Uncle Sam Should Not Be Your Financial Advisor
Friday, July 31st, 2009
Whenever there is a financial issue on the table, there is usually a broad range of strategies and financial products available to provide a solution. The details can make many money decisions seem quite complex, but here’s a general principle that’s relevant to all financial decisions:
FIND THE FREE-MARKET SOLUTION. IN THE LONG RUN, IT’S THE APPROACH THAT WILL DELIVER THE BEST RESULTS.
Since the Great Depression, the US government has tried to improve the financial lives of Americans by providing government-sponsored alternatives to solve the financial issues of life. While well-intentioned, these programs inevitably have not delivered on their promises.
To understand the dynamics, here’s the general pattern: The free market will always include some adverse outcomes and shady dealers. Not all investments work out, and someone will lie, cheat or steal. As a result, some people will lose money, lose work, lose financial security. At that point, someone will say “there ought to be a law!”
This is music to politicians’ ears. Politicians look for chances to right wrongs, defend the downtrodden (and get reelected). And making laws is one of the things politicians do best.
Alas, even with good intentions, the political, law-driven approach to solving problems (financial or otherwise) usually misses the mark. In fact, the historical record of political problem-solving is that most people end up worse off than before.
Meanwhile, the free market will grind away, eventually finding an effective (and cost-efficient) method to deter adverse outcomes and bad behavior, because people operating in a free market environment have strong incentives to preserve the integrity of their businesses and their markets. Over the long run, free market dynamics produce better regulation, better behavior - and better results.
Think of the many financial issues where government already plays a strong role, either as a direct provider or regulator:
Banking (Federal Reserve, FDIC)
Retirement (Social Security, the Pension Benefit Guarantee Corporation, qualified retirement plans)
Medical insurance (Medicare)
Mortgage lending (Fannie Mae, Freddie)
Housing (FHA)
College funding (Pell Grants, student loans).
In any of these areas, you could make a strong argument that a free-market alternative would work better. Unfortunately, once government programs get started, it can be hard to unwind them; constituents who have become dependent on subsidized benefits can’t afford to give them up, and politicians have no incentive to stop delivering benefits and buying votes.
You can see this pattern played out with Social Security. Amid the Great Depression, taking care of the country’s elderly citizens was a legitimate concern. The social and financial structures of life were changing, and many were unprepared to deal with the financial stresses of living longer but not being able to work. Out of this crisis (exacerbated by the Depression) came the cry “someone ought to do something.” And government did.
The short-term results seemed ideal. The payoff to the retiree was huge when matched with the contribution. For the first time in recorded history, an average citizen could retire - they could stop working and live comfortably on a guaranteed monthly income. But the good times didn’t last.
Because of its format (a legalized Ponzi scheme in which current workers fund benefits for current retirees) Social Security has delivered an increasingly poor return to its participants. Even worse, everyone (including the politicians) now knows it the program is unsustainable in its current form, and must either be scrapped or drastically reduced.
In the meantime, the free market has developed several workable private alternatives. Life insurance and annuities have been modified to offer many of the same long-term retirement benefits to a broader section of the American public. Mutual funds have become an avenue for smaller investors to participate in the opportunities in the stock market.
Consider all the taxes a typical 60-year-old American has paid into Social Security over the past 40 years. If you apportioned that same amount into a mix of private life insurance, annuities and investments, the guess here is that 60-year-old is looking at a better retirement package than the one promised by Social Security - more insurance, more income, more options, and better promises. Because unlike Social Security’s formula, insurance companies project their payouts based on specifics and known variables; the amount invested, the age of the annuitant, and real mortality experience. In the long run, which program would work better?
The problem of course, is that Social Security is mandatory - almost everyone has to participate, has to pay. This compulsory factor makes it harder for the average American to afford a better choice. In fact, the typical American retiree “needs” his Social Security check because he hasn’t established much in the way of alternative retirement resources. It may have taken 70 years to reach this point, but the average American is now dependent on a government retirement plan that can’t deliver on its promises.
This long-term result is not unique to Social Security. The next time you face a financial decision, think long and hard before signing up for government-sponsored programs. Better yet, look for the free market alternative. Uncle Sam has not proven to be a reliable financial advisor.