Clinton’s Investment Plan--Shrewd or Socialist?


In the two weeks since President Clinton first proposed investing Social Security funds in the stock market, any hope that a consensus opinion might emerge from the nation’s normally genteel economic fraternity seems all but lost.

Opponents, led by Federal Reserve Chairman Alan Greenspan, have burst forth to claim that the idea would lead to well-intentioned bureaucratic meddling in markets at best, and outright socialism at worst.

Supporters--eyeing the bonanza that Wall Street’s historic bull market has been for investors--champion the plan as a way to bring more Americans into that party while addressing the undeniable long-term funding shortfall facing Social Security.


Yet many of the questions being raised are, for the most part, answerable only on a theoretical level: Does the government, by owning stocks, take those earnings away from private investors? Or by contributing more capital to free enterprise, does the government increase the long-term wealth creation potential of society? Economists can’t agree.

The Clinton plan itself is, so far, lacking all but the barest details: To rescue Social Security from being bankrupted by the retirement of the baby boomers beginning 15 or so years from now, Clinton proposes earmarking nearly two-thirds of the projected federal budget surplus through 2015 for the Social Security trust fund.

Of this sum, 25%--an estimated $700 billion over 15 years--would be invested in the stock market.

Clinton also proposes a new class of retirement funds for lower-income Americans. The government would contribute matching funds as an incentive for people to save more for retirement. Potentially, hundreds of billions of dollars of this money also could go into the stock market.

Putting aside the major question of whether the federal budget will even achieve the surplus totals that Clinton projects, economists seem to agree that the sheer size of the proposed investment wouldn’t be enough to swamp the stock market. Even if it all were invested at once, it would come to less than 10% of the nearly $12-trillion total value of U.S. stocks.

State and local pension funds, by contrast, already hold $1.12 trillion of stocks, according to consulting firm Greenwich Associates. Yet there is no debate over whether that has somehow compromised the U.S. capitalist system.


No, it isn’t the size of the investment; it’s the identity of the investor that raises the hackles of most opponents of the Clinton plan.

Heading the list is Greenspan, who reiterated Thursday before a Senate committee his view that it would be impossible to insulate the Social Security fund from political pressure “to allocate capital to less than its most productive use.”

What the Fed chief had in mind are regulations--fairly common among public pension funds--that either “target” investments into areas such as low-income housing or that ban investments in companies that sell tobacco, for example.

Because of such rules, Greenspan said, public funds tend to have lower average returns than private ones--even assuming a large investment in stocks. “There is evidence that suggests that the greater the proportion of trustees who are political appointees, the lower the rate of return,” the Fed chief added.

According to the Cato Institute, a Washington think tank that favors privatizing Social Security, 42% of public pension plans have targeted investments and 25% have investment restrictions.

A Texas school board, in one extreme example, ordered the divestiture of Walt Disney Co. stock in its teachers’ pension fund as a protest against certain movies made by a Disney film unit, said Cato executive Michael Tanner. He cited a 1995 study showing that the average returns of plans with such restrictions were 2 percentage points lower than those of unfettered plans.

To Greenspan, as laudable as any social goals might be, it is a mortal sin, economically speaking, to put any investment objective above seeking the highest free-market return at a given level of risk.

Interfering with that process means jeopardizing the development of new technologies and services--the very basis of our standard of living, he said.

But former Clinton Labor Secretary Robert B. Reich, now an economics professor at Brandeis University, said Greenspan should know better than to say it is impossible to insulate a federal institution from political interference. Indeed, the Federal Reserve itself is a counter example.

Under the Clinton plan, direct investment decisions would be made not by government officials but by 10 or so private money management firms hired in open bidding.

Because of the size of the funds, most of the money probably would be managed “passively”--that is, invested in index funds that attempt to mirror the performance of such market barometers as the Standard & Poor’s 500-stock index.

“Investing in index funds creates a second firewall” against political meddling, Reich said.

Yet there are other reasons why officials might want to intervene in the investment process than simply to steer money toward pet projects.

The California Public Employees’ Retirement System (CalPERS), the nation’s largest public pension fund, has for years tried to prod under-performing corporate managements, issuing annual “10 worst” lists of companies whose shares it owns.

But while that approach might work for CalPERS, it takes on an entirely different tone when it’s Uncle Sam doing the complaining.

Writing in the Wall Street Journal last week, economist Milton Friedman said that had the government fully funded its Social Security obligations by investing everything in the stock market beginning in 1937 when the system was created, government today “would own more than half of all corporations”--amounting to “complete socialism.”

Greenspan said the risk of government interference might be worth taking if the plan would leave Americans better off, but he said that is doubtful. He sees the exercise as “essentially a zero-sum game.”

How so? Social Security funds now are invested in U.S. Treasury bonds--super safe but generating relatively low returns compared with stock. Private pension funds, meanwhile, mainly own stock.

As the government sells its Treasury bonds to buy stock, or invests in fewer Treasuries, Greenspan said, there would be a “mirror-image displacement of corporate securities by government securities in private portfolios.”

In other words, somebody must earn less if somebody else is to earn more.

Exactly right, says Alicia H. Munnell, a Boston College professor and member of the President’s Council of Economic Advisors. She agrees with Greenspan that there would be no difference in overall investment earnings, but says there could be a big change in how the gains are distributed.

Lower-paid workers, for whom Social Security will make up a significant part of their retirement income, stand to benefit the most from an increase in the rate of return earned by the trust fund, she said.

It is true that Social Security is a defined-benefit plan--that is, recipients get a fixed monthly payout regardless of how the trust-fund investments perform. But if stock purchases improve that performance, Munnell said, it should reduce pressure on Congress to raise payroll taxes, cut benefits or raise the age when recipients start receiving checks.

The debate, she said, should be less about whether to invest than how. Should the money be invested collectively with all decisions made by government-appointed money managers, or should it be invested through individual accounts with taxpayers making their own decisions about how to allocate funds?

To Munnell, the answer is simple: It has to be done collectively because it’s too expensive otherwise. Money management firms would charge very small investors too much to do the job, she contends, despite Greenspan’s point that the economy is better off when all investors are free to make their own decisions about allocating capital.

Some observers, while conceding that the debate over all of this is just getting started, wonder if it’s already moot. Sarah Teslik, executive director of the Council of Institutional Investors, argues that no government ever saves anything for the next generation except by mistake.

Even the Roman Empire, renowned for long-range planning, would have invested far less in its superb aqueducts had it known they would outlast the Caesars, Teslik suggests.

In today’s poll-driven atmosphere, where politicians rarely look past the next election and with pressure mounting in Congress for an income tax cut, it is even less likely that the government will put any hard cash into savings--in the stock market or anyplace else, Teslik said.

“I would love to see it,” she said, “but it won’t happen.”


Thomas S. Mulligan can be reached by e-mail at