Krasting v. Angry Bear on Social Security: ‘Critical’ interest rates

by Bruce Webb

The following is the opening of a proposed post by financial blogger Bruce Krasting.

SSTF – My Numbers (by Bruce Krasting)

A week ago I attempted to get a consensus estimate on some of the critical variables of the SSTF puzzle from the readers and contributors at Angry Bear. I started that effort with what I thought would be the easiest component to estimate; interest rates. That effort failed. It seemed to me that no one reading my thoughts on this cared about interest rates and their impact on the Fund. That is thick headed. They are a central component.

Given that this audience showed no interest in participating in the development of a reasonable set of assumptions, I have used my own. Once assumptions are established and a methodology to use them is created a projection for future annual and monthly results can be established. The actual arithmetic is easy; the hard part is making the assumptions.

Krasting’s full letter and a response thereto will be up on my web-site shortly (I’ll update with the link). But as one of the “thick headed” ones in question I would like to examine a core assumption here, that interest rates ARE a critical variable. Because they really aren’t, not at least over the time period Krasting is using. The following table is derived from Krasting’s numbers. The last column is his calculation for total surplus/deficit, the interest rates are his as well, making the accrued interest calculation one of simple multiplication. The unlabled column is simple subtraction and represents the net negative cash flow from operations in each of the years needed to offset the interest accruing.
Year TF Bal Int Rate Interest Surplus/deficit
2010 $2.5 trillion x 4.58% = $114 billion – $20 billion = $94 billion
2011 $2.6 trillion x 4.40% = $114 billion – $56 billion = $58 billion
2012 $2.6 trillion x 4.20% = $109 billion – $86 billion = $25 billion
2013 $2.6 trillion x 4.15% = $108 billion – $125 billion = -$7.2 billion

Krasting places 2013 at $2.7 trillion but that would not matter much, nor would keeping the interest rate steady at 4.58% instead of having it drift to 4.15%, anyway you slice it you have a TF that WILL throw off some $400 to $450 billion in interest between now and 2013. Under Krasting’s calculations by 2013 cash losses from operations will eat up not only that entire $110 billion or so in annual interest but enough more to actually start cutting into cash principal. Which is a big claim and one which will be discussed in the later post, but which has nothing to do with interest rates. And changes in interest rates of the order Krasting suggests can only move the number up or down a couple of percent from a median of say $425 billion.

Krasting is making the claim that a variable that can move total accrued interest dollar totals by $5 or 6 billion per year critically explains a projected change that would have total income move by $125 billion per year. That just doesn’t make any sense.

Interest is indeed a key variable in Social Security finance (though at least one Bear would dispute whether that makes it a critical variable). But what the simple arithmetic above shows changes in the interest RATE are not critical, instead they are quite literally marginal moving total Social Security financials on the order of +/- 1% per year.

Personally I have used 5% as a nominal interest rate in the past, largely because that is quite close to the average rate during the 1995 to 2005 period in which most of the Social Security debate took form (as shown in the following table And since that nominal rate came in at 4.8% in 2006 and 4.7% in 2007 felt pretty comfortable continuing to do so. If someone wants to insist on using something closer to 4.5% then fine. Because within the broader context of Social Security a 0.5% change in interest rate over a four year period just doesn’t move the macro numbers in any important way. Interest is important in the medium term, interest rates are important in the long term, but short term changes in those rates are simply not important at all.

The Angry Bears are often stubborn but rarely thick-headed when it comes to simple multiplication and addition. Of the six columns in the mini-table above the interesting ones are columns five and six and for those calculations the variations in column three literally effect numbers around the margin. They just are not a central component for calculating short term TF balances.

I have a good idea why Krasting thinks they HAVE to be critical, because tiny variations in interest rates are indeed critical in his particular area of finance. But Social Security is not an investment fund, it works on an entirely different principle. It intersects the investment world without actually being part of it, something I suggest Mr. Krasting is himself too thick headed to quite understand.