The economics professor who may have coined the expression “irrational exuberance” has been acting pretty irrational himself lately, having just published a shoddy and deceptive “paper” designed to torpedo President Bush’s ideas for Social Security modernization with personal accounts. And the leftist media has been entirely too exuberant in publicizing this bogus research.
Here are the first two sentences from Jonathan Weisman’s story about the so-called “paper” in last Friday’s Washington Post:
Nearly three-quarters of workers who opt for Social Security personal accounts under President Bush’s “default” investment option are likely to earn less in benefits than those who stay with the traditional Social Security system, a prominent finance economist has concluded. A new paper by Yale University economist Robert J. Shiller found that under Bush’s default “life-cycle accounts” … nearly a third of workers would bring in less in benefits than if they remained in the traditional system.
Wait a second — is it “three-quarters of workers” or “nearly a third of workers”? If you read Shiller’s “paper” — which apparently Weisman didn’t — you’ll discover that it’s neither (looks like it’s time for another humiliating correction of a Weisman Social Security story). What the “paper” really said was that, in computer simulations of past investment performance, an investment strategy that Shiller invented out of whole cloth underperformed the returns of the existing Social Security system in 32 percent of the trials.
This leads Shiller, in overheated language not found in authentic research papers, to say in his “paper” that life-cycle accounts in Social Security “could be disastrous for some workers.”
By now you’re probably wondering what the heck these “life-cycle accounts” are. If you are like most people, you haven’t heard a lot about them in the Social Security debate. Indeed, they play a bit part in this great drama. They are not, as Weisman calls them, “Bush’s ‘default’ investment option.” And they are not, as Shiller’s “paper” calls them, “the centerpiece of the personal account plan.” They are simply a way for older workers with personal accounts, if they wish, to automatically have their investments become less risky as they approach retirement.
In a nutshell, a life-cycle account automatically moves an investor from higher risk holdings such as stocks into lower risk holdings such as bonds. A professional investment counselor might advise you do just that as you get older. It just so happens that I know quite a bit about life-cycle accounts and how they work, because I invented them (you can view my patents here and here).
The White House has talked about life-cycle accounts in a general way, but it has never defined in detail how they would be designed. So Shiller’s “disastrous” simulated investment performance is for a strategy that he himself made up. And as you’ll see in a moment, he cheated.
The only thing the White House has said, in press briefings and in policy documents, is that a life-cycle account would shift “investment allocations from high growth funds to secure bonds as the individual nears retirement.” And the 2002 report of the President’s Commission to Strengthen Social Security talked about an investment option that would be 50 percent stocks and 50 percent bonds. Shiller knows all that — because he specifically cited all three sources.
Shiller says his simulated life-cycle portfolios were “designed to capture the President’s proposal.” Yet all of his simulations are based on hypothetical life-cycle accounts in which half the bond allocation is, in fact, arbitrarily devoted to money market assets. Historically, according to Ibbotson Associates, the real return for money market assets has been less than a third of the real return of Treasury bonds. Thanks to the power of compound interest, over many years that makes a huge — and “disastrous” — difference in returns.
Then, to make life cycle accounts look even more “disastrous,” Shiller uses historical returns that are far less than those actually achieved by the investments he is simulating. Instead of using returns from U.S. markets, he uses returns from an average of 15 countries. What, exactly, is the relevance of those 15 countries? Today the country ranked 15th by gross domestic product is Indonesia — is there really any point in including the investment history of such a country, except that in doing so the president’s proposal is made to look bad? Shiller simply says that his way is “more realistic.”
Shiller didn’t come up with all this realism alone, by the way. On the first page of his “paper” he thanks Jason Furman “for substantial assistance.” Furman is currently with an ultra-leftist think tank, the Center for Budget Policies and Priorities. He was also director of economic policy for the Kerry-Edwards campaign.
If the way Shiller cooked the numbers in his “paper” isn’t bad enough, some of his incidental commentary plainly reveals the irrational depth of his antipathy for Social Security modernization. He says personal accounts would be a form of “government intervention,” and would be
nothing more than a plan to encourage people to buy stocks and bonds on margin, that is to borrow money to buy stocks, with the Federal government as the lender.
With that statement, Shiller stands athwart the fundamental truth that animates the whole concept of the ownership society — it’s your money. There’s no intervention, no borrowing, in personal accounts. Quite the contrary — there is empowerment and returning ownership of your money to you.
At one point Shiller offers up this fearful fantasy:
the personal accounts program could have the effect of causing speculative demand to bid up the stock market in the short run, followed by a crash in the longer run …
And since life-cycle accounts are so “disastrous,” Shiller suggests that
It would seem to be a better plan if the government merely subsidized personal financial advisors, making it cheaper for people to get financial advice that is really appropriate for their own economic circumstances.
And just what kind of “financial advice” would Shiller suggest for the tens of millions of low-wage earners in America, people whose every penny of potential savings and investment is consumed by the cruel payroll tax that feeds Social Security?
Yes, it’s tempting to dismiss Shiller’s ravings, because after all, he is the wise and celebrated economist who suggested the expression “irrational exuberance” to Alan Greenspan, who made it immortal in a December 5, 1996, speech. It’s true that four years later the stock market bubble burst, so many people seem to regard Shiller as a prophet.
Prophet perhaps, but not profit. The Dow Jones Industrial Average stood at 6437.10 the day Greenspan gave that speech. It traded a little lower for a couple weeks after that, because the speech itself spooked investors. But since then, the Dow has never traded lower. Today it stands at more than 10,500. That’s a gain of near 65 percent, and I haven’t even included dividends.
The seemingly prescient “irrational exuberance” prophecy stands as perhaps the single worst market-timing call in history. But on the basis of that, the Washington Post expects us to take Shiller’s deceptive “paper” on Social Security seriously?
Now that would be irrational.
– Donald Luskin is chief investment officer of Trend Macrolytics LLC, an independent economics and investment-research firm. He welcomes your visit to his blog and your comments at don@trendmacro.com.