Social Security Reform: What Plan Might Mean

President Clinton’s plan to reform the ailing Social Security system is, so far, as vague as it is bold.

Still, the basic ideas the president put forth Tuesday evening in his State of the Union address could turn more individuals into investors, and provide more fuel for the highflying U.S. stock market in the years ahead.

Here’s a look at some of the key issues involved in Clinton’s proposals, and the possible implications of his plan:

Q: Did the president actually call for privatizing Social Security?

A: The plan has some elements of privatization.

There are two major parts to the president’s plan. First, he wants 62% of the projected federal budget surpluses for the next 15 years--that works out to about $2.7 trillion, based on current estimates--to be “transferred” to the Social Security system. (Of course, this is a bit disingenuous, since without Social Security funds, there would be no surplus to begin with.)

Currently, none of the money collected through Social Security taxes is invested in the stock market. It all is held in the form of U.S. Treasury IOUs.

The president last night called for investing up to 25% of the transferred surpluses in the “private sector”--meaning, for the most part, corporate America--to boost returns. That would mean stocks, bonds and other securities issued by private enterprises.

Second, the president also wants to use 11% of future budget surpluses--estimated at $480 billion over the next 15 years--to supplement the traditional Social Security system. He plans to do this by establishing and funding separate personal retirement accounts called universal savings accounts, or USAs.

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Q: How would these work?

A: Many details are yet to be worked out. We don’t know, for instance, how much money workers could invest in these tax-deferred accounts in addition to the $200 to $300 the government might pay in annually, or when and how money could be withdrawn.

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Q: Adding up the numbers, it looks like about $1.2 trillion of federal funds could be earmarked for investment in the private sector over the next 15 years. Isn’t that good news for the stock market?

A: It would seem that way. Still, the numbers have to be put into perspective. The value of the total U.S. stock market, as measured by the Wilshire 5,000 index, now is $11.5 trillion. So we’re really talking about 10% of the market’s current value being put into stocks over 15 years--and that’s assuming all of that money even materializes, and that it all goes into stocks rather than bonds or other securities.

“When the markets are viewed as a whole, the projected flows from the Social Security trust fund are a drop in a very large bucket,” Marc Lackritz, president of the Securities Industry Assn., told a U.S. Senate subcommittee debating the privatization of Social Security.

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Q: At the very least, won’t this save Social Security?

A: Well, that’s jumping the gun. Remember, this is only a proposal.

Also, predicating this entire plan is the assumption--a very optimistic one, according to most on Wall Street--that the government will even have regular budget surpluses over the next 15 years.

“A forecast like this cannot be taken at face value,” said Salomon Smith Barney equity strategist Marshall Acuff. “I’m sure we’ll have at least one recession, more likely two, in that 15-year period.” And in the event of a recession, balancing the budget, let alone squeezing out a healthy surplus, will be difficult.

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Q: What happens if there isn’t a budget surplus? Will the federal government “transfer” any money to the Social Security system?

A: “That’s a very good question,” said Evan Liddiard, partner in KPMG’s legislative services group in Washington. “I think the answer is, we don’t know at this time.”

So if this proposal gets passed--and that’s a big if--there’s still a chance that the USA accounts won’t get funded in certain years.

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Q: Let’s get back to this idea of investing a portion of the Social Security trust in stocks. Who would decide how much to invest in stocks, and which stocks?

A: That is still to be decided. All the White House said was that investments would be made independently and without political interference. Presumably, a board would be set up to make decisions.

Some have argued that it would be dangerous to allow the federal government to invest Social Security money directly. For instance, the government could wind up as a major shareholder of a particular stock, which opens up myriad potential conflicts of interest.

Notes Muriel Siebert, president of New York-based discount brokerage Muriel Siebert & Co.: “I don’t want the government being able to vote their proxies and influence how companies are run.”

The counter-argument, of course, is that state and local governments have been investing employee pension money in the stock market for years.

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Q: Is it likely that blue-chip stocks would end up getting most of the Social Security funds?

A: Yes. Because this is taxpayers’ retirement money, the funds almost certainly would be invested in a conservative manner--no matter who’s in charge.

That means that larger, more established companies in the Standard & Poor’s 500 index of blue-chip stocks probably would be favored. Indeed, a simple investment strategy would be for the Social Security or USA account money to be invested in “passively managed” funds that merely track the S&P; 500. That’s what many state pension funds do.

Because indexes like the S&P; 500 are market-capitalization-weighted, the bigger stocks in an index fund will automatically get more of the money that flows into the funds. That could be bad news for smaller stocks, which have been lagging for five years.

Also, knowledge that Social Security money is on the way could spur more mergers, as medium-sized companies tried to grow to maximize benefits of stock market indexing, said James Stack, editor of the InvesTech market newsletter.

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Q: Doesn’t the mutual fund industry stand to win with the proposed USA accounts?

A: Funds might indeed be the investment of choice for these accounts. But at the same time, the balances in many USA accounts could be small. “Administratively, this could be a nightmare,” said Kelly Olsen, research associate at the Employee Benefits Research Institute in Washington, noting that fund companies would not initially embrace the task of managing tens of thousands of accounts with less than $500 in them.

Also, this being a federal program, “there’s going to be a great deal of pressure on the part of Congress to make these products as cheap as possible,” which could cut into the companies’ profits, notes Geoff Bobroff, an independent industry consultant in East Greenwich, R.I.

* MAIN STORIES: Clinton’s proposals, and the Republican reaction. A1