Thursday, April 07, 2005


In response to yesterday's blog about the "IOUs" (a.k.a. government bonds) in the Social Security Trust Fund, the estimable KipEsquire comments that "full faith and credit" is only meaningful if it is between two independent parties. An "IOU" from me to myself is meaningless (is that an "I-O-Me"?), and equally meaningless, he argues, are bonds issued and held by the federal government. While I understand his point, I disagree that an "I-O-Me" is necessarily meaningless. Any IOU (including an I-O-Me) is as good as the "faith and credit" (i.e., willingness and ability to pay) that backs it up. You can have IOUs between independent parties where the "faith" and/or "credit" is weak (think "junk-grade" corporate bonds), and you can have I-O-Mes backed by a solid intention and future ability to repay (think home equity line of credit). So the strength of the "full faith and credit" is not necessarily correlated to the arms-length of the transaction. Of course the danger of a loan to yourself is that it makes it easier to forgive (and write off) the debt. How willing and able the government will be in 2017 to meet its obligations to the Trust Fund is the $6.4 trillion question.

It should also be noted that a shift to personal accounts will not eliminate I-O-Mes. The majority of American corporate pensions/401(k)s and individual retirement accounts allow for the individual to borrow their own money out of their retirement account for present use. (Nearly one in five American families with a retirement account has an outstanding loan against it, per a 2004 ICI report.) The individual is expected to repay the loan with interest, but like all loans, it is always possible to walk away from the debt (with tax and credit repercussions). And late last year, ING announced a new credit card that is backed by your own retirement. (This was actually the idea, in part, of the Nobel-winning economist Modigliani, who believed it would have beneficial effects.)

The impact of borrowing one's own retirement savings depends on a couple of factors, according to the Center for Retirement Research. The first factor is whether the loan is used to increase current consumption (e.g., a vacation), or merely to rearrange current finances (e.g., consolidate credit card debt at a lower rate). The second factor is whether the loan is ultimately paid off or not. They note that increasing current consumption reduces total lifetime consumption. The money that you won't have later because you've spent it now is compounded by foregone earnings and tax leverage. Most of these same issues would apply to the federal government borrowing from the Trust Fund. It's already clear that the money borrowed has been used to increase federal consumption (it wasn't used to pay off other bond debt). Given the gaping national debt, will the loan turn out to have been an "early distribution"? That will depend on the willingness and ability of Americans to pay more taxes, and whether the rest of the world will finally put a credit limit on the American national credit card.

1 comment:

KipEsquire said...

"you can have I-O-Mes backed by a solid intention and future ability to repay (think home equity line of credit)"

But a home equity LOC is most definitely not an "I-O-Me" (I like that expression, btw!). It's a transaction (or more correctly an agreement to potentially enter into a future transaction) between the homeowner and the lender, not between the homeowner and himself.

And actually "full faith and credit" doesn't even apply to home equity loans anyway -- such loans are backed not by "full faith and credit" but rather by a lien on the property.

A student loan might be a better example of a debt backed only by "FF&C," but again the loan involves a borrower and a lender, not a borrower and himself, so it is not a valid analogy to the Social Security "trust fund."

Thanks for the hat tip. :-)