Has Privatization's Bubble Burst?

Move over bin Laden; the big bad Dow Jones is quickly becoming Public Enemy #1. As a result of the market’s recent freefall, the latest NBC News/Wall Street Journal poll found the memory of September 11th fading to where “strengthening the economy” has become the top priority for 32 percent of those polled, while “fighting terrorism” was cited by just 33 percent–a statistically insignificant difference. The public’s confidence in corporations and their executives also has been stung by the recent string of accounting fiascos and bankruptcies.

Democrats, finally armed with an issue with which to beat on the Republicans, are lacing their policy arguments with the assumption that the stock markets are to be feared and corporations aren’t to be trusted. The biggest target of this assumption is the proposal to privatize the Social Security system, still backed by the Bush administration, which would allow workers to buy stocks and bonds with some or all of their Social Security taxes. When the markets were flying high it was easy to advocate privatization, but to the Left the best argument against that idea is the latest downturn, seemingly proving that the “stock market [is] a game for rich people when they have money to play with,” and the government should be “developing retirement programs that are safe, secure, stable and not dependent on stock returns,” according to Ellen Frank, professor of economics at Emmanuel College.

Certainly, when one considers that the stock market has lost about a third of its value since the highs of two years ago, it can seem like a bad idea to base one’s retirement on stocks. If we privatized Social Security back when President Clinton was mulling it over before the Lewinsky mess hit, detractors reason, then everybody’s retirement account would be in bad shape today and wouldn’t we be sorry now? If pessimism about the economy is bad in today’s world where only half of America owns investments, wait until a plunging stock market sinks all boats, they say.

But wait, the privatizers reply: Historically the stock market provides a return of around 7 percent per year. Social Security, at best, will return about 1.5 percent per year for the next generation of retirees, and will most likely give a negative rate of return for the youngest workers today. Detractors point at the recent stock market plunge: Where is your 7 percent now? Hasn’t the bubble in favor of privatization burst along with the market?

The crux of the anti-privatization argument is to only focus on the last couple of years. Once you widen the scope, you find that the 7 percent return in the stock market is safe and sound. On November of 1995 the Dow hit 5,000 for the first time. The bottom of the recent stock market fall was 7,702.34 on July 23rd. Do the math and you’ll find a return of almost 7 percent per year, which was pushed over that mark in the next day’s recovery. Or go further back to November of 1972 when the Dow broke 1,000. A 7 percent yearly return means that the value of your investment should double every ten years. Thirty years after breaking 1,000 the Dow should be at around 8,000. Guess what? It is.

The problem with the stock market’s recent fall is that it happened to occur after a time when the market was climbing at a far faster rate than has been historically typical. We got used to the Dow breaking new records, jumping up another 1,000 points every few months or so. When you’re used to 15 percent returns, coming back down to earth feels like a depression; similarly, only in a tall family is a person of average height seen as a runt.

And what about the effects of a short-term dive on peoples’ retirement funds? If a person were to retire this year, wouldn’t the recent crash have severely crimped their plans if they depended on private investment? Not unless they were foolhardy. As any privatization plan would allow people to invest in government bonds and Treasury bills, a person for whom retirement is on the horizon could easily shift their holdings into these low-risk investments to ensure maximum security a good five to ten years before they actually retire.

The rest of us have a much more long-term outlook. If you’re not retiring for 30 or 40 years, to what extent should you be upset over today’s fluctuation? There’s plenty of time for a rebound. And despite the market’s earlier “irrational exuberance,” we’re still on the expected historical track for average returns. In fact, now is the time to buy into the market. The long-term still looks good, and is certainly far better than what the Social Security program has to offer.

Indeed, when one compares the safeness and stability of the stock market to Social Security, the market still looks better on both counts. Despite the slump, the Dow is still churning out the historical rate of return while stocks are still completely safe from any attempt by the government to steal them from you, while Social Security’s rate of return is steadily decreasing from bad to worse as politicians continually whittle away your “promised” benefits without your assent. If Prof. Frank wants a system that provides a reliable retirement, stock returns are the best way to get there.

The Social Security privatization bubble has most definitely not burst. If anything, with stock prices at a momentary lull, now is a great time to get new investors into the market. We shouldn’t let fear mongers who only look at recent history dictate our retirement.