If Social Security is a Ponzi scheme, does that make CalPERS a Ponzi scheme, too?

If Social Security is a Ponzi scheme then all of our defined benefit pension plans such as the California Public Employees’ Retirement System (CalPERS) risk falling into the same category. CalPERS is a $226 billion pension fund with an estimated $240 billion unfunded liability according to a Reuters article. So even if you are willing to concede the point that Social Security and CalPERS are primarily "pay-as-you-go" systems as advocated on the Social Security site, you are confronted with three almost insurmountable problems.

  1. How do you scale back the future benefits in an equitable manner?
  2. How do you convince current contributors to contribute more money at the same time you are scaling back benefits?
  3. In the case of defined benefit programs that are partially advance-funded, who is responsible for investment risk?

This is not a new problem. For many years companies had difficulties managing the funding and benefits of their pension plans. An additional problem was what to do with defined benefit plans for companies that no longer existed. This problem became very apparent when the steel companies disappeared in the 1970’s. In 1974 the government created the The Pension Benefit Guaranty Corporation(PBGC) to take over the defined benefits for pensions for bankrupt companies. The funding for the PBGC came from fees charged on the remaining existing corporate defined benefit plans. This policy seems to have worked. In the following years most private companies converted their pension plans into defined contribution plans and problems with the remaining defined benefit plans diminished considerably. On the other hand public sector fully embraced the defined benefit plans. Part of the allure was that the promise of future benefits was a major issue in collective bargaining agreements. Instead of pay raises they were promised future health and pension benefits.  The long history of problems that the private sector had with funding and managing defined benefit pension plans seems to have been ignored by the public sector. Since the management of defined benefit plans were not being managed differently than the way the private sector managed their plans it is inevitable that they would duplicate the same mistakes. Considering the size and extent of the public sector unfunded pension and health care liabilities, most of these agreements were done in bad faith and led to deliberate mismanagement of pension funding and benefits. It will probably take some form of the PBGC for state and local governments that is funded by the public sector pension funds and has strict funding and benefit rules to clean up the public sector pension mess.

Social Security is different from the public pension plans but it shares many of the same mismanagement of funding and benefits problems and a more puzzling style of investing. Considering the size of unfunded liability for Social Security, the funding and benefits have been negotiated in bad faith, too. So although comparing Social Security to a Ponzi scheme may seem too severe, it shares the same bad faith negotiations and plan mismanagement as public sector pension plans. A pension plan relying solely on "pay-as-you-go" financing and funky investing may have been a viable option for my father’s generation but not my son’s generation. The pact between one generation and the next is about to be broken. The future of defined benefit plans in general is in doubt. Defined contribution plans are the preferred option in the private sector but suffer from inadequate savings rate. This problem can be fixed by a relatively simple solution, policies to encourage a higher savings rate. It remains to be seen whether defined benefit plans can overcome their predisposition to bad faith negotiations and mismanagement and create a better pension outcome than those offered by defined contribution plans.