Tuesday, June 25, 2013

The "Moral Hazard" of Social Security ... An Example of "Do-Good" Government and Its Often Unintended and Negative Results

{NOTE: Many of you may not want to hear about the moral hazard effects of government programs, and especially those that help the "middle class," and you may disagree with what I have to say, but I'm going to say it anyway. So here goes.}

"Do-good" or "progressive" government safety nets all too often result in unintended harmful consequences for their intended beneficiaries.

By trying to keep us safe and secure, these government actions only serve to make us more dependent on government and less likely to become or remain a nation of self-reliant individuals.

From Social Security to Medicare to ObamaCare to student loans to unemployment benefits and countless other well intentioned safety nets for the vulnerable among We the People, more and more of us become vulnerable and dependent on government programs. It's called "moral hazard" and it's very real and very harmful to We the People as a whole. It's most harmful to the vulnerable among us.

Simply put, moral hazard describes the risk that one party (herein the individual citizen) to a 'contract' will change his behavior and adversely affect his future well being due to the nature of the contract with the other party (herein the government). The classic example of moral hazard at work takes place in the insurance industry, where coverage against a loss might increase the risk taking behavior of the insured.

Which brings me back to the moral hazard of Social Security dependency and other forms of government "help" intended to act as a safety net for We the People.

We all know that most people rely too much on Social Security for their old age income and that too many of us failed to save and invest enough during our working years to generate anything close to a non-government dependent income for the rest of our lives.

But how many of us have asked ourselves why? And what the answer to that question has to teach us about other forms of government assistance, which, albeit perhaps well intentioned, result in much different actions from the desired behavior.

When some people retire early because their benefits are substantial (think teachers and other public employees) but didn't save and invest sufficiently during their working years, and still others refuse to take jobs for which they are qualified but would pay them not much more than not working and taking government benefits (and having leisure time available while doing so), and young people enroll in college just to get the "free" Pell Grant money, and other so-called students take out expensive loans that they may not be able to repay, especially if they don't graduate, they're in all probability still acting somewhat logically, at least at that particular point in time. But over the longer term, due to this government "assistance," they're often doing themselves great harm.

So with "moral hazard" clearly in mind, please consider Will Social Security be your only hope? and what it really means to We the People down the road. To me it's indicative of the big box we're in as a result of all this government "help" over the past several decades:

"It is working Americans' greatest fear: Being dependent on meager Social Security benefits in old age. A surprisingly large number of people will be in that position — a median dependence of 39% in the year 2022 and slightly higher (41%) in 2062, according to a government study.

What "dependence" means for the typical household is that 39 cents of each dollar of income they get will come from the government-run retirement plan.

As with all statistics, averages obscure important information. Among the lowest earners, dependence on government income is much higher (52%). Still, even the top fifth of Americans will find that 25% of their income — on average for their group — comes from Social Security.

The government does these studies not to alarm people (goodness knows they're dry reading) but to try to figure out how much economic pain would be inflicted by changes in how Social Security is funded. In short, if a future Congress cuts benefits, who suffers?. . .

The government figures the median retiree 62 or older will have an 86% replacement rate in 2022 under current law. Put another way: A retiree on average will see a 14% decline in total income compared to his or her working years. All the more reason to be debt- and mortgage-free by retirement.

The SSA projects a replacement rate of 84% by 2062 but points out that current tax rates only support a payout of 72%. As you likely already know, we aren't taking in enough money to meet the obligations promised.

So, if you're average, early in your earning years and tax law stays the same, get ready for a pretty hefty lifestyle change at 62. You're likely to lose 28% of your current income, all told.... the very next thought to enter your mind is probably "What can I do about it?" Here are your marching orders for the next few years:

1. Ramp up your savings rate

Do you take advantage of the government's catch-up allowance for those 50 and older? Do you put away the maximum in your IRAs and 401(k) accounts? . . .

2. Pay down debts for good

This is huge. During the boom times, people traded up houses like they were changing clothes out of season and leased brand-new cars every 18 months. Credit card spending was seen as a tool of the privileged and smart. Nothing could be further from the truth. Borrowing is the mirror-image reverse of smart investing: Rather than making money on your money, you become the milk cow for the big banks and other lenders. It's time to change those habits.

3. Invest for the long term

How long will you live? Will you need money all of those years? Nobody knows the answer to that first question, but the second is a no-brainer. Your income needs will never disappear and might even increase in old age. It's critical to assume that your investing time-frame at retirement is decades long — because it might be — and that low cost and efficiency in your investment approach is paramount. Your worst-case scenario should be deciding which charity deserves your estate or how best to benefit your heirs, not how to pay the power bill in your 90s."

Summing Up

The old joke about "We're from the government and we're here to help" doesn't seem funny to me. In fact, it's actually pretty sad, moral hazards included.

Do you feel that way, too?

If so, let's each resolve to do what we can to take care of ourselves, and let's especially encourage the younger ones among us to do the same, starting early in life.

In other words, to do as we now "wisely" say, not as perhaps we once "unwisely" did.

Thanks. Bob.

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