment could be substantial.

There is reason to suspect, however, that if such a liability is made explicit in

a mariner similar to the transition procedure in Chile, each dollar of new liability

will weigh far less on financial markets than a dollar of current public debt. In the

case of the Chilean pension reform, a significant portion of the implicit liability of

their old system was made explicit at the initiation of the new pension system by

the issuance of ‘‘recognition bonds’’ that were deposited in workers’ individual accounts. These bonds were initially nonmarketable, indexed for price inflation, and

yielded a fixed real return on a specified face value. In Chile, the liquidation of

these bonds generally occurs only after a worker retires and the proceeds from the

bonds are required to be paid in the form of an annuity or through programmed

partial withdrawals. These bonds have been viewed as a different instrument from

other forms of public debt, and it is likely that if an instrument such as recognition

certificates were issued here, it also would be viewed as distinct from fully-liquid

marketable public debt.

In effect, under privatization, the obligations of social security would be transferred from an implicit government account to millions of private individual accounts. Retirement needs would be funded first by the conversion of recognition certificates, and later by withdrawals from private defined contribution funds. The outstanding certificates would accordingly decline with time, and finally be paid off

some decades in the future. But if benefits and contributions do not change, national

savings are only being transferred from the federal government account to that of

households and are not increased in the process. It is only if contributions or private

saving increases that household and national saving increases.

The transfer of savings from public to private accounts would affect the unified

budget balance of the U.S. government, although precisely how that balance would

be affected would depend on the exact budgetary accounting treatment adopted for

recognition certificates. Certainly, with immediate and full privatization, the ongoing annual unified budget balance would decline by at least the amount of the

social security surplus: As payroll taxes were diverted from public coffers to private

accounts, they would no longer count as tax revenues; similarly, payments of social

security benefits would not count as outlays.

The issuance of recognition certificates under current accounting rules presumably would also increase outlays and the deficit by the value of the certificates at

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4For example, if the certificates could be treated as non-interest bearing, then the notional

face value of the certificates would be quite large; their issuance would lead to a one-time spike

in the deficit, but the certificates would not affect the deficit in future years.

Alternatively, if the certificates were accorded an imputed interest rate for budget accounting,

while the immediate effect would be to record a lower deficit, the unified balance of the U.S.

government would increase in subsequent years by interest accruing on the certificates. Finally,

should the recognition certificates be kept separate from the unified budget, the unified deficit

would only be affected by the loss of the social security surplus. 5The cumulative total effect of privatization on the unified budget is approximately the same

whether the privatization is immediate or phased in. Immediate privatization results in bigger

up-front deficits.

the time of issuance. Exactly how much the deficit would be affected in the initial

year, and how much in subsequent years, would depend on how the certificates were

structured and on bookkeeping conventions.4 However, the basic effects of privatization on the budget deficit are clear—the implicit liabilities of the social security system would start to appear on our balance sheets now, rather than when the baby

boomers retire.

It is an open, but crucial, question as to how financial markets would respond to

a change of the magnitude contemplated by immediate full privatization. Before any

such move is made, a thorough examination of the risks and benefits to the financial

markets would be wise. The key issues that will affect the economy are (1) the

change from the implicit liability of the current system to one of an irrevocable obligation to pay and (2) the magnitude of changes in national saving and the level of

productivity-spurring investment. The budget bookkeeping on how privatization is

recorded has little significance.

An alternative to what is clearly a ‘‘big bang’’ one-shot transition, in which privatization occurs immediately for all, is a gradual transition where, for example, only

younger workers are accorded recognition certificates, and are required to fund the

remainder of their retirement needs through defined contribution plans. Over the

years, ever older groups would be included in the new system. During the transition, two systems would operate in parallel. Such a transition would involve smaller

immediate increases in recognition certificates (and in the unified budget deficit)

and smaller accompanying market risks, but would have larger effects in subsequent years, as tax revenues from the younger groups would be diverted as contributions to private accounts, whereas all social security benefits to retirees would

still be counted as government outlays.5 Thus, if there is a unified budget surplus

before the transition, it will be reduced or turned to a deficit at least to the extent

of the loss in tax revenues. In effect, social security benefits will be increasingly financed with ‘‘general revenues’’ for a time. Should this be the direction that the

Congress decides to move, containment of spending outside of social security doubtless would be necessary to add assurances to the market.

Ultimately, of course, even under a gradual transition, the system would be almost fully privatized. I say almost because I presume Congress would provide some

form of assistance to those who through investment imprudence or unforeseen

events had retirement benefits below a certain level perceived as an absolute minimum. Needless to say such a new entitlement would have to be rigorously delimited because political pressures to increase it could be overwhelming.

Despite all of these complications, in the broader scheme of things, the types of

changes that will be required to restore fiscal balance to our social security accounts

are significant but manageable. More important, most entail changes that are less

unsettling if they are enacted soon, even if their effects are significantly delayed,

rather than waiting five or ten years or longer for legislation. We owe it to those

who will retire after the turn of the century to be given sufficient advance notice

to make what alterations in retirement planning may be required. If we procrastinate too long, the adjustments could be truly wrenching. Our senior citizens, both

current and future, deserve better.

Mr. BARRETT. I would appreciate that. Thank you.

Mr. OXLEY. The gentleman’s time has expired. The gentleman

from Oklahoma, Mr. Largent.

Mr. LARGENT. Mr. Greenspan, is Social Security figured into the

national savings rate?

Mr. GREENSPAN. The Social Security Trust Fund is. Let me put

it to you in specific terms. The unified budget surplus, or, more exactly, the unified budget, is part of the national savings to the exVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00107 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
105

tent that the Social Security Trust Fund increases; to the extent

that there is a surplus in it, that is part of the national savings.

Mr. LARGENT. So, when a national savings rate is figured on a

per-capita basis—and, we have seen figures—they figure in the Social Security Trust Fund and any surplus to it?

Mr. GREENSPAN. I don’t know what specific numbers are referred

to here, but there is no doubt that the contribution, not the level

of the trust fund, but the net annual surplus, is added to the net

household savings, plus business savings, plus non-Social Security

savings, to get the total national savings.

Mr. LARGENT. Okay, that was my question. Mr. Greenspan: What

is the relationship between tax rates and national savings rates?

Mr. GREENSPAN. In an accounting sense, none, but in an economic sense, one must presume that if you have very high tax

rates in an economy, its ability to create capital wealth and standards of living will be significantly diminished. So, one can probably

argue that in economic terms they are very likely inverse.

Mr. LARGENT. Okay. So, one of the things you hit pretty hard in

your testimony is figuring out a way to increase national savings.

And, so, according to your last response, your last answer, one way

to increase national savings would be to decrease tax rates.

Mr. GREENSPAN. Well, I can conceive of a scenario in which that

would be true, yes.

Mr. LARGENT. Okay. One other thing that I wanted to get a comment on—this is the last thing—is that I think that one of the fundamental and significant differences between privatizing Social Security to individuals versus privatizing Social Security by simply

allowing the government to invest assets in equities, that one of

the real significant differences between those two forms of

privatizing Social Security, if you will, is the issue of ownership—

and, one that we hear a lot about from our constituents—meaning:

when my husband died, the assets that he had in Social Security

weren’t passed on to his children, versus, when an individual has

the opportunity to own an account and invest it in equities—like

we do with our Federal program—those assets do pass on to your

heirs. Could you comment on that?

Mr. GREENSPAN. Congressman, I think it is a good point that you

are making. In fact, there is a little confusion about what constitutes Social Security wealth. Social Security is essentially a defined-benefit program in which the government, by law, is obligated to pay certain amounts to individuals, wholly independently

of what is earned in the Social Security Trust Fund. Now, to be

sure, they try to make relationships between them, but the specific

annuity in Social Security that an individual potential retiree has

is the claim against the government, not what the government

trust fund earns or doesn’t earn.

So, in that sense, there are no ownership rights whatsoever in

the equities by Social Security recipients. It is merely a funding

means, and the funding—the relationship between Social Security

benefits and what is in the trust fund is very, very loose, to say

the least. While there is a superficial resemblance between investing in equities, whether it is public or private, it is in fact night

and day. And, I am strongly supportive of investing in equities in

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the private system, but not in the public system, on the basis of

the various judgments that I have made.

Mr. OXLEY. The gentleman’s time has expired. The gentleman

from Florida, Mr. Deutsch.

Mr. DEUTSCH. Thank you, Mr. Chairman.

Thank you, Mr. Greenspan. If I can maybe follow up on Congressman Largent’s questions, the distinction between some type of

privatization versus the President’s proposal versus some of the Republican proposals, and the difference in terms of private accounts

versus this sort of public investing, could you respond how you

would expect those two systems to work differently in a significant

market downturn situation?

Mr. GREENSPAN. I am sorry, could you repeat that again?

Mr. DEUTSCH. In the difference between the private individual

account versus the public investment, what the response would be

in a market downturn situation?

Mr. GREENSPAN. Yes. Are we assuming that the public account

has got equities in them?

Mr. DEUTSCH. That is correct.

Mr. GREENSPAN. In the private system, it is going to depend, to

a large extent, on to what extent you have a safety net in there.

All the private programs of which I am aware have some element

of minimum guaranteed benefit of some form or another. In the

public sector, as I said before, the relationship between what is in

the trust fund in Social Security and what the benefits are is very

loose.

I can conceive—it is tough, but I can conceive—of a case in which

you would have a severe decline in equity holdings in the Social Security Trust Fund, and it would create some pressure to somehow

alter Social Security benefits. I think that is extraordinarily unlikely, but I will admit to the fact that it is possible.

In the private sector, obviously, if a decline in equities occurs—

there is a loss to the retiree, with the exception of the guarantee

part of the program. So, in one sense, I would almost say it is almost irrelevant to the Social Security Trust Fund; it is not irrelevant, obviously, to the private sector.

Mr. DEUTSCH. Again, I think what is clear, though, in the proposal that the President has made is that those potential

downturns—i.e., the 1974 situation—in a sense, both past generations and future generations could level that. I see a scenario

where, in the private system, if we allow people to invest privately

in individual accounts, that you have a scenario that someone

turns 65 in 1974—assuming that the system existed you know, let

us say, for 40 years up to that point—wanting to retire at 65 in

1974, for a reduction of 40 percent in a total equity, or an index

account at that point. What happens to that person? Again, how

much can a safety net make up for that 40 percent decline?

Mr. GREENSPAN. Well, I think the way you solve that is, basically, I would assume, as you move closer and closer to retirement,

you move to less and less risky assets. In other words, if you have

everything in equities, if you have everything in Internet stocks, I

mean, you are in real trouble. But it is a question of how you manage the potential portfolio.

107

But let me say this: If you are going to have a small amount of

equity in the Social Security Trust Fund, its purpose has got nothing to do with guaranteeing benefits.

Mr. DEUTSCH. Right.

Mr. GREENSPAN. The benefits are guaranteed by law. And, what

they will do is, essentially, increase or decrease the unified budget

surplus or deficit of the Federal Government. In other words, if

there is a large loss in equities held by the Social Security Trust

Fund, the general taxpayer is the one who will field the cost.

Mr. DEUTSCH. Let me just, in my last question—obviously, we

are about to have a vote; I think they want to finish up—related

to your statement about Internet stock, and just market conditions,

just in terms of the potential in the market in the big picture—and,

obviously, it relates to Social Security, ultimately—the fact that we

have this phenomena of incredible amounts of the market being

day traded and margins of up to 10 percent margins in some of the

way that they are able to do their margining, what is your concern

about that in terms of market conditions overall? What are we

doing to try to correct the potential disaster that might be out

there?

Mr. GREENSPAN. Congressman, if you wouldn’t mind, I am going

to fudge on that question. I do it generally, but I usually don’t ask

permission.

It is complex answer, and we just don’t have the time, but if you

like, I would be very glad to discuss it with you on the phone if

you want to give me a call.

Mr. DEUTSCH. Okay.

Mr. OXLEY. The gentleman’s time has expired. The gentleman

from California.

Mr. BILBRAY. Thank you. Mr. Greenspan, I want to really commend you on your testimony today, I appreciate it.

I want to clarify, to make sure we are talking apples and oranges

here. You made a reference to the fact that you felt that if there

was a choice between spending and tax cuts, if that was a choice,

rather than paying down the debt, you would recommend tax cuts.

Mr. GREENSPAN. Absolutely.

Mr. BILBRAY. You are speaking plain English here. It if was a

difference between investments and tax cuts——

Mr. GREENSPAN. I am sorry, investment where?

Mr. BILBRAY. Well, I am just saying that in Washington right

now spending is now tagged as investments.

Mr. GREENSPAN. Oh, that. Oh, okay. This is a cost-benefit analysis. I can conceive it—I was asked in the Senate the other day

precisely that question on an issue of education on certain sorts of

things. And, I said: ‘‘Look, if you can demonstrate that there is a

very significant benefit to a specific type of outlay, then I think it

has a priority.’’ In my judgment, it is very difficult to do that usually in most cases, and in the particular instance where the educational system has been very dramatically enhanced by the need

to increase the skills of the working age population. Most of the

types of programs which one would like to put into a government

form, I think, in part, are already existing. But if you can find one

which really comes to grips with something which would enhance

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the skills of the workforce, I would think it would—one would have

to——

Mr. BILBRAY. So in other words, spending that you could prove

a nexus between cost-benefit ratio, a direct nexus.

Mr. GREENSPAN. I am sorry, give me that question again.

Mr. BILBRAY. In other words, spending or investment that could

show a direct nexus to a benefit, a direct benefit revenue enhancement?

Mr. GREENSPAN. Yes.

Mr. BILBRAY. I guess what it really comes down to, when we talk

about this issue of investing into the stock markets—and correct

me if I am wrong; I was a history major. It sort of reminded me—

I think Mussolini was the man who really came up with the idea

of government funds making major investments in the Italian stock

market at one time. Somebody may correct me later on that.

My question, though, is: It really comes down to trust. Do we

have more trust in the security of a communal investment of our

retirement programs or do we have more as an individual, have

more trust in the individual, to be able to monitor, at least, the

supplemental side of the retirement program? And, I would use an

example.

Here in the Federal system, the Federal employees and Members

of Congress pay a base Social Security participation, but, as a supplemental, have individual retirement accounts to be able to reduce

the dependency on the communal fund. Do you see major problems

with the rest of the Nation being able to opt into this supplemental

element, and being rewarded for it, as those of us in the Congress

and those in the Federal employment have today?

Mr. GREENSPAN. I personally think not, but, you know, what we

are talking about here is a really fundamental view of the way our

society functions and the willingness that we all have to take risks

or not take risks. The choice of what type of risks you want to take

in your life differs form individual to individual. I think we ought

to give people the ability to differentiate amongst themselves.

Mr. BILBRAY. To allow the individual to make the choice?

Mr. GREENSPAN. Allowing the individual to make that choice. I

mean, you can, at this particular stage, if you are, say, 25, you

could take all of your Social Security taxes and invest it in, say,

safe corporates—or, something like that—corporate debt, with a little bit of equity, have a little bit of risk involved. Or, you could

have a huge equity portfolio and take very large risks——

Mr. BILBRAY. So, in other words——

Mr. OXLEY. The gentleman’s time has expired. We have got to

get to——

Mr. BILBRAY. I appreciate that, and I appreciate the fact that we

address this issue that a government monopoly isn’t necessary always the best way to provide security to individuals. And, I appreciate your testimony. I yield back, Mr. Chairman.

Mr. OXLEY. The gentleman from New York.

Mr. FOSSELLA. Thank you, Mr. Chairman.

Chairman Greenspan, with respect to tax reduction, talk about

targeted tax relief as opposed to, say, a reduction in the marginal

tax rates. What do you think is the appropriate course?

109

Mr. GREENSPAN. Well, as somebody that is looking at the economy, clearly marginal tax rates, by all measure, have significant

impact on economic efficiency and growth, whereas, targeted ones

do not, or at least certainly not to the extent that cuts in marginal

rates would do.

Mr. FOSSELLA. Thank you. Do you feel that there is an opportunity, in your hierarchy, to reduce the debt, or is that just something that is not possible at this point in time?

Mr. GREENSPAN. You mean to reduce the debt? I think that, one,

we are reducing it now, and I would hope we would continue to do

that. In fact, if we run a surplus, there is almost no alternative but

to reduce debt. The only other alternative is for the U.S. Treasury

to buildup cash balances, which it can only do up to a certain limit.

And, reduction of debt, in my judgment, is clearly something which

will probably make long-term interest rates lower than they otherwise would be; mortgage rates would be lower. I think there are

some very considerable benefits from lowering the aggregate level

of debt in this country.

Mr. FOSSELLA. Okay, I have other questions I will submit.

But, in light of the time, I want to shift gears for a second on

a totally different topic and that has to do with the subcommittee,

once again, considering the financial services reform. One issue

that has raised some concern is using taxpayer dollars to subsidize

activities of bank operating subsidiaries.

I want to enter, Mr. Chairman, for the record, pieces of a March

1st issue of Business Week—first, a commentary that notes that

Federal safety net deposit insurance and access to the Fed’s emergency funds, gives banks a lower cost of capital that should not be

used to subsidize banks and securities, insurance, or other fields.

That observation is that the safety net might encourage banks to

take bigger risks at the expense of taxpayers. And, the second editorial asserts that it makes sense to separate the securities, insurance and banking business, as the Federal Reserve suggested,

through separating capitalized affiliates, rather than operating

subsidiaries.

[The information referred to follows:]

[Business Week/March 1, 1999]

COMMENTARY

THE STARING CONTEST THAT’S STALLING BANK REFORM

By Mike McNamee

Could it be that, after a quarter-century, the planets have finally aligned for an

overhaul of the U.S. financial system? It seems so. Three big chunks of the industry—banks, securities firms, and insurers—agree that the old rules restricting mergers among them should go. Republicans and Democrats alike agree it’s time for reform.

But Washington’s biggest financial stars remain out of line. Federal Reserve

Chairman Alan Greenspan and Treasury Secretary Robert E. Rubin can’t agree on

how banks should operate securities and insurance arms—and on who will oversee

the new combinations.

It’s time for these titans to quit squabbling. Greenspan has the right idea: The

risky business of underwriting securities and insurance should be kept outside the

walls of banks, in separate affiliates. This holding-company setup would put supervision under the Fed, where GOP leaders and the securities industry agree it should

go. Even banks aren’t fighting that.

But Rubin is. The Treasury chief wants to let banks conduct securities and insurance operations within subsidiaries owned by the bank. ‘‘Financial-services firms

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should have the choice of structuring themselves in the way that makes the most

business sense,’’ he says. Another benefit for Rubin: That approach would ensure

continuing oversight by Treasury’s Office of the Comptroller of the Currency (OCC),

which regulates national banks. The Fed regulates holding companies that own

banks, so Greenspan’s proposal would reduce the OCC’s role.

Financial-services reform is too important to be held hostage to bureaucratic egos.

‘‘We are more than willing to sit down and find a way to increase [Treasury’s] powers,’’ Greenspan told the House Banking Committee on Feb. 11. ‘‘And if it comes out

of the turf of the Federal Reserve, so be it.’’

Public Trust.—The real issues, the Fed chief maintains, are fair competition and

proper use of the federal safety net—deposit insurance and access to the Fed’s emergency funds. That backing gives banks lower cost of capital, which, Greenspan rightly asserts, should not be used to subsidize banks in securities, insurance, or other

fields. That safety net might also encourage banks to take bigger risks than their

rivals in, say, stock underwriting, because they know taxpayers stand behind their

losses.

In the end, Greenspan is likely to prevail. Rubin has already conceded that insurance underwriting belongs outside of banks. If the Fed chief gives Rubin a small

concession, they might strike a deal. What could Greenspan offer? Senate Banking

Committee Chairman Phil Gramm (R-Tex.) on Feb. 16 proposed one idea: Smaller

banks could underwrite securities and insurance through subsidiaries, while other

banks would operate through Fed-regulated holding companies.

Over the past four years, Rubin and Greenspan have taken Treasury-Fed cooperation to new heights. They should keep working together now—to make financial reform a reality.

[Business Week/March 1, 1999]

EDITORIALS

TIME FOR SOME NEW THINKING, MR. RUBIN

As U.S. Treasury Secretaries go, Robert E. Rubin has got to be one of the best.

His old-fashioned fiscal rectitude helped transform federal budget deficits ‘‘as far as

the eye could see’’ into surpluses that reach deep into the next century. Along the

way, he helped set the stage for the longest peacetime economic expansion in history. Rubin’s deep knowledge of markets, at a time when markets define so much

of our lives, makes him a bastion of confidence to the business community. And his

personal modesty is matched by a less-is-more approach to policy. Pick an issue,

from tax reform to bank reform, from restructuring the IRS to redesigning the international financial architecture, and he invariably chooses a minimalist approach.

Rubin’s caution often serves him, the United States, and the global economy, well.

But not always. Take international finance. In a little-noticed speech given to the

World Economic Forum in Davos, Switzerland, Rubin poured cold water over each

and every proposal to curb the volatility of global capital markets. Rubin cast a

skeptical eye on capital controls, early warning systems, pre-qualification for IMF

borrowing, curbing hedge funds, currency target zones, etc. The analysis was coldly

brilliant, but the accretion of ‘‘no’s’’ added up to a virtual veto of any attempt to

fix the global financial system—and was seen as such by Europeans, Asians, and

Americans in the audience.

Yet some changes are needed, especially in emerging markets that are not yet

ready for unfettered capital inflows. The nonconvertibility of the renminbi shielded

China from the Asian crisis, and there were capital controls in effect in the U.S.

and Europe for decades after World War II. Tax penalties on short-term capital

inflows, to take one example, have worked for Chile, and they might be good for

other small countries. As for hedge funds, why shouldn’t they be regulated like all

other financial institutions? It may be difficult, but it’s not impossible.

Rubin’s bias against bold changes also works against needed reform in banking.

Banks are moving quickly into securities and insurance. The Federal Reserve wants

banks to use holding companies to contain each separate business. Large banks already do so. The Treasury insists that banks should be allowed to operate securities

and insurance businesses within the traditional banking structure.

But Rubin’s Treasury is wrong. These new businesses are very different from traditional lending. Indeed, banking alone has proved to be risky enough for the government to have set up deposit insurance and a whole raft of safety measures that

are not applicable to securities and insurance. It makes sense to separate each business and not mix them. It makes for greater transparency and sounder regulation.

Rubin was scheduled to fly to Bonn, Germany on Feb. 20, for a meeting of the

Group of 7 industrial nations. Topic ‘‘A’’ is how to avoid future global financial crises. The Europeans and Japanese prefer heavily managing the markets. This is

111

hardly the optimal solution, but neither is doing nothing. The key to dealing with

a fast-changing world economy is knowing when to create new rules and institutions

to fit the new reality. That’s the challenge before the Treasury Secretary.

Mr. FOSSELLA. Mr. Chairman, could you just discuss the public

policy concerns raised by the operating subsidiary structure that

has been proposed by some Members of Congress, and how could

these concerns be addressed? And I will conclude my questions.

Mr. GREENSPAN. Well, the issue is fundamentally, as you know,

Congressman, the question of whether the new powers in financial

modernization are put into the affiliates of holding companies or

into subsidiaries of commercial banks. It is our judgment—and I

think the evidence very strongly supports it, and, indeed, we would

agree with the comments of the editorial you just read—is that

there is a quite significant subsidy that inures within the bank,

owing to, one, deposit insurance, access to the discount window at

the Federal Reserve, and having effectively guaranteed payments

from the Fed wire system. They are reflected in a lower cost of capital for bank issuances, debt of banks, than even the holding company of that bank, and especially, those who have to compete with

those banks, finance companies, securities companies, and the like,

who do not have access to the safety net and do not have the subsidy.

My general view, as I have stated on numerous occasions, is that

we at the Federal Reserve support all of the powers, that are embodied in the financial modernization bill. But we believe that they

should be financed in the marketplace. Which means that affiliates

of the holding company would have to finance at higher credit

costs, rather than be effectively using the sovereign credit of the

United States to help subsidize and finance these new powers. I

think it would be a mistake to do that.

Mr. OXLEY. The gentleman’s time has expired.

Mr. FOSSELLA. Thank you.

Mr. OXLEY. Mr. Chairman, again, thank you so much for your

wonderful testimony. We found it most helpful in our deliberations.

With that, the subcommittee stands at recess until 1:30.

[Brief recess.]

Mr. OXLEY. The subcommittee will come to order.

We are honored today to have the Treasury Deputy Secretary,

Lawrence H. Summers, testifying. I know that, Mr. Summers, you

have had a busy morning already in another committee. We appreciate his perseverance and patience in coming to the Finance and

Hazardous Materials Subcommittee to testify on a very timely

issue; that is, the issue of Social Security as it relates to investments in the stock market, which, of course, comes under the jurisdiction of this committee.

So, as I understand, this is your maiden appearance before the

Commerce Committee, Mr. Summers. We appreciate your willingness to appear, and we will turn it over to you.

STATEMENT OF LAWRENCE H. SUMMERS, DEPUTY

SECRETARY, U.S. DEPARTMENT OF TREASURY

Mr. SUMMERS. Thank you very much, Mr. Chairman, Mr. Ranking Members Towns, members of the committee. I appreciate the

opportunity to appear today to discuss President Clinton’s proposVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00114 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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als to ensure the financial well-being of Social Security. I have a

long statement which I will submit for the record.

Mr. OXLEY. That will be made a part of the record, without objection.

Mr. SUMMERS. If I might just briefly summarize just a few comments, Mr. Chairman.

The basis of the President’s approach is this: We have a remarkable opportunity in this country with $4.8 trillion in budget surplus

projected over the next 15 years. We have a large challenge in this

country with an aging population. The President’s approach marries the two by contributing the lion’s share of the projected surpluses to the Social Security Trust Funds to meet the Social Security challenge.

This proposal has important economic benefits, as Chairman

Greenspan stressed in his testimony before you this morning. By

preserving the unified surplus, and reducing the national debt, it

increases America’s national savings rate and increases the supply

of capital that can flow into new plant and equipment for American

workers and new homes for American families.

It also makes important room in the Federal budget. On the current projections, which are, of course, uncertain, the President’s

proposals, if enacted, will substantially eliminate the national debt

by the middle of the 2010-to-2020 decade. That will result in interest savings of hundreds of billions of dollars, nearly 2.5 percent of

GDP, enough to finance the increment to Social Security benefits

that will occur as a consequence of the aging population. By contributing the proceeds of deficit reduction to the trust fund, we ensure that those savings will be put to that crucial use.

The President’s proposal also contains a proposal for USA accounts that would strengthen the non-Social Security pillars of our

national retirement security system by making universal savings

accounts, a kind of pension coverage, universally available, and

available, in particular, to the 73 million Americans who have neither IRA’s nor 401(k)s nor private pension arrangements.

The focus of this hearing, as I understand it, Mr. Chairman, is

on a different aspect of the President’s proposal, and that is the

President’s call for use of a portion of the Social Security Trust

Funds for equity investments. This in line with best practice in the

management of defined-benefit pension plans in both the public

and the private sector, where in almost all cases a substantial

amount—in many cases in excess of 40 percent—of pension funds

are invested in equities, so as to realize the extra returns that equities have proven to run over the longer term. The President’s proposal calls for a conservative 15 percent of the Social Security

Trust Fund to be allocated to equity investments.

Just as private and public sector managers of defined-benefit

pension plans choose equity investments as a way of making those

pension plans operate more efficiently, so, too, Social Security equity investments can have important benefits. Even the limited equity investments contemplated by the President’s proposal would

obviate the need for what would otherwise be a 5 percent acrossthe-board benefit cut in 2030, or an increase in the retirement age

of 18 months for participants who reach age 67 in 2022. Equity inVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00115 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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vestments would have comparable long-term actuarial benefits to

those rather radical steps.

Now equity investment raises a number of questions. One is with

respect to risk. Of course, the risks of government equity investment will be felt much less by any individual than would be the

case in the context of an individual account. So the government

would guarantee a defined benefit and would have the capacity to

smooth equity returns over very long periods of time.

We have carefully considered the risks, and risks at the level of

the equity investment contained in the President’s program are, in

our judgment, manageable. In the outyears, approximately 70 percent of benefits will come from, will be paid out of, the continuing

stream of payroll tax revenues. Even in 2032, the remaining 28

percent will be paid out using assets of the trust fund. Of that 28

percent, only 15 percent would depend at all on equities—making

the system very safe.

A second concern that has been raised, and a very serious concern, in our view, is the concern about the integrity of Social Security investments. Here we recognize the seriousness of this issue

and envision an approach with a number of protections. First, the

investments would be limited. Second, the investment would be

managed by an independent Senate-confirmed board. Third, the

board would not do the investment itself, but would, instead, only

be free to select private sector managers. Four, those private sector

managers would be charged not with discretionary investment either with respect to timing or particular securities, but only—

only—with respect to investing in broad-gauge indices.

We believe these four protections taken together would provide

adequate protection for the assurance of the integrity of the investment process and the permit the 50 percent of Americans who don’t

own stock, and depend almost entirely on Social Security for their

retirement benefits, to realize the same kinds of benefits of equity

investments that the upper half of the population has realized for

a long time.

Now there has been a great deal of discussion, Mr. Chairman, of

the State and local experience in this regard. There are different

readings of that experience. I would highlight just two points.

One is that the best available evidence appears to us to suggest

that, while some time ago there was a lag in the returns on State

and local pension funds relative to stock market indices, it appears

that in recent years, over the last decade or so, any differences

have been negligible, and that the main reason why that lag has

been made up is that State and local government pension funds

have increased equity investments, to the point where their equity

investment rate is roughly comparable to that of the private sector.

Previously, it had lagged, and that had been a large part of the

reason why their total return had lagged.

But I think there is a second crucial point, and that is that the

practices under which Social Security would be managed differ

from those that have been in some cases used in the State and

local sector. In particular, many State and local statutes actually

prescribe various kinds of social investing, whereas, the statute we

contemplate would proscribe that kind of investing. Unlike the case

in the State and local sector, we would constitute a legally binding

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obligation to invest only in whole market indices, and not to engage

in discretionary stock picking, which would have the prospect in a

Social Security context of various kinds of mischief.

Again, if investments take place in the whole of market indices,

there is really no scope to either underperform the market or outperform the market. Capital would be allocated in a way that is

very consistent with the way that market forces are now allocating

capital.

Let me conclude by addressing a subject that is of obvious relevance, given the ongoing debates. That is the relative merits of

the collective approach that is embodied in the President’s budget

versus the individualized investment approach that has received a

great deal of discussion. We believe that there is a role for individualized investment. That is why the President has put forth the

universal savings account as a way of strengthening our Nation’s

pension and private savings system. But in a Social Security context, we believe that the collective investments approach is best for

three separate reasons:

First, it minimizes risk to individuals. In 1974, for example, over

one 12-month period, the stock market fell by more than 50 percent, and individual accounts at that point for someone retiring

would have led to a very unpleasant surprise about retirement benefits. The Social Security System, operated like a defined-benefit

pension plan, would have the opportunity to smooth those kinds of

fluctuations out over many years without disruptions to individual

benefit levels.

Second, a collective investment approach economizes on administrative costs. One of the great things about Social Security as an

insurance program is that 99 cents out of every dollar of taxes or

contributions that are made are paid out in benefits. Best available

evidence, looking at the British experience, looking at the Chilean

experience, looking at private experience with mutual funds, suggests that administrative costs of 100 basis points would reduce by

20 percent the total account accumulations at the end of a 40-year

period, if one pursued an individual investment approach.

Third, the collective investment approach preserves the basic

progressivity and integrity of the Social Security Program, which is

much more than a private pension system. It is a system of income

support. It is a system for meeting survivors’ needs, for meeting

the needs of disability. So, in that way as well, it seems to us to

be a preference approach.

So, for these three reasons—administrative costs, progressivity,

minimization of individual risk—we believe that the collective investment approach with adequate safeguards is the best way forward.

I might just note that, if one is concerned about the integrity of

investments—and I think one should be, although those concerns

can be managed—that concern is in no way unique to proposals for

collective investments, because any system of federally administered individual accounts would run into the same issue of a generalized mandate that the Federal individual accounts couldn’t invest

in stocks of a certain kind or needed to target a certain portion of

their investment to a particular use. So that is a problem we are

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going to have to address, and address in a way that makes us all

feel comfortable, no matter what type of approach that we pursue.

Finally, I might just note that the Markey-Bartlett bill, which

has been recently introduced, seems to us to be a positive step forward in the debate, embodying as it is does the notion of an independent board, private sector managers, and indexing for investment choices. This is a very complicated subject, but it is at least

as important as it is complicated. Speaking for all my colleagues

in the administration, I know we recognize that our prospects of

finding a solution can be realized in only one way: by working in

a very cooperative way, both on a bipartisan and bicameral basis,

involving all of those concerns, to chart the best course. That is

what we are determined to try to do, working with you, Mr. Towns,

members of this committee, and members of other committees in

the Congress.

Thank you very much.

[The prepared statement of Lawrence H. Summers follows:]

PREPARED STATEMENT OF LAWRENCE H. SUMMERS, DEPUTY SECRETARY,

DEPARTMENT OF THE TREASURY

Mr. Chairman, Mr. Ranking Member, and Members of the Committee, I appreciate the opportunity to appear today to discuss President Clinton’s proposal to ensure the financial well-being of the Social Security and Medicare programs and improve the retirement security of all Americans.

The advent of an era of surpluses rather than deficits has radically transformed

our national debate about entitlements. The terms of all of the earlier tradeoffs in

the entitlements debate have been eased—provided we seize the opportunities now

available to us. The President’s framework for Social Security both recognizes the

brighter present reality, and moves us well along the road toward seizing the opportunities currently available, if we can work together on a bipartisan basis.

Today I will first briefly describe the President’s program. I will then devote the

bulk of my remarks to the issue of the President’s proposal to raise the rate of return earned by the Social Security trust funds by investing part of the surplus in

equities.

The President’s Proposal

According to the Office of Management and Budget, the surpluses in the unified

budget of the federal government will total more than $4.8 trillion over the next 15

years. This presents us with a tremendous opportunity. At the same time, we are

also facing a tremendous challenge: the aging of the ‘‘babyboomers’’ is projected to

put enormous strains on the Social Security and Medicare systems, on which so

many retirees depend.

The natural approach would be to take advantage of this opportunity to meet the

challenges facing us. This is the objective of the President’s plan.

The President’s framework devotes 62 percent of these projected budget surpluses

to the Social Security system. Of the roughly $2.8 trillion in surpluses that will go

to Social Security, about four-fifths will be used to purchase Treasury securities, the

same securities that the Social Security system has invested in since its inception.

The remaining one-fifth will be invested in an index of private-sector equities. These

two actions will reduce the 75-year actuarial gap from its current level of 2.19 percent of payroll by about two-thirds, to 0.75 percent of payroll. And they push back

the date at which the Social Security trust funds are projected to be exhausted, from

2032 to 2055.

Substantial as that accomplishment would be, it is critical that we do more. Historically, the traditional standard for long-term solvency of the Social Security system has been the 75-year actuarial balance. A 75-year horizon makes sense because

it is long enough to ensure that virtually everyone currently participating in the system can expect to receive full payment of current-law benefits. Attaining this objective will require additional tough choices. But the objective is both important and

obtainable. To reach it, the President has called for a bipartisan process. We believe

that the best way to achieve this type of common objective is to work together,

eliminating the need for either side to ‘‘go first.’’

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In the context of that process, we should also find room to eliminate the earnings

test, which is widely misunderstood, difficult to administer, and perceived by many

older citizens as providing a significant disincentive to work. In addition, it is critical that we not lose sight of the important role that Social Security plays as an

insurance program for widows and children, and for the disabled. As President Clinton said last month: ‘‘We also have to plan for a future in which we recognize our

shared responsibility to care for one another and to give each other the chance to

do well, or as well as possible when accidents occur, when diseases develop, and

when the unforeseen occurs.’’ That is why the President has proposed that the eventual bipartisan agreement for saving Social Security should also take steps to reduce

poverty among elderly women, particularly widows, who are more than one and onehalf times as likely as all other retirement age beneficiaries to fall below the poverty

line.

In addition to shoring up Social Security, the President’s plan would transfer an

additional 15 percent of the surpluses to Medicare, extending the life of that trust

funds to 2020. A bipartisan process will also be required to consider structural reforms in this program. The Medicare Commission is expected to report soon on these

important issues.

The President would also use 12 percent of the surpluses to create retirement savings accounts—Universal Savings Accounts or USA accounts—and the remaining 11

percent for defense, education, and other critical investments. The President will be

announcing further details regarding the USAs soon.

At the same time, the President proposes to strengthen employer-sponsored retirement plans in a variety of ways. The President’s budget addresses the low rate

of pension coverage among the 40 million Americans who work for employers with

fewer than 100 employees by proposing a tax credit for start-up administrative and

educational costs of establishing a retirement plan and proposing a new simplified

defined benefit-type plan for small businesses. Workers who change jobs would benefit from the budget proposals to improve vesting and to facilitate portability of pensions. In addition, the retirement security of surviving spouses would be enhanced

by the President’s proposal to give pension participants the right to elect a form of

annuity that provides a larger continuing benefit to a surviving spouse and to improve the disclosure of spousal rights under the pension law.

Benefits of the President’s Approach

In essence, the President is proposing that we use the Social Security and Medicare trust funds to lock away about three-quarters of the surpluses for debt reduction and equity purchase, and ensure that they are not used for other purposes. This

would have three key effects:

• First, it would greatly strengthen the financial position of the government. If we

follow this plan, by 2014, we will have the lowest debt-to-GDP ratio since 1917

and will free up a tremendous amount of fiscal capacity. The reduction in publicly held debt will reduce net interest outlays from about 13 cents per dollar

of outlays in FY99 to about 2 cents per dollar of outlays in 2014. Under the

President’s program, the decline in interest expense resulting from debt reduction will exceed the increase in Social Security expense through the middle of

the next century.

• Second, it would strengthen significantly the financial condition of the Social Security and Medicare trust funds. Indeed, it would extend the life of the Social

Security trust funds by more than 20 years, to 2055, and extend the life of the

Medicare Hospital Insurance trust funds to 2020. Meeting our obligation to the

next generation of seniors should be the number one priority in allocating the

surpluses.

• And third, it would substantially increase national saving, which must be a priority in advance of the coming demographic shift. By paying down debt held by

the public and investing in equities, the President’s program will create room

for about $3.5 trillion more investment in productive capital. In effect, this will

be the reverse of the ‘‘crowding out’’ that occurred during the era of big deficits.

With government taking a smaller share of total credit in the economy, interest

rates will be lower than otherwise would be the case. The implications of lower

interest rates will be profound. Not only will individuals be able to borrow for

mortgages, school loans, and other purposes at lower rates, but importantly,

businesses will be able to finance investments in productive plant and equipment at the lower rates. And the resulting larger private capital stock is the

key to increasing productivity, incomes, and standards of living. Ultimately, one

reason why this program is sound economically is that it will result in a more

robust private economy, which will expand our capacity to make good on our

Social Security and Medicare promises. This increase in public saving also has

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beneficial implications for our balance of payments side. Reduced government

borrowing would lead to a reduced dependence on foreign financing, and an improvement in our status as a net debtor to the rest of the world.

Benefits of USA Accounts

Social Security, strengthening employer-sponsored retirement plans, and creating

USA accounts are key pillars of the President’s proposal to provide financial security

to retirees. We believe that USA accounts will provide a significant stimulus to private savings, by enabling millions of Americans to begin to set aside some money

for retirement.

The President’s proposal aims to deal more broadly with the challenges of an

aging society by expanding individual access to retirement saving. As I noted earlier, the President proposes to devote 12 percent of the surpluses to establishing a

new system of Universal Savings Accounts. These accounts would provide a tax

credit to millions of American workers to help them save for their retirement. Workers would qualify for a progressive tax credit match against their own contributions.

For example, a low-income worker may receive a dollar for dollar match up to a cap.

In addition, low- and moderate-income workers will qualify for an additional tax

credit, even if they make no contribution themselves.

Overall, the USA program would be considerably more progressive than the current tax subsidies for retirement savings—where higher bracket taxpayers get higher subsidies. This proposal would contribute significantly to national savings, because it will produce retirement savings for millions of low- and moderate-income

people who do not have access to pensions. The tax credit match will provide a

strong incentive for workers to add their own saving to accounts.

Investing Part of the Surplus in Equities Would Raise the Rate of Return Earned

by the Social Security Trust Funds

As I have mentioned, the President has proposed transferring 62 percent of projected surpluses to Social Security, and investing a portion of these transferred surpluses in equities.

To date, the trust funds have been invested exclusively in U.S. Government

bonds. While these bonds are essentially risk-free, they have the corresponding

downside that they have historically paid a lower rate of return, on average, than

other potential investments. Between 1959 and 1996, the average annual rate of return earned on stocks was 3.84% higher than the rate earned on bonds held by the

trust funds.

Currently, the pension savings of many upper income Americans are invested in

private plans that earn these higher equity returns. The higher equity returns can

potentially make it possible for these Americans to have more upon retirement. We

believe that it is important to give all Americans, even those of low and modest

means, the opportunity to enjoy these potential benefits from stock market performance.

Raising the rate of return on the trust funds would mean that the Social Security

system could be brought into long-term actuarial balance with smaller reductions

in benefits, smaller increases in revenue, and/or less transfer of surplus. The President’s plan for investing in equities will reduce the actuarial gap by an estimated

0.46 percent of taxable payroll—and thus will close roughly one-fifth of the problem

we face over the next 75 years. If one were to try to achieve the same actuarial impact of equity investments through alternative measures, we would have to immediately reduce the COLA on Social Security benefits by 0.3 percentage points. The

equity investment in the President’s package achieves as much for the financial

soundness of the system as would moving the normal retirement age up by about

an extra year and one-half for participants who reach age 67 in 2022. If we delayed

until 2030 to make the changes necessary to set Social Security back on a sound

actuarial footing, the required across-the-board cut in benefits would be 5%.

Investing part of the trust funds in equities would also bring Social Security into

line with the ‘‘best practice’’ of both private and public sector pension plans. Among

large private-sector defined benefit plans (those with more than 100 participants),

more than 40% of total assets were invested in equities in 1993; this number has

risen significantly since then. Nearly all state pension plans also now invest in equities. In 1997, state and local government plans invested 64% of their portfolios in

equities.

I want to take a moment to applaud the efforts and leadership of Congressman

Markey, Congressman Bartlett and Congressman Pomeroy, who have introduced a

bill authorizing the investment of a portion of the trust funds in equities. We welcome their commitment to ensuring that trust fund investments are insulated from

political pressures.

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Would Equity Investments Add Risk to the Trust Funds?

I see two broad concerns regarding trust fund investment in equities. These concerns are legitimate, but we believe they are manageable, and should not stop us

from achieving the potential enhanced returns of equities.

First, stock returns are more volatile than the returns on the government bonds

held by the trust funds. However, the trust funds are well-situated to bear equity

risk, because they have long—or indefinite—time horizons. The trust funds would

be capable of riding out the ups and downs of the market, because they receive the

cash flow from payroll taxes, and because of the cushion provided by the trust funds’

bond holdings.

More specifically, investing only 15 percent in equities seems to us to be a prudent balance between receiving the potentially greater return from equities and

keeping the investment small enough so that the trust funds are not overly exposed.

This 15 percent allocation to equities is much smaller than the customary allocation

to equities in either public or private pension plans. Moreover, 85% of the trust

funds will still be invested as before in risk-free Treasury securities.

In addition, the equity investments and disinvestments that we are proposing will

be smoothed in incremental additions over 15 years. In any year, investments or

disinvestments are projected to be less than 0.5% of the stock market. Incremental

investments and disinvestments—rather than total divestiture at one time—will

help to mitigate the risk from adverse price movements.

Finally, in the near term, all benefits will continue to be paid out of payroll and

other taxes. Furthermore, under current law, even in 2032 payroll and other taxes

will be sufficient to pay for the lion’s share—about 72%—of Social Security benefits.

The remaining 28% of benefits will be paid out using the assets of the trust funds.

As only 15% of the trust funds’ assets would be invested in equities, only about one

sixth of this 28% would be backed by equities. In short, even in 2032, only about

4-5% of payments from the trust funds will be backed by private sector investments.

Ensuring the Integrity of Investment Decisions

The second concern is that of political influence on trust fund investment decisions. Any system of collective investment can and must address these concerns. We

believe that we can successfully work with Congress to design a system that is free

from political influence. We need to strike the right balance, so that we can earn

the higher potential returns to equities, by finding a way to take care of these legitimate concerns.

That is why we will work with Congress to design a system that observes five core

principles. These five core principles will establish several levels of protection.

First, the share of trust fund assets invested in equities ought to be kept at a very

limited level. We have proposed that equity investment be limited to 15 percent of

trust fund balances. This will be important to limit the trust funds’ exposure to

price movements from equity investments, and to ensure that collective investments

never account for more than a small fraction of the stock market. During the first

years of the program, from 2001 to 2014, Social Security would own, on average,

only 2% of the stock market. On average through 2030, Social Security would own

approximately a 4% share of the total stock market.

Second, the investments should be independently managed and non-political. We

suggest that trust fund managers be drawn from the private sector through competitive bidding and that the trust fund managers be overseen by an independent

board. There should be wholly independent oversight of investment, in order to

shield the trust funds from political influence.

Third, the sole responsibility of the independent board would be to select private

sector managers through competitive bidding. Private sector management will provide a further degree of political insulation. Moreover, Social Security beneficiaries

deserve the same efficient management and market returns that people receive for

their private pensions and personal savings.

Fourth, equity investments should be broad-based, neutral and non-discretionary.

Assets should be invested proportionately in the broadest array of publicly listed equities, with no room for discretion in adding or deleting companies and no room for

active involvement in corporate decisions. We have proposed that the funds be invested in a total market index, which would encompass a broad range of stocks. In

addition, the managers should be on autopilot in investing the funds; they should

have little or no discretion in the investment of trust fund assets, so they cannot

‘‘time the market’’ or pick individual stocks.

As a shareholder the trust funds should be entirely passive. One way to accomplish this might be to mandate that proxies be voted in the same proportions as

other shareholders.

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Fifth and finally, collective investment needs to be achieved at the lowest cost

available. This will be important both to obtain the highest possible returns and to

further enhance the system’s transparency and independence. Indexed investment

is less expensive than active management. In addition, given the large size of the

potential equity investments by Social Security, we would expect to pay very low

asset management fees.

Let me emphasize our belief that there should be zero government involvement

in the investment. We will work with Congress to design a system that is completely

insulated from political pressures.

The Experience of State and Local Governments

As I mentioned earlier, virtually all state pension funds now invest in equities.

In 1997, state and local government plans invested 64% of their portfolios in equities, up from 56% in 1996. State and local pension plans now hold fully 10 percent

of the overall stock market. By contrast, the Social Security trust fund equity investments would total only 15% of the trust funds, and would represent, on average,

about a 4% of the equity market.

Some have suggested that the trust funds might fall short of earning market returns, based on the experience of state and local pension plans. I would emphasize

first that the experience of state plans is really not directly comparable to what we

are proposing for Social Security. State plans do not generally operate under the

kinds of restrictions that are envisioned under the President’s proposal. That is, the

statutes governing state plans do not generally require that investments be made

only through indexed funds, with a clear prohibition against adding or subtracting

equities from the index. Many state pension plans are actively managed, and some

have explicit investment goals. As a result, the experience of these plans may not

be relevant as a guide for what Social Security’s experience would be.

Our preliminary analysis of the available data suggests that, over the period

1990-1995, public plans actually received returns that averaged two basis points

higher than private plan returns (this difference is statistically indistinguishable

from zero). Although in earlier periods (from 1968 to 1983) the performance of public pension funds was slightly inferior to that of private pension funds, this difference is also not statistically significant. More importantly, this very slight difference in performance during earlier periods can be explained by the fact that public pension funds generally allocated a far smaller portion of their portfolios to equities, and in some cases were statutorily prohibited from buying any equities.

The returns to trust fund investments to this date would not stack up well in this

comparison of earnings of public and private pension funds. Because the trust funds

have been invested exclusively in government securities until now, both public and

private pension funds would likely have outperformed the rate of return earned on

trust fund investments.

Advantages of Collective Investment of Social Security

There are three key advantages to having the trust funds invest collectively in

equities for the American people. These advantages relate to the ability of defined

benefit plans to bear market risk, minimize administrative costs, and achieve progressivity. Defined contribution plans, such as the proposals for individual accounts,

are less able to realize these objectives. In addition, the potential political risk from

collective investment in equities through the trust funds is not very different from

the political risk that could arise from investing in equities through defined contribution plans.

An advantage of collective investment in equities through the trust funds is that

periods of poor equity performance could be spread over many generations of current and future Social Security participants. By contrast, during a market downturn, participants in a defined contribution system could be forced to choose between postponing retirement and a severely reduced retirement income. For example, for the year that ended with the third quarter of 1974, the S&P500 declined

by 54 percent in real terms. By placing the risk of a market downturn in the trust

funds, we can greatly reduce this risk to beneficiaries. Additionally, we have proposed limiting Social Security’s equity holdings to 15% of the trust funds. As I noted

earlier, this means that only 4% of benefits payments would be backed by the performance of equities.

The second advantage of collective investment in equities is that the returns to

trust fund investments in equities would likely be higher than the returns to equities held in individual accounts. This is primarily because it would be much more

costly to administer a defined contribution plan than it would be to administer a

defined benefit plan. The trust funds would expect to pay very low asset management fees, because of the large size of the trust fund asset pool. These asset manVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00122 Fmt 6601 Sfmt 6621 X:\HSECOM\55156.TXT txed01 PsN: txed01
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agement fees could be comparable to, or lower, than the 1 basis point (0.01%) currently paid by the federal employees’ TSP plan for private management of the equity-indexed ‘‘C Fund.’’

By contrast, administrative costs for a system of defined contribution plans held

in the private sector could be comparable to the commissions and fees charged by

equity mutual funds today. The average equity mutual fund currently charges between 100 and 150 basis points for administrative and investment management

services. Costs of this magnitude could significantly reduce the balance that could

be accumulated in an individual account. According to our estimates, administrative

costs of 100 basis points would reduce by 20 percent the total account accumulations

at the end of a 40-year career. Collective investment through the trust funds would

avoid the need to pay the administrative costs associated with individual accounts.

The experience of individual accounts in Britain and Chile illustrates how significant these risks and costs can be. In Britain, many personal pension plans take

more than 5 percent of contributions in administrative charges.

Chile also has had high administrative costs. According to the Congressional

Budget Office (CBO), fees and commissions of the Chilean pension system amounted

to 23.6 percent of contributions in 1995. As a result, according to the CBO, Chilean

workers who invested their money in an individual account in 1981 received an internal real rate of return of 7.4 percent on that investment through 1995, despite

average real returns of 12.7 percent to pension fund investments. Even in the best

of circumstances, however, costs will be higher for a system of individual accounts

than for collectively investing trust fund assets.

The third advantage of collective investment is that it is progressive. This is one

of the most important features of Social Security: benefits are greater, as a percentage of wages, for low-income workers than high-income workers. By investing in equities, we are able to maintain this critical feature of progressivity and avail Americans of modest means of the higher returns that have historically accrued to equities.

In addition to these key advantages, one might note that, with regard to the concern about political influence, this concern also exists for individual accounts. Most

individual account proposals have suggested some centralized plan structure, both

in order to reduce administrative costs and to help familiarize tens of millions of

Americans with the range of possible investment vehicles. These individual account

plans would create a large pool of money under a single manager, or a handful of

managers. This pool of money would not look very different from the Social Security

trust funds. With any centralized pool of assets there is the potential for those pursuing a political agenda to try to influence it.

We can all be encouraged by the history of the Thrift Savings Plan (TSP), whose

investments have not been subject to political influence. We believe that some of the

features that have protected the TSP system so well are worth emulating. These include the TSP system’s independent board, its private sector managers, and the rule

that equity investments can only be made by tracking an index.

Conclusion

In conclusion, it will be critical to have the Administration and Congress work together to address the needs of future generations. We need to keep the promises

that we have made to retirees, without unduly burdening younger generations. We

want to work with you, on a bipartisan basis, to implement the President’s program.

I believe that we can find a safe and prudent way to participate in the enhanced

returns in equity markets.

Thank you. I would welcome any questions.

Mr. OXLEY. Thank you, Mr. Summers.

It appears that inherent in the administration’s proposal on Social Security was the realization that any increase in the FICA tax

or reduction in benefits essentially is not only unpalatable, but

probably unpassable in the Congress, which leaves us with the

third option, which would be maximizing return on investment. Is

that a fair statement?

Mr. SUMMERS. I find economic prognostication difficult enough

without attempting political prognostication, Mr. Chairman. But,

certainly, I think it is appropriate for us all, before looking at those

painful steps, to go the distance that we can go with the apVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00123 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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proaches of better investment management and making use of the

budget surpluses that have been very hard won.

Mr. OXLEY. The original intent of Social Security, if I recall my

study in high school and college, was essentially to be a supplement to one’s retirement. Has the Social Security System over the

years come to be much more than a supplement to one’s retirement? If so, should we continue that concept or should we take a

look outside the box, if you will, to try to restructure the future of

people’s retirement and give them more ability to participate in

that important endeavor?

Mr. SUMMERS. It is the trite metaphor that I think has been used

for awhile in talking about our national retirement. Security system is a three-legged stool. Social Security is one leg, private pension is the second leg, and private savings is the third leg. And,

frankly the strength of those legs differs very much across individuals. On an aggregate basis for the age and population, all three

of those legs play an extremely important role for millions of people. I don’t remember the precise fraction—I’ll send it to you in

writing—though the social security accounts for the lion share of

the resources that they have available in retirement.

I draw from that, Mr. Chairman, two conclusions. One is that we

have to work to strengthen the other leg. That is why the administration put forward the USA’s proposal along with a variety of

other proposals to strengthen the private pension and 401(k) system. That is the first conclusion.

The second conclusion is that, because for the foreseeable future

something like half the elderly population would be in poverty

without social security, we have to make sure that we recognize

that we are working on a highway over which a lot of traffic is

flowing, and make sure that any reforms we make in social security preserve the basic protections that it provides, because there

are a large number of people for whom that is what will be there

during the retirement period.

Mr. OXLEY. You cited the 1 year when the market went down

substantially to some 50 percent. And yet we have had testimony

before this committee from experts who say that over the long

term—which is really what we are talking about in terms of retirement in 25, 30 years in a system—investment and equity actually

has provided the most return, about 7 percent, even including back

to 1929 through the present. If that is the case, then, indeed, we

should not be concerned about the ups and downs of the market.

Why would we not give people, empower people essentially, to set

up these kinds of accounts to not only take the pressure off of the

Social Security System, but, even more so, create more capitalists

in our country and allow them to see the magic of compound interest and those kinds of return.

Mr. SUMMERS. Here is the issue, Mr. Chairman: I share your

judgment and that of the experts who have testified before you.

This is actually a subject I used to work on when I was a professor

in the economics area. Over the long run the stock market returns

tend to be the best available asset. That we want to give an opportunity to realize the benefits of stock market investments, I share

that judgment completely.

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The question before us is which of two ways to do that. One approach is the defined-benefit approach, where there is a commitment to provide a defined stream of benefits that is calculated on

the basis of average stock market returns, which is funded by the

government, recognizing that there will be periods, there will be

bear market periods and bull market periods, and as a consequence

the size of the trust fund will sometimes rise and the size of the

trust fund will sometimes fall, and on average it will work out to

provide people with those returns, but you guarantee them a fixed

return and they do not experience the risks associated with the

stock market. They get their assured benefits. That is the approach

that I believe is the sounder approach to social security.

The alternative approach is to say to an individual—in part I

suppose it is a political judgment, but it is beyond a political judgment—for an individual, for example, who retired in a year—I cite

as an example in 1974—and who had been contributing over their

working life since 1935, when what looked like a $1,000 a month

benefit when they were 64 turned into a $450-a-month benefit

when they turned 65, because that was the year they retired, you

could explain to them that it was really okay because over the 40

years since 1935 they had actually done much better than they

would have if they had been investing in bonds. But I have feeling

that you are going to have some very unhappy people who would

have preferred to have been insulated from the risk of that kind

of dramatic market movement in the period just before their retirement.

That is why many pension funds in the private sector are on a

defined-benefit basis, and I think there is an enormous advantage

to that. I think you also have a large number of individuals who

are likely to be relatively unsophisticated about markets and who

may well be better off. And this is the approach that many employers follow in providing defined-benefit pension plans who are better

off realizing the benefits of investments and markets, but not in

the way where they are in the position of making their own

choices.

Now I am very much aware of people’s sense of the difficulty of

government doing things effectively, and we would not support an

approach in which public investment would take place with substantial discretion. But we believe an auto-pilot approach can be

crafted in which the Social Security Trust Fund benefits from the

tendency of equities to outperform bonds without getting involved

in making discretionary choices. And we think that is what takes

advantage of the long-term benefits but does not place, what seems

to us, to be unnecessary risks on individuals in their Social Security part of the system.

Mr. OXLEY. The Chairman of the Fed would respectively disagree

with that position. I think he testified this morning that he had

some grave concerns about that context. I am sure we are well

aware of his position and I thought he articulated those quite well.

One of the things I asked Chairman Greenspan this morning was

about the Thrift Savings Plan as part of the Federal Employees Retirement System. That is, essentially they now have, or employees

have, a choice of three investments from high-risk securities: Put

it in a bond index fund, both based on index funds, and then the

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government’s obligation, which are the safest return, but obviously

the lowest return, at least historically since 1984. And when I discuss that with my constituents, many of them, particularly the

baby-boomers and the younger generations, say, ‘‘Well, we ought to

have an opportunity to do that. We do not think that there is going

to be Social Security there for us, and even if it is, projections are

that the returns are going to be less than 2 percent. We think that

we could do better if we just went into the safest investment.’’

What would you tell those folks that think that the Feds have a

pretty good system?

Mr. SUMMERS. I would tell them three things. I would tell them:

First, the Federal workers are also included in Social Security and

that the Thrift Savings Plan is a separate and additional system.

Mr. OXLEY. Another leg of the stool.

Mr. SUMMERS. Another leg of the stool for Federal workers, just

like pensions are an additional leg for private workers. That is a

leg that we need to build on and that is why they should support

the administration’s USA proposal—is the first thing I would say

to them.

The second thing I think I would suggest to them, Mr. Chairman,

is that while as tempting as it was, that to focus on the 2 percent

return for Social Security was really quite, with respect, a misleading statistic. And the reason is just this: Ninety percent of the

Social Security taxes that you and I pay this year are going to go

for the retirement benefits of our parents, of my parents’ generation. They are not there for us. They are going to meet the obligation that the country entered into 25 years ago. We have got to

meet that obligation anyway. So we have no option of sort of making Social Security go away and letting everybody into some Federal Thrift Savings Plan.

The reason why Social Security shows up as having a low return

is that we have a large obligation to the current age generation

which has not been funded in the past. That is the reason why Social Security shows up as having a low return, and no new system

can make that obligation go away. The only choices we can make

are, given that we are going to make that obligation, how are we

going to provide for retirement benefits in the future? And every

bit of return advantage that is potentially available by having people invest in individual accounts is also available through collective

investments on behalf of all the people through the Social Security

Trust Fund—with the only differences being, on the one hand, the

administrative costs, the risk-sharing benefits that I have emphasized, versus, on the other hand, the set of considerations around

facilitation and benefits of individual choice that people who favor

a more individualistic approach favor.

But the argument about the low return from Social Security is,

with respect, I think, not a fair argument because it does not take

account of the obligation to pay for my parents’ generation’s Social

Security benefits.

Mr. OXLEY. Well, in fact, our parents’ generation did pretty well

in their Social Security, did they not? I mean, for them Social Security was a pretty good deal.

Mr. SUMMERS. It has been a very good deal; it has, indeed, been

a very good deal. And it is in the nature of the pay-as-you-go Social

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Security System that, for those who are there at the beginning, the

return is going to be best. While Social Security does, I think, rest

on a quite firm foundation, there is a sense in which it is a little

bit like a chain. The deal is that I am going to give you a dollar

and then you are going to give the person next to you a dollar and

that chain is going to continue. The first person who gets a dollar

is obviously getting a very substantial advantage. And that is the

situation, in some sense, that our parents are in.

Mr. OXLEY. Well, as a matter of fact, some of the severest critics

of Social Security would say that is essentially what it is, a fancy

scheme that is based on some faulty assumptions, and that, particularly for those baby-boomers and beyond, they walk into that

at their peril. Some indications are that some people will never get

back the money they paid into the system. Obviously, that is why

we are trying to address this shortfall.

Mr. SUMMERS. But I think that points up the fact, Mr. Chairman,

on which I think there is now universal agreement. That we need

to make, whereas in the past, social security has been a chain, the

people who were 40 in 1939 paid for the people who were 70, and

then the people who were 40 when they were 70 paid for them, and

then that process continued. I think there is now agreement, very

widely that we now need to have some system for the baby boom

generation of prefunding which the baby boom sets aside increased

savings in order to pay for its own social security benefits, rather

than putting that burden onto its children. I think what the debate

is really about is between two different approaches for putting resources aside.

One, which is the kind of approach that is embodied in the administration’s proposal, involves using the budget surpluses, enlarging the Social Security Trust Fund, investing it better and

more wisely to meet the obligations. The other involves simply

moving to a more privatized approach in which individuals take

their own responsibility for their future Social Security. Those are

two different approaches to making the very important change that

I think we all agree on as a country, which is to work toward

prefunding this obligation.

Mr. OXLEY. Let me ask one more question. I have far exceeded

my time.

If I understand the USA account, essentially, the government

would be providing seed money to people to set up that account. Is

that correct?

Mr. SUMMERS. Yes.

Mr. OXLEY. Instead of allowing them to take part of the money

they pay now into FICA and fence that and allow them to invest

that? So the difference between the USA accounts and ones that

are proposed by Chairman Kasich and others, including myself, is

the difference between getting people some money out of the surplus to start the account, from your perspective, and from ours it

would be to take part of the FICA tax and allow them to invest

that portion of the FICA tax they would not pay directly into FICA

to set up their own account.

Mr. SUMMERS. I think that is the essential difference. Our approach essentially builds on the Thrift Savings Plan idea by setting

up a separate system outside of and reinforcing the Social Security

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System on the principle of balancing those three pillars that we

talked about.

Mr. OXLEY. Would that also include, then, government matching,

like the thrift accounts?

Mr. SUMMERS. Yes. The administration has laid out the general

nature of the USA account proposal. We expect to come forward

with more details before long, but what I can say at this point is

that there would be seed money for people up to a certain income

threshold. For them and for people above that income threshold,

there would be matching tax credits. For example, for each dollar

you contribute into an USA account, you get a tax credit of 40

cents, or whatever it was. So that would also be, in a sense, like

the Federal Thrift Savings Plan. It would in some ways be like

these tax credits. It in some ways be similar to the deductions that

people get on IRAs. But they would be somewhat more generous

and I think much more effective and targeted, because of the seed

money, in reaching what are more than 70 million people who do

not benefit from any of our tax-favored savings vehicles right now.

Mr. OXLEY. Thank you. The gentleman from New York.

Mr. TOWNS. Thank you very much, Mr. Chairman.

Mr. Summers, this morning Chairman Greenspan testified as follows: He said, ‘‘I doubt that it is possible to secure and sustain institutional arrangements that will insulate, over the long run, the

trust fund from political pressure. These pressures, whether direct

or indirect, could result in suboptimal performance in our capital

market, diminish economic efficiency, and lower overall standards

of living than would be achieved otherwise.’’ Does the administration agree with that statement?

Mr. SUMMERS. No, it does not, although we have enormous respect for Chairman Greenspan, and I think the issues that Secretary Rubin and I have worked with him very, very closely over

the last few years, as we have all have. I think the issue he raises

is one that has to be considered very carefully. I would just make

two points in response.

The first is that the combination of limiting the size of the independent board, private sector management, and investment only in

across-the-board indices without discretion—those seem to us to

constitute a set of institutional arrangements that would provide

the kind of integrity that we are seeking and it would not be subject to the kind of attack that he describes.

The second point that I would make is that, if one looks at the

performance of the Social Security Trust Fund, and the return that

it earns on government bonds, and compares that with the return

that has been earned on pension funds in either the public or the

private sector—and, obviously in the public or private sector, some

have been invested better and some have been invested worse over

recent years. But almost none, even those where the equities investments have turned out not to have been so strategically selected, have, nonetheless, outperformed government bonds and

could be expected to outperform government bonds over the longer

term.

So I believe that a properly indexed set of investments would actually earn the same average market return that all the other investors earned in the economy with no significant impact on capital

126

allocation in the economy. But even in the event that that somehow

proves to be incorrect, and even in the event there ended up being

some changes in the allocation of capital, along the lines that we

perhaps have seen it in some points in the past in the State and

local sector, the performance of the fund would still be substantially stronger than the performance of the trust under current

practices of investing it wholly in bonds.

I might also say that, while we are obviously dealing with what

is a very important and large issue, we also have an enormously

large and liquid capital market in the United States. So I would

expect any tendency of this fund to go into one class of investments

to be offset by some reallocation on the part of private sector. So

I would not expect this proposal to have an important impact on

the allocation of capital or its efficiency in the economy. What I

think is significant is that it is just good funds management on behalf of what is the most important defined-benefit pension plan in

the country.

Mr. TOWNS. I do not know whether you had an opportunity to

look at the Markey bill or not, but would that be able to avoid the

kind of political pressure that some people are saying that might

happen? Would that actually prevent it?

Mr. SUMMERS. I have not had a chance to study in great detail

the bill developed by Congressman Markey and Congressman Bartlett. But my understanding is that it embodies what we have identified as the key protections; namely, a public sector board, private

sector managers, and wholesale indexing, and, in that sense, I

think represents a very constructive step forward.

There is a lot to discuss in this area about how best to do it, and

just to reemphasis a point that I made earlier, even if one were to

decide to go in a different route toward a more individualized investing approach, one would need to face exactly the same kinds

of questions. Because exactly the same kinds of questions would

arise when one shows the two or three funds and what rules govern the two or three funds that individuals should choose. So this

question that we are talking about is not a question that should

be a basis for distinguishing. It is a question we all have to work

through and we should work through it together. But it is not a

question that is an important question or a high order in distinguishing between a more collective and a more individual approach.

Mr. TOWNS. Thank you. Chairman Greenspan also expressed the

view that investing in the Social Security Trust Fund and equity

does little or nothing to improve the overall ability of the United

States economy to meet the retirement needs of the next century.

Could you be more specific about the benefits of the President’s

plan, given Chairman Greenspan’s concern?

Mr. SUMMERS. Sure. As I think, Congressman Towns, I think

Chairman Greenspan also recognized in his testimony, the components of the President’s proposal that involve preserving the surplus and contributing it to the trust fund offers a politically sustainable way of running the national debt down very substantially

and, therefore, increasing national savings. And that, as I think he

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tional savings, strengthen the economy, so that we can better meet

these retirement needs.

The argument for equity investments is not an argument that is

grounded in increasing national savings; that comes from another

important part of the plan. The argument for equity investments

is the argument for good and strong financial management. If you

were operating a pension fund for a group of employees and had

to choose between asking the employees to contribute more, cutting

the employees benefits, and investing the employees’ money better,

I think you would choose as the best course for the employees to

invest their money better. And that is the basic logic of the argument we are making. It is an important one and I think Chairman

Greenspan recognizes in his testimony, while he does have some

reservations about the overall approach, the likelihood that trust

fund investment equities would outperform trust investments and

bonds.

The calculations that we have done suggest that this is not

small. To get a similar contribution to actuarial balance to that

achieved by the President’s proposals, investments in equities, you

need to have either a 5 percent across-the-board benefit cut in 2030

or, alternatively, an increase in the retirement age of approximately 18 months for people who reach 67 in 2022. It seems to us

that in pure Social Security terms, not so much in national economic performance terms, but in pure Social Security terms, the

equity investments is the better way to go.

Mr. TOWNS. Final question, Mr. Chairman: He also testified that

increasing our national saving rate is essential to any Social Security reform. How does the President propose to increase the national savings rate?

Mr. SUMMERS. I am glad that you asked that. The President’s

proposal increases the national savings rate by preserving that surplus and increasing the public savings rate by preventing the dissipation of the surplus on new spending or other programs. The

President’s proposal would essentially save the country money, just

as there are two ways I can save. One way I can save is I can put

money in a bank account and another way I can save is I can pay

back the debt that I owe. In just the same way, the Country can

save by paying off its national debt. What the President’s proposal

would do is eliminate $3.5 trillion of debt on the American people,

$3.5 trillion of debt that they would otherwise have to pay taxes

or interest on, that they would otherwise have to pay taxes to

repay the principal on.

The President’s proposal, by using the surplus, would make that

debt no longer a burden on the American people over the next 15

to 20 years. That, in turn, would make possible those $3.5 trillion,

which now are American savings that is going into the sterile asset

of government paper, would instead be available to invest in new

plants and equipment, and would instead be available to invest in

new homes; and would have one other benefit, which is that in

order to maintain the strong level of investment we have in our

economy, we are borrowing very substantially from abroad and

that is why we have such a large current account deficit and we

have all of these trade dislocations. By eliminating the national

debt, we would increase American savings; reduce our dependence

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on foreign capital, and realize the benefit in terms of our trade situation by as well.

So Chairman Greenspan is right about the importance of increasing national savings. The President’s proposal on the government

side by eliminating the national debt and on a personal side

through USA accounts, we believe there is a great deal to increase

national savings.

Mr. TOWNS. All right, thank you very much.

Mr. OXLEY. The gentleman from Wisconsin, Mr. Barrett.

Mr. BARRETT. Thank you, Mr. Chairman.

Mr. Summers, I am going to ask you to comment on a couple of

the points that Mr. Greenspan made this morning. One of the first

points, one of the points he made in his testimony, and I am

quoting from his testimony here, ‘‘Any increase in returns realized

by Social Security must be offset by a reduction in returns earned

on private portfolio, which represent to a large extent funds held

for retirement. Investing Social Security assets and equities is then

largely a zero-sum game.’’ Do you agree with that or what is your

response to that statement?

Mr. SUMMERS. In a sense, I agree and, in a sense, Congressman,

I would not agree with Chairman Greenspan. It is always true—

and this is I think the sense in which he means that—that suppose

I make a wiser set of investments; I improve the way that I am

investing my money. I am buying a set of things that have higher

returns, and somebody is selling those things to me and somebody

is buying the lower-return things that I was holding before. So in

a sense you could say that that was a zero-sum game. I am better

off and they are earning a lower average return.

So whenever somebody improves their own investment performance, there is a sense in which a part of that is going to come at

others’ expense. My own feeling is that if you have to ask, if you

want to frame the question in that way, if you have to ask whether

Social Security should subsidize the rest of the economy by running

a much lower rate of return than is run by all the other private

pension plans, or whether Social Security should improve its own

return to bring it more in line with the way other pools of funds

are managed in this economy, I would argue that it is a very good

thing for the half of population that does not really have important

investments elsewhere, and relies on Social Security, for Social Security to improve its own investment performance.

But I think, in a different sense, I would also argue, Congressman, that at least to some extent Chairman Greenspan overstates

the case a little bit when he talks about the zero-sum aspect. Because as he recognizes it at a different point in his testimony, the

expansion of Social Security’s participation in the stock market

would be likely to be associated with the reduction in risk premium, risk premiums precisely because Social Security is able to

spread risks across all the individuals in the population and is able

to spread risks across very long periods of time. That greater

spreading of risk represents a kind of economic efficiency gain

which turns it into a positive-sum game.

And the last point that I would make is, it is just this: I think

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nomic performance. But I would hope that we would put first emphasis, as we look at Social Security, on making sure that it is consistent with a sound economy, but, above all, that it works for Social Security beneficiaries. And that is what I think is so important

about the approach that the President pursues and why pursuing

the opportunity for trust fund investments would be putting Social

Security recipients at a very great disadvantage, and forcing them

to accept rather painful alternatives to the risk acceptance gains

that come from equity investments.

It is a kind of convoluted way of saying it will be better for Social

Security recipients if they are invested in equities, and it will probably be a little bit better for the economy, better for Social Security

recipients, is good enough for us in the context of an overall economic plan that is conferring a major benefit on the economy by

eliminating the national debt.

Mr. BARRETT. Yes, I understand. The other point that he made

was that there was a self-policing mechanism in place in a definedcontribution plan. When I put money into a defined-contribution

plan, I am watching to see what kind of return I get, and if I am

getting a lousy return, I and millions of others will put pressure

on the plan to have a better return. In contrast, if I am in a defined-benefit plan, I do not care just as long as I get my check at

the end. That was essentially the point that he was making. How

do you respond to that?

Mr. SUMMERS. Congressman, I would respond this way: I am

glad that you asked that question because I think it is a very important one and it is the answer to the point that I was suggesting

about how you are going to have to manage this integrity of investment issue. It is an attempt to answer the point that I was making

about how you would have to manage the integrity of investment

issue either with a collective or individual approach, and I would

answer it in this way:

When you are talking about Social Security, you do not have one

individual policeman. You have 250 million policemen in this country, and everything we have seen in the political process—think

back to the discussions we had at the time of the debt limit issue;

think back to other moments—everything we have seen suggests

that if there was any hint that anyone, for any other purpose, was

messing with the Social Security Trust Fund, manipulating it, operating it to the disadvantage of its beneficiaries to serve some

other individual, the collective recourse and the political appeal of

responding to the sense of resentment and outrage that that generates is so strong that it seems to me that it is the overwhelming

popularity and salience of the Social Security Program that would

provide a far larger resonance to concerns about manipulation of

investments than would be the case in an individual.

If you ask individuals who have these kinds of individual accounts without quite elaborate education programs, in lower-wage

individuals, in the context of corporations, frankly, there is a lot of

confusion about what is going on, a lot of reluctance to notice, and

I suspect rather little ability to organize and express concern.

On the other hand, the number of people who are watching every

move that the Social Security actuaries make, every move that Social Security trustees take, would, I think, provide enormous reasVerDate 18-JUN-99 11:23 Sep 20, 1999 Jkt 010199 PO 00001 Frm 00132 Fmt 6601 Sfmt 6602 X:\HSECOM\55156.TXT txed01 PsN: txed01
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surance with respect to the integrity of that fund. So I actually

think the manipulation risks you can argue might even be smaller

in a collectively policed Social Security System than in an individual, with relatively uneducated individuals, police individual account systems.

Mr. BARRETT. If I could, Mr. Chairman, follow up with one question along those lines? I served in the State legislature before I was

here. And at one point there was a hot issue in the State legislature about investment of retirement funds in South Africa. This

was a time when apartheid was the rule of law in South Africa.

And so there was enormous political pressure on the State legislature to withdraw funds from companies that invested in South Africa. How do you see that dynamic at play here?

Mr. SUMMERS. That is the $64,000 or maybe a $64 billion question. I think the answer really goes to three things. One, the statute that we envision would be one that would operate on a permanent to continuing basis. It would not involve specific congressional

involvement in investment decisions. Second, the investment decision would not be made by this board, but they would be made by

private sector managers. And third, and most important, the rules

would say that the investments could only take place in broadbased indices in their entirety, with no scope for picking and choosing which stocks in those indices were to be purchased. And it

would be those requirements that would provide insulation from

the temptation to make those kinds of choices, just as they provide

insulation in the case of Federal Thrift Savings Plan right now.

My own feeling would be, and it is a judgment, that when you

are speaking about a program in which almost all Americans have

a stake in successful investments, it is likely to be much easier to

resist the temptation to engage in those kinds of things than in a

situation where it is a much more limited universe of participants

and there are a large number of people who are interested in the

point made by giving an investment strategy, but who do not have

a direct economic interest in the success of the economic strategy,

such as would be the case where you have public employees’ pensions, but only a very small fraction of a State’s voters’ pensions

that are at stake in a given context.

Mr. BARRETT. Thank you.

Mr. OXLEY. The gentleman from Massachusetts, Mr. Markey.

Mr. MARKEY. Thank you, Mr. Chairman.

My own feeling about that in the drafting of my bill with Mr.

Bartlett—I have a 100 percent ADA record and he has a zero ADA

record—is that we agreed that it is theoretically possible, but we

also understand that that the paradox would set in quite quickly.

That is, when someone went after apartheid, someone else would

go out for abortion.

From the other end of the spectrum and in the same debate, you

would be having votes now on issue after issue which would ultimately lead to a realization that you cannot go down that track.

You would be setting up a situation where the Social Security

Trust Fund that every American has a stake in would now be used

as a vehicle. And I think while some people do not mind the U.N.

budget being used or some other vehicle, if you are going to be

playing with Social Security, I think both sides will quickly realize

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it is political dynamite. It is why it is called the political Third

Rail, and we just do not think, as a practical matter, that either

side would want to go down that course more than the first couple

of hours of that debate.

Can I ask you to follow up on something that I asked Mr. Greenspan about? That was the question of what the impact is if the

exact amount of money invested in the same common stock index

or indexes would have on the national savings debate, if it was invested pursuant to your plan or something that Mr. Greenspan

would support. What is the difference in terms of its impact on the

savings plan?

Mr. SUMMERS. I think that by and large——

Mr. MARKEY. Mr. Greenspan said there would be no difference.

I am just wondering if you agree with that?

Mr. SUMMERS. I think a crucial point would be this: I think this

would command very widespread agreement that, by running down

the national debt, the President’s program would have a substantial increase in national savings. I think that point would command

very wide agreement. I think the choice that is made as to how

best to invest one’s resources is an important choice in a variety

of respects, but it is not that its impact is primarily on national

savings. That is, my wife and I, if we earn a $1,000, face two

choices. One is, are we going to save $100 or are we going to save

$200? And then, given that we have to save $100, how much are

we going to put in stocks and how much are we going to put in

bonds? Changing the amount that we put stocks versus bonds does

not change what our savings rate is. But, nonetheless, investing

wisely is much better for us than investing unwisely. And that is

the nature of our argument with respect to Social Security.

Mr. MARKEY. I agree with that. Now let me ask you a series of

questions, if I could, and you would help us by getting this on the

record.

With regard to the privately managed individual accounts, the

Advisory Council on Social Security has estimated that the administrative costs and fees of a privately managed individual account

would average at least 1 percent per year. And other studies show

that the mutual funds that invest in stocks have annual fees averaging between 1 and 1.5 percent per year, is that correct?

Mr. SUMMERS. That is very much in line with our own feeling.

That 1 percent a year would mean that over an individual’s life

time approximately 20 percent of their total accumulation would be

going to various kinds of administrative costs.

Mr. MARKEY. Now if the fund has been accumulating in an individual account over a 40-year period, were to be converted into an

annuity upon retirement, is it not true that there would be an additional fee and expense that could consume an additional 15-20

percent of the savings of the account?

Mr. SUMMERS. I think, to my knowledge, 15 or 20 percent would

be a plausible estimate of the load on currently purchased private

market annuities. What it would be in the context of any overall

scheme would depend upon how that scheme was designed.

Mr. MARKEY. I am just talking about a range here. So then, adding those two numbers together then, 30-35 percent or so of the

132

amounts deposited into an individual account could end up being

eaten up by fees and expenses over a 40-year period?

Mr. SUMMERS. It would be possible if the effects would be that

large. And, indeed, one study, one analysis that I have been told

about that looked at the experience in Britain and built in one

other element, which was the costs and one-time fees when competing vendors bid people away. What the individual accounts suggested in that case, at least based on what I was told, that the

costs could be as high as 40 to 45 cents out of every dollar.

Mr. MARKEY. So would you not agree, then, that a privately managed individual account would have to substantially outperform a

passive index centrally managed fund in order to make up for all

the annual fees and expenses and annuitiation costs?

Mr. SUMMERS. Certainly, unless some way could be found of producing a very large improvement in the efficiency over what seems

to be the normal practice. In Chile, in fact, Congressman Markey,

I am told that on at least one set of estimates the administrative

aspects absorbed essentially 500 basis points, or 5 percentage

points, of the return that was being earned on the equity investments, which would be pretty much the whole difference between

stocks and bonds.

I think I have just been passed a note. I think there is one point

that is fair for me to make a little bit more clearly, which is 15 to

20 percent on annuities is, indeed, an estimate of the current private sector costs. But that has a lot to do with the fact that annuities are voluntary, and it is the people who expect to live longest

who buy the annuities. In the context of a mandatory system, those

annuitiation costs might be somewhat lower.

Mr. MARKEY. But still substantial in terms of the aggregate combined with the other fees?

Mr. SUMMERS. That is right.

Mr. MARKEY. So it is unlikely to happen then? That a fund, an

individual fund account with those fees would outperform a passively managed index fund that tracks the S&P 500, because that

already routinely outperforms most actively managed equity mutual funds, anyway, with much lower fees and administrative costs

than we are going to see in this program?

I think it is associated with centrally managed individual accounts have been estimated by MIT Economist Peter Diamond to

consume approximately 7.5 percent of the funds in an average

worker’s account over the same 40-year worklife, which is better

than losing 20 percent of your savings. But such plans still would

have to be converted into an annuity upon retirement, would they

not?

Mr. SUMMERS. Yes.

Mr. MARKEY. You certainly would not view cutting a check and

giving the retiree a lump sum upon retirement—would that be the

Clinton administration policy?

Mr. SUMMERS. No, I would certainly envision, we envision a Social Security Program that provides for continued annuitiation, just

as current Social Security benefits do, simply supplemented by the

benefits of collective investments.

133

Mr. MARKEY. And I have not heard the advocates of the individual retirement accounts advocating to that either; that is, just

handing over the lump sum and not annuitizing.

Mr. SUMMERS. I think there have been some variations, but I

think in most cases they envision some annuitiation, that is right.

Mr. MARKEY. Now is it not true that the basic structure and governance of a government-managed private account system would be

pretty similar to the Bartlett-Markey bill?

Mr. SUMMERS. That is my understanding.

Mr. MARKEY. So both models would still face roughly the same

risks of political interference in corporate governance matters or social investing under such a system? Is that not correct?

Mr. SUMMERS. Indeed, I think that is a fair judgment, which I

tried to draw out in my testimony, although there is the question

of whether the defined-contribution element would lead to greater

discipline versus the discipline inherent in Social Security—being

widely watched.

Mr. MARKEY. Would you agree that it would be prudent for us

as a committee to consider what additional risks a private account

scheme might face?

Mr. SUMMERS. I would think, for all those involved in private account schemes, one would want to consider the risks very carefully.

Mr. MARKEY. I mentioned earlier this morning that when Congress originally created IRAs, they were supposed to be used only

for retirement accounts, retirement savings, but now money can be

withdrawn from IRAs and used to help purchase a home or pay for

educational expenses. Is it not possible that Congress will be no

more successful in insulating Social Security private accounts from

the inevitable political pressures to make these funds available for

similar purposes than it was in limiting the IRA to retirement savings only? Would we not have the same political problem there?

Mr. SUMMERS. There is certainly that possibility, which I think

you would be better able to judge than I.

Mr. MARKEY. If there is a recession, is it not possible that Congress would face demands from the public that they be allowed to

withdraw their own funds from their own individual accounts right

then, to alleviate their immediate economic distress?

Mr. SUMMERS. It could happen.

Mr. MARKEY. And what would then happen to the individual accounts when the beneficiary reaches retirement age? Will we still

mandate that they convert into annuities? And if so, what would

happen to those who gamble away their savings in riskier investments? Would we wind up, in other words, creating a new generation of stock market notch babies where the Federal Government

would have to move in or be pressured to move in to prop up those

that were now in a more disadvantageous position as pensionists?

Mr. SUMMERS. Congressman Markey, that seems to me to be an

important issue that should be addressed to advocates of particular

individual accounts proposals to see how they would work through

that.

Mr. MARKEY. Should we force, would we be in a position where

we would force retirees with serious medical problems or terminal

illnesses to accept a lifetime annuity or else they will not be able

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ment of their own money right now? How are we going to say no

to those people with terminal illnesses, if they are in individual accounts? How do we tell them, no, that we are not going to do it—

in terms of political pressure because it seems to be the big issue

here?

Mr. SUMMERS. Many of these are good questions to address to

what I suspect will be other witnesses before this committee who

are in the position of advocating individual account proposals because, certainly, as we thought about them, those are the kinds of

issues that would certainly have to be addressed.

Mr. MARKEY. Everyone who testifies from that seat, Mr. Summers, is an expert on what the governing class will do under pressure. So I am just giving you the same opportunity to prognosticate

what our actions will be. We are a stimulus response institution

and there is nothing more stimulating than public pressure on us

in an election year. So everyone is free to sit down there and speculate as to what we would do.

And what I would argue, I guess, is that a preconstructed system

would ensure, at least to the best of our ability, that the accounts

would be protected politically. They we would be far better off, in

terms of the gambling aspects of going into the stock market, and

it centrally managed, and having the government there to still

guarantee that annual income to retirees. Because you still only

know the protocol pressure issue. By going to the individual retirement accounts, you still wind up with all kinds of pressures from

constituents along the way.

Anyway, thank you so much, Mr. Summers, for your testimony

today. It was very helpful.

Mr. Chairman, thank you for your indulgence.

Mr. OXLEY. The gentleman’s time has expired.

Mr. SUMMERS. And BC is behind 47 to 18 at the half to Syracuse.

So I have no reason to leave and I will go another round if you

want to.

Mr. OXLEY. No, I don’t want to hear any more moaning about the

coach and the star player going to Ohio State. We have heard

enough about that.

Mr. Summers, thank you so much for appearing before the panel

today. It was most informative.

Mr. SUMMERS. Thank you very much for the opportunity, and I

hope our comments were of use to you.

Mr. OXLEY. Very good. Thank you very much.

The subcommittee stands adjourned.

[Whereupon, at 2:45 p.m., the subcommittee adjourned.]