During the Social Security debates of the late 1990s and early 2000s, some conservatives argued that investing the trust fund (or letting individuals invest their payroll taxes) in stocks would generate a “free lunch” — much greater retirement savings at seemingly no budgetary cost. That’s nonsense, said the Center on Budget and Policy Priorities (CBPP) and other liberal groups at the time, because equity investment increases risk, and risk has a cost.
Today CBPP, along with most of the Democratic party, argues that the federal government can buy up private-sector student loans, disregard the risk that student loans will not be repaid as expected, and thereby book a profit on the transactions even while making the loans more generous to students. Free lunches all around! That’s nonsense, conservatives say, because risk has a cost.
For both parties, market risk is costly except when it’s not. More precisely, market risk adds a cost to government programs that politicians dislike, but it doesn’t add a cost to programs that they like. This is one of the starkest (yet largely unacknowledged) hypocrisies in Washington. Jason Delisle and I tried to call attention to it in our National Affairs article, “The Case for Fair-Value Accounting.”
The “fair value” of an asset is the market price, which is determined both by expectations of its future value and by the risk that those expectations may not be met. The price of risk matters: Millions of knowledgeable investors around the world forgo the higher average return on risky stocks because they prefer the safety of lower-returning bonds.
When pricing government assets, fair-value accounting naturally incorporates both expectations and risk. By contrast, the government’s accounting system is typically based on expectations only, disregarding the cost of market risk. This means that the government could value a dollar of stock more than a dollar of bonds — which calls to mind the old joke about which weighs more, a pound of bricks or a pound of feathers. It also means that the government can claim phantom “profits” simply by purchasing private-sector assets (such as student loan repayments) and assigning them above-market values due to the exclusion of market risk.
In response to our article, the CBPP has acknowledged its inconsistency and officially changed its view of Social Security budgeting. The organization now opposes risk-adjusting any equity investment by the trust fund:
Jason Delisle and Jason Richwine, writing in the latest issue of National Affairs, correctly note that the logic of our argument [against fair-value accounting] is inconsistent with a 2005 CBPP analysis of proposals to invest part of the Social Security trust funds in stocks instead of Treasury bonds. We concur. …[R]isk is an important consideration in assessing the pros and cons of a proposal, but it’s not an actual cost to the government and therefore doesn’t belong in the budget. This conclusion differs from the one CBPP reached in 2005, which, upon further consideration, we now believe was mistaken.
Reacting to CBPP’s change of heart, Andrew Biggs illustrates the absurdity of free-lunch budgeting as applied to Social Security. Imagine that the government sets up private Social Security accounts, guarantees everyone at least the same benefit as the current system, and then takes a portion of any returns above that level. Under CBPP’s revised view, this proposal — in which everyone will receive benefits at least as high as current law provides — would cost less than the present system. That’s something for nothing, the kind of seductive scam that politicians will always find hard to resist without fair-value to rein them in.
Nevertheless, kudos to the CBPP for valuing intellectual consistency and providing an honest clarification. It would be nice if others followed suit. I’m especially interested in hearing from Republicans who hyped the high returns on Social Security equity investments but want fair-value accounting applied to student loans and public pensions. Which position do they consider wrong today?