For better or worse, Social Security is our nation's most valuable social resource. Since the first payouts began nearly eight decades ago, the program has helped pull tens of millions of retired workers out of poverty.
Yet, it's also a program facing serious funding challenges in the years that lie ahead.
The newest Social Security Board of Trustees report estimates that it'll be facing a cash shortfall totaling $13.9 trillion between 2035 and 2093. The year 2035 is significant in that it's the year Social Security's asset reserves -- i.e., its aggregate net-cash surpluses since inception -- are slated to run out. Once this excess cash is gone, Social Security's retired worker benefits could be cut by as much as 23%, depending on whether or not lawmakers in Washington have acted to raise additional revenue and/or reduced expenditures.
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Social Security's investment holdings contain a bounty of useful data
Having regularly followed Social Security's outlook for quite some time, and being a numbers guy, I tend to keep very close tabs on the program's annual revenue collection and expenditure figures. Of course, a lot of these figures aren't made known until early in the following year.
However, the Social Security Administration (SSA) does disclose the investment holdings of the Old-Age and Survivors Insurance (OASI) Trust and Disability Insurance (DI) Trust each month. As a refresher, the SSA is required by law to invest the program's net-cash surpluses into special-issue bonds and, to a far lesser extent, certificates of indebtedness, each of which sport various yields and maturities. The interest earned on these bonds and certificates of indebtedness totaled $83.3 billion of the $1 trillion collected by Social Security last year.
On one hand, Social Security's investment holdings as of the end of August 2019 have produced a welcome surprise. When the year began, the program had $2.895 trillion in asset reserves, after having added a little over $3 billion in net-cash surpluses in 2018. But as of the end of August, the program's asset reserves had increased to $2.91 trillion, representing a gain of roughly $15 billion in eight months. Remember, the Trustees portended an increase of a mere $1 billion in 2019, so stronger-than-expected economic growth looks to be once again aiding the Social Security program.
But not everything is good news.
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A dovish Fed could cost Social Security billions
The special-issue bonds that the SSA is required to purchase are governed by the same rules as any interest-bearing investment. In other words, special-issue bond yields are going to be sensitive to the monetary actions of the Federal Reserve, just like any interest-bearing asset.
For a period of seven years (December 2008 to December 2015), the Fed kept the federal funds rate at a historic low, which had the effect of dramatically pushing down bond yields. This meant that any newly purchased special-issue bonds had nominally smaller yields, and therefore produced less in interest income for Social Security.
Of course, the Fed wound up raising rates nine times between December 2015 and the end of 2018. This helped to modestly boost bond yields for a short period of time. But if you've been following the Fed of late, the central bank has again moved to a period of monetary loosening (i.e., rate cutting). As rates fall, the likelihood that bond yields will decline increases. And when bond yields decline, Social Security nets less in interest income.
Given that the SSA buys bonds in multiple maturities, we really haven't witnessed a huge drop-off in average yield... until now. Every special-issue bond with a yield of 4% or greater will mature by 2023, or earlier. Meanwhile, more than $860 billion of the program's $2.91 trillion in investment holdings is earning 2% or less.
Over just the past eight months, the average interest rate on Social Security's investment holdings has declined from 2.85% to 2.744%. That may not sound like a lot, but that just over one-tenth of 1 percent decline in average yield means about $3.1 billion less in interest income on an annualized basis. And make no mistake about it, this trend of a declining average interest rate is going to continue, thereby adding more pressure to an already challenged program.
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If Congress doesn't get its act together, there will be no interest income
Then again, a dovish Fed may be the least of Social Security's worries. That's because if lawmakers don't get their act together, and quick, there won't be any asset reserves left to earn interest income.
The Board of Trustees believes that 2020 will be the first year since 1982 when Social Security expends more than it collects. Though these outflows should be relatively manageable early on, they're expected to grow rapidly. By 2028, the Trustees foresee a $182.5 billion single-year outflow, leaving the program with "only" $2.148 trillion in asset reserves. Assuming these outflows continue, all $2.91 trillion will be gone by 2035, leaving no excess capital to loan to the government in order to generate interest income.
Mind you, there are multiple proposals on the table to raise revenue and/or cut long-term expenditures. A lack of viable solutions isn't the problem. The crux is that Democrats and Republicans each have proposals that fix the problem, and therefore neither party feels the need to cede an inch and find common ground with their opposition on a bipartisan solution.
Historically, overhauls to the Social Security program have come during the eleventh hour, which isn't a good sign for the program and its as-of-now abundant interest income. Only time will tell if Washington has a surprise or two up its sleeve.
