Social Security: If the Trust Fund is Bankrupt – Explain Long-term Interest Rates

AB readers – endure me for a moment as I have an opportunity to capture some of the dumbest arguments for privatization of Social Security by referring to a single blogger who refuses to let us comment at his blog (I guess his team has zero members) even as he proves his arrogant idiocy routinely here. OK, you have figured out already I’m referring to Patrick R. Sullivan aka Roland Patrick:

the claimants to Phd’s in economics don’t understand time horizons and their effect on risk/return ratios

Read all his meaningless ramblings if you will but this troll does not understand that “risk” has different meanings with the appropriate measure for this discussion being captured by Paul Samuelson in his 1963 Scientia paper entitles “Risk and Uncertainty: A Fallacy of Large numbers” which can be found here and his 1969 The Review of Economics and Statistics paper, Lifetime Portfolio Selection By Dynamic Stochastic Programming.

But then we know Patrick has never read a real discussion of financial economics. How do we know? Well, let’s start with his claim that the government bonds in the Trust Fund offer a lower return than those government bonds you and I purchase. Why? Because they pay an interest rate determined by government fiat? Well – it’s interesting to know that if the Trust Fund were given a long-term government bond today, its coupon rate would be around 4.7%, which is the coupon rate we were offered – and this is by design.

Patrick has a natural counter, which is essentially default risk. Never mind that the Trust Fund’s projections have plenty of resources on paper for the next two generations. You see – the Trust Fund buys essentially the same financial instruments that the General Fund deficits are rapidly making worthless. OK, Patrick supports the Bush fiscal policies that have led to these General Fund deficits, but we are not supposed to notice this inconsistency. And Patrick adds that we can’t cash in Trust Fund bonds because of trading restrictions. Is this some astute point as those who privately hold Federal bonds can trade them in? Well, let’s think about how market prices respond to default risk. Oh yea, the market prices of long-term bonds would fall, which would mean that their yields would be higher. So let’s check with the reporting of market rates from the Federal Reserve. One would think that long-term rates on Federal bonds would be substantially higher than short-term rates under Patrick Sullivan’s little hypothesis. However, short-term rates are near 5%, while long-term rates are around 4.7% to 4.8%. So is there a default premium? Guess not. Maybe Patrick thinks those who trade in the bond market are not as “smart” as he is.

If you think otherwise, which would you prefer Patrick to do first, open his blog to comments or go buy a decent Finance of Dummies book?