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April 07, 2005
Arthur Andersen Ain't Got Nothing On These Guys
More on loan document typos soon, I promise or something. But, today Don Luskin points out a major flaw in the NYT's editorial on Bush's visit to the "Social Security Trust Fund", you know, the one that's just made up. Well, okay, it technically exists, but in order to think it's worth anything you have to get into some really creative accounting. Now, I got through an entire undergraduate education and managed to avoid the B-school like the plague, but I can at least read a balance sheet. Luskin's main point is this:
The point that all this hand wringing is designed to distract you from is that it is both semantically and financially meaningless for anyone to owe a debt to himself. The US government can no more fund Social Security obligations by issuing Treasury bonds to itself than the New York Times Company can fund its pension obligations by issuing corporate bonds to itself. Debt that one issues to one's self cannot represent savings or wealth, because the same entity that owns the debt as an asset owes the debt as a liability.
And I thought I'd further demonstrate this with a fictional balance sheet I made in Excel. Let's suppose I have a business called Money Corp LTD, and that I start off with $1,000 (in liquid cash, Money Corp has no capital investments and extremely low overhead, and this is just an example). My initial balance sheet looks like this:
So, I the clever Corporate Tyrant think to myself, why don't I buy some Money Corp bonds with this? We've got an A rating, it's a safe investment, we've never defaulted! All right, I think, let's do it! The new Money Corp balance sheet looks like so:
Gee, I think to myself, what a shrewd investor I am, I'm running a surplus! Thusly, I get together with the Money Corp Board and we decide to use that $1,000 of bond revenue to pay each of the nine directors and myself a bonus of $100. Total bonus: $1,000. New balance sheet:
But, oh no! Our shareholders have gotten wind of this, and they're demanding a penny a share on all 100,000 shares (they're also remembering that's what I promised them)! What am I going to do? I have no assets left! My balance sheet is scary:
But wait! I really forgot to count holding those bonds as an asset, because I owe myself $1,000, it says so right on the bonds! But...I issued those, so I'm also in debt to myself $1,000. There's nowhere to get the money! Our shareholders are S.O.L! And I might be on my way to Federal-pound-me-in-the-ass-prison...hold on, there's a secondary market in bonds. I guess I can sell them at face value and reap the revenues to pay the stockholders so I don't go to jail. The balance sheet looks like so:
But, hold on, something's rotten in the state of Money Corp. I don't actually have those bonds any more, because I sold them to someone who isn't me, so they have to come off the Assets side, and my balance sheet actually looks like this:
Which means, of course, that when those bonds come due Money Corp is going to have to come up with $1,000 out of future earnings to pay them all back.
This is exactly what's going on with Social Security. The Social Security system (a branch of govenment) has traded its surplus cash for bonds, government bonds. That money went into the General Fund and was spent as soon as it came in. The issuer of those bonds is the Congress of the United States of America, another branch of government. In the future, SS expenditures will exceed its income (payroll taxes), meaning that Congress is going to have to start paying back those bonds using its income (income taxes). Meaning, of course, that we've already robbed the hell out of Peter and Paul is standing around the corner pretty upset about not having been paid yet.
By issuing bonds to itself and then spending the revenues of the bond sales, the government has put itself in a pretty precarious position. Even if the Treasury bonds that are in the Trust Fund were sold on the secondary market, and those cash revenues used to shore-up the present system or pay some of the conversion costs to a solvent system, there would still be billions trillions or hundreds-of-billions of dollars in outstanding government debt. So, the next time somebody tries to sell you on the validity of the Social Security Trust Fund, remind him/her that Bernard J. Ebbers is going to prison for a while for doing something, well, not too dissimilar.
UPDATE: Welcome Asymmetrical Information readers, thanks to Mr. Dreck for the link! Click around, if you feel like it.