A Candle In The Kitchen

I was reviewing my investment statements for the second quarter and noticed my investment return for the year on a money market fund I own.

I have almost $14,000 in this Treasury money market fund.

My total return for 6 months----66 cents!  This is an annualized return of .01%.  That is 1/100 of 1%.  At that interest rate it will only take me about 7,000 years to double my money.

The policies of Ben Bernanke and the Federal Reserve are killing savers.  I have written previously about this subject here and here.

These policies are also accelerating the demise of Social Security as we know it.  They are also preventing our politicians from facing the tough decisions that need to be made.  As a result, the can is being kicked further down the road.

Social Security has a so-called "Trust Fund" which is owed about $2.75 trillion from the federal government.  These special treasury securities carry an interest rate that is set by a formula that averages market based bond yields over a rolling three-year period.  This formula was established in 1960 to  insulate the Trust from transitory changes in interest rates in order to provide stability to the Trust Fund.

This formula has worked to the benefit of the Trust Fund over the last few years as interest rates plunged.  However, we are now over three years into the low-rate Fed policy and the interest income outlook going forward will no longer work to the benefit of the Trust Fund.  For example, last month $135 billion of securities earning an average yield of 5.64% were replaced with bonds yielding only 1.375%.

Bruce Krasting writes an excellent blog on the financial issues of the day that I read regularly.  His most recent post is on the impact of the Fed low interest rate policy (Krasting calls it ZIRP-the Zero Interest Rate Policy) on the Social Security Trust Fund (SSTF) which highlights all of the above and much more.  Here is how Krasting sees it looking forward.

As a result of the Fed’s extended ZIRP policy, and the SSA's interest rate setting formula, it is now a certainty that interest income at SSA is going to substantially drop over the coming decade. The problem is that SSA has provided projections for its interest income over this time period that don’t jive with this reality. From the 2012 SSA report to Congress:

The SSTF believes it will earn an average of 4% over this period. That is not possible any longer. I calculate that the most SSA could earn is an average of 2.3% (it could be significantly lower). The drop in yield translates to a reduction in income of $535B over the forecast period. That’s a lot of dollars.  

Consider again the base case provided by SSA in April. The following compares the size of the trust fund based on SSA’s estimates and my adjustments for what interest income will be (everything else is constant).

Based on a realistic assessment of interest income at SSA, the trust fund tops out in 2015, its peak value will be ~$2.823B. The SSTF has reported that the TF will top out at $3,061B, and that milestone will not be reached until 2021. Essentially, the train wreck will happen six years earlier then assumed, and the TF will be $250B short. It gets worse.

The other key ingredients in the SS "pie" are tax receipts from workers and the amount of monthly benefit payments (the assumptions used is that GDP growth will average 4%, and unemployment falls to 5.5% -  no recessions over the ten-year horizon). These are not realistic assumptions. This means that once the SSTF hits its peak in 2015, the run off in assets will happen very quickly. 
The SSTF has stated that the date in which the TF falls to zero will be 2033. The actual termination date of the TF is much closer than that. It could come as early as 2023.

I referred to it as a "so-called Trust Fund" above.  That is because there is nothing about it that anyone should have any trust in.  There are no assets in the Trust Fund beyond a promise from the Treasury to make good on a future payment.  The promise is only as good as the government's ability to raise future tax revenues (or borrow even more money) to transfer to Social Security.  Therefore, the promises will only be met if the next generation is willing to absorb significantly higher Social Security taxes than are being paid today.

Of course, in order to maintain all of the federal spending we have today on things other than Social Security, that also means significantly higher Medicare taxes and income taxes as well.  We also have to figure in the new taxes to help pay for Obamacare and its increase in government spending.  Something has to give.  Spending levels must be reduced or taxes will need to be sky high in the future.  Oh, to be young and have all of this to look forward to!

One could argue that since the Trust Fund is nothing but an illusion, it does not really matter what the interest crediting rate is on the bonds owed to Social Security.  However, the illusion that everything is fine with Social Security because it has $2.75 trillion in its "Trust Fund" masks the danger ahead.  It also allows politicians like Harry Reid to say there are no problems with Social Security.  Rest assured everyone, Senator Reid states that he is willing to look at fixing Social Security in two decades!

The same can be said for Bernanke's low interest rate policy which is permitting the federal government to finance its massive debt at unrealistically low rates.  It is another illusion that is permitting our elected representatives to avoid doing what has to be done.   For example, with nearly $16 trillion in federal debt, if interest rates were 3% higher across the board (close to historical averages) the annual federal deficit would be almost $500 billion higher.  This year's estimated $1.1 trillion deficit would balloon to $1.6 trillion from higher interest rates alone.

In effect, we have a house that is fully engulfed in flames but the illusions of the Trust Fund and the Fed's ZIRP make it seem that the only thing burning is a candle in the kitchen.  At least that is how our elected officials are acting.

Of course, all of this can be solved if voters lit a fire under the collective rear ends of our elected representatives.  We truly get the representation we deserve.  We soon will get other things that we deserve.  There are going to be a lot of promises that will not be kept.  Or there are going to be a lot of new taxes.  Start preparing or start voting to change what is happening in Washington.