You won’t hear many politicians discussing Social Security these days, and probably even fewer will next year. But changes are occurring in the program. Not long ago, the trustees of the Social Security Trust Fund were projecting that tax revenue would exceed benefit payments for some years to come. Things have changed. According to The Washington Post, in 2010 the recession reduced revenue and increased benefit payments so that for the first time the program took in less revenue than it paid out. It’s happening again, with the program requiring supplements from the Treasury.
Now, Social Security is sucking money out of the Treasury. This year, it will add a projected $46 billion to the nation’s budget problems, according to projections by system trustees. Replacing cash lost to a one-year payroll tax holiday will require an additional $105 billion. If the payroll tax break is expanded next year, as President Obama has proposed, Social Security will need an extra $267 billion to pay promised benefits.
Politicians in both parties aren’t discussing the issue, because they’re afraid of how senior citizens will react. But failing to take some action will make the situation worse and put both the program and the rest of the federal budget in deeper trouble than it already is.
Social Security is hardly the biggest drain on the budget. But unless Congress acts, its finances will continue to deteriorate as the rising tide of baby boomers begins claiming benefits. The $2.6 trillion Social Security trust fund will provide little relief. The government has borrowed every cent and now must raise taxes, cut spending or borrow more heavily from outside investors to keep benefit checks flowing.
Many Democrats have largely chosen to ignore the shortfall, insisting the program is flush, citing the existence of the trust fund. They argue that fixing Social Security can wait, perhaps for years.
Senate Majority Leader Harry M. Reid (D-Nev.), who is fighting to maintain control of the Senate, has been particularly outspoken. In March, as a bipartisan group of six senators was gaining attention for a push to draft a debt-reduction plan that included a Social Security fix, Reid summoned hundreds of activists to a rally on Capitol Hill. Fresh off a tough reelection campaign that turned in his favor after he accused his tea party opponent of wanting to “wipe out” Social Security, Reid exhorted policymakers to “leave Social Security alone.”
Read the whole article. It’s worth learning what’s been going on behind the scenes. It’s understandable why the politicians are trying not to talk about the issue, but it’s not clear at all why the media haven’t given this more attention.
Big rallies often give investors the confidence to add more stocks to their portfolios. That’s the reverse of the way they should do things, but it’s human nature. Here’s a study from Birinyi Associates, indicating that after last week’s rally most U.S. stocks are extremely overbought. That’s a technical sign that stocks are overvalued or have exceeded reasonable prices. They’re likely due for a reduction or an extended period of flat trading. Tread cautiously in equity markets now.
Major banks have shelved plans to impose monthly fees on debit cards. Bank of America introduced a $5 monthly fee on some debit cards a few weeks ago. There was a pretty severe consumer backlash. Bank of America apparently lost a number of customers over the fee. Last week several banks announced they would not add debit card fees. Bank of America said it is considering options on the fee it announced.
Of course, that’s not the end of the story. Banks still need to replace the revenue they lost when Congress mandated lower charges on retailers when customers use debit cards. If banks can’t replace the revenue with monthly debit card fees, they will try to establish other revenue sources.
The federal government announced that the increase in Medicare Part B premiums for 2012 will be much less than expected and won’t absorb all of the Social Security benefit increase announced recently. The basic premiums will be $99.90 per month, an increase of $3.50. The average Social Security benefit increase will be $39 monthly. Some analysts were anticipating a Part B premium increase of more than $10 monthly.
Not everyone pays the same Medicare premium. Those who enrolled for the first time in 2011 $115.40 monthly. They’ll actually see a decline to $99.90 in 2012. Others pay higher premiums because of the means-testing that was introduced into Medicare premiums a few years ago.
You can read more about the premium increases and other changes in Medicare for 2012 here.
The Department of Labor issued new regulations last week that allow fiduciaries of 401(k) plans and IRAs to offer investment advice under some circumstances. The law prohibits such advice, but the DOL carved out some exceptions. Fiduciaries may offer advice, beginning Dec. 27, if their compensation doesn’t depend on the investment recommendations or they use a computerized investment system from a certified third party. The first exception means the fiduciary is paid the same amount for the advice regardless of the investment that is recommended, such as receiving a flat fee or a flat percentage of the account’s value. Many fiduciaries already offer advice based on separate exemptions they received from DOL.
These regs don’t resolve a very hot issue that’s been debated in Washington. The DOL issued proposed regulations not long ago that essentially provided that anyone who offered investment advice or had almost any role with a retirement plan would be a fiduciary. The regulations were withdrawn after a lot of complaints from financial services companies and members of Congress. The DOL still is working on those regulations. The financial services industry argued that if the proposed regulations stood, then many firms would decide not to provide advice to retirement plan members. Currently, brokers and investment advisors can offer paid advice to participants without being considered fiduciaries. Fiduciaries have a higher level of legal scrutiny than non-fiduciaries.
It’s well-known that people have emotions and other hard-wired traits that make it difficult to make good investment and financial decisions. One of those emotions is regret. That emotion, and particularly efforts to avoid it, leads to bad decisions. For example, Terrence Odean, a professor at the University of California at Berkeley, did some studies that showed how emotions affect investing. One study found that investors were likely to re-purchase a stock they owned previously only if they made a profit from the previous holding and the stock has declined from the price they sold.
Regret is also a key factor in what Odean calls the “disposition effect.” His research through the years has shown that investors are more disposed toward selling stocks that have made money, while holding onto those that are poor performers. Even though the results of this can be counterintuitive and even detrimental to a stock portfolio, the overriding reason has to do with managing their emotions vis-à-vis the stocks they own, in particular the regret at owning stocks that are poor performers.
“When people hold onto stocks that are losers, they are trying to minimize their regret, because if a person sells at a loss, he or she runs the risk of regretting that they bought that stock in the first place,” Odean says. “If people hold onto their poorly performing stocks, though, they’re doing so because they’re telling themselves that the market will come back, and they’re coping with their regret by convincing themselves that those stocks that are performing badly will turn around.”
Social Security retirement benefit payments weren’t increased for inflation the last two years, because there wasn’t inflation as measured by the CPI. In 2012, the benefits will increase by 3.6%, the rate of price increases measured by the CPI.This will increase the average retirement benefit by $516 to $14,748 for the year.
But not all beneficiaries will see that increase in cash. Beneficiaries who also are enrolled in Medicare mostly will have their Medicare premiums subtracted from their SS benefits. The Medicare increase, which hasn’t been fixed yet, is expected to offset a large portion of the benefit increase for most. These recipients did not have their SS benefits reduced the last two years, because the rules are that increases in Medicare premiums can’t reduce the net payout to a SS beneficiary when the Medicare premium increase is greater than the SS benefit increase for a year.
I regularly encourage Retirement Watch readers to fight their intuition when making personal finance decisions. The actions that people are most comfortable with and that are instinctive often are bad decisions. I know that from seeing the decisions people make and from conducting detailed, independent research before making a recommendation in the newsletter or web site.
There also is substantial academic and clinical research to support that view, including a Nobel Prize in economic science to Daniel Kahneman. Kahneman’s been conducting research on how people make decisions and concluded that most humans are “hard wired” to make the wrong decisions when following their intuition or instincts. He’s summarized decades of his research in a well-written book for the average reader titled Thinking, Fast and Slow. You can read a very good review of the book here. (Subscription might be required.) Take a look at it and see which of your own patterns you can identify. Recognizing a problem is the first step in fixing it.
This passage from the review addresses a topic that’s always concerned me: Drawing conclusions from limited data.
The first article they wrote together, titled “Belief in the Law of Small Numbers,” showed that even trained research psychologists had poor judgment about statistical inferences: The sample sizes of their experiments were often too small to support their conclusions. This problem, like so many others, had broad implications. Crucial policy decisions are often based on statistical inferences, but as Mr. Kahneman notes, we “pay more attention to the content of messages than to information about their reliability.” The effect is “a view of the world around us that is simpler and more coherent than the data justify.”
One major effect of the work of Messrs. Kahneman and Tversky has been to overturn the assumption that human beings are rational decision-makers who weigh all the relevant factors logically before making choices. When the two men began their research, it was understood that, as a finite device with finite time, the brain had trouble calculating the costs and benefits of every possible course of action and that, separately, it was not very good at applying rules of logical inference to abstract situations. What Messrs. Kahneman and Tversky showed went far beyond this, however. They argued that, even when we have all the information that we need to arrive at a correct decision, and even when the logic is simple, we often get it drastically wrong.
European policymakers delivered what the markets seemed to want overnight. They announced their latest solution to the sovereign debt crisis with three key provisions: Greece’s debt would be voluntarily reduced by the lenders by 50%; the European Financial Stability Fund would be increased by four or five times; and capital of the continent’s 70 largest banks would be increased. The markets liked the deal. All risk assets increased sharply on the news.
As with past deals on the sovereign debt crisis, the long-term isn’t considered and details aren’t there. It isn’t clear how the EFSF will be increased. Is China adding capital or buying bonds issued by the EFSF? Germany already indicated it isn’t going to put in any more money. Did it change its mind, or is someone else adding all that money? We don’t know. Presumably, the EFSF will be used to guarantee bonds of other countries in trouble, particularly Spain and Italy. The deal doesn’t specifically mention those countries, but those are the next problems to deal with. It also isn’t clear how the capital of the banks will be increased. Will that come from the EFSF, from the home countries of the banks, or from private investors? Private investors have been resistant to buying bank stock, but perhaps they’ll be relieved enough by the deal to take the risk. Another question is whether this deal is big enough to really solve the problem or is merely sufficient to get Europe through the latest crisis.
Long term the question is what is there to propel economic growth? Cutting Greece’s debt in half makes the debt almost manageable. But Greece is going to have to continue austerity policies to pay the remaining debt. Austerity reduces economic growth and government tax revenue, making it more difficult to pay off the debt. In addition, austerity causes public unrest, as we’ve seen during the year and a half of the crisis.
The deal will help markets for a while, if only to cause a lot of short covering. But at some point investors will realize the deal doesn’t solve everything, and it’s going to create a problem by reducing growth in Greece. Greece can’t devalue its currency to help pay debt, because it’s part of the euro. Greece also can’t spur economic growth, because it’s required to practice austerity. A trader will try to figure out how long investors will take to realize the grand deal doesn’t solve the problem but merely deals with the latest crisis. Investors will be more cautious.
At the moment, Democrats won’t agree to any plan to reduce spending, especially in Medicare and Social Security reforms. The Republicans won’t agree to any tax increases, including removing tax breaks that are special favors to industries or subsidies for certain taxpayers. But those probably are largely campaign postures, designed to get the parties through the major federal elections of 2012. After that, elected officials and policymakers will recognize the seriousness of the fiscal problems. They’ll agree to major tax reform and also reforms to Social Security, Medicare, and other programs.
That’s the analysis of Martin Feldstein. He’s not only a good economist but also a major behind the scenes political player. His analysis is optimistic and a reason to be optimistic about the future, though not necessarily the next 13 months or so.
The current economic stalemate is troubling, because financial markets could react adversely, and because delays in addressing the fiscal deficit means a higher national debt. I may be too optimistic, but I think there is good reason to believe that the current budget stalemate reflects election posturing, and that the US political system will prove more effective at making progress on fiscal consolidation once the election is past.
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