Grading PolitiFact (Rhode Island): John Loughlin, Social Security and Ponzi schemes

The issue:

John Loughlin is a Republican running for the House of Representatives in Rhode Island's District 1.

The fact checkers:

Cynthia Needham:  writer, researcher
Susan Areson:  editor

Analysis:

Full disclosure:  I've referred to Social Security as a Ponzi scheme in the past.

PolitiFact Rhode Island provides ample context in presenting Loughlin's statement:

In perhaps the most extensive example, Loughlin had this to say while speaking in February at a Rhode Island Voter Coalition forum:

"For those of you who haven't retired yet, Social Security is a Ponzi scheme. The people who are working are paying for the people who are retired. There is no Social Security trust fund per se. Your money doesn't go into a big bank and come out when you retire. You're hoping there will be enough young people working to be able to pay your Social Security when you retire. That, ladies and gentlemen, is a classic Ponzi scheme. It's a textbook definition."

Though the story provides plenty of context for Loughlin's remarks, Needham brackets the quotation with references to Bernie Madoff, the guy convicted of securities fraud in association with a Ponzi-structured system.  Madoff was also found guilty on a host of other charges.  Needham writes that Loughlin is comparing the federal government to Madoff (which Loughlin did during an interview with PolitiFact Rhode Island).

So what is a Ponzi scheme?  Needham provides an answer:

The current definition on the U.S. Securities and Exchange Commission website identifies it this way: "A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors."

Sound familiar? Loughlin thinks so. He insists that's the same process used to finance the federal Social Security program. And he believes that when benefits owed exceed the money coming in, the system will fall apart.

All three of Needham's statements concerning Loughlin appear dubious.  Since Loughlin's description of Social Security is different in substance from the SEC version it does not necessarily follow that Loughlin thinks the SEC version sounds familiar.  Likewise the presumption that it's "the same process used to finance the federal Social Security program" since Loughlin says nothing about purported "returns" on the investment.  And the third represents an ambiguity in terms of how we define "the system will fall apart."  Private investment firms can't compel participation by law, so the government will not chase away potential investors the way the failure of a traditional Ponzi scheme might.  Should we assume that Loughlin assumes otherwise without hearing him say it?  Is it fact checking if we make that assumption?

PolitiFact Rhode Island allows "there are similarities" between Social Security's structure and a Ponzi scheme.  Monies from new investors (younger workers) go to those previously invested in the program.  And whatever "trust fund" is said to exist amounts to an IOU from the government.

PolitiFact asserts one major difference:

But there is a second, critical component that defines a Ponzi scheme: fraud. To reach the level of this kind of scam, an investment setup must intentionally con investors, while making efforts to convince them that the finances are legitimate.

Is fraud an absolutely critical component of a Ponzi scheme?  The government, as noted above, can compel participation in the program.  There's no need to dupe people into participation because they're forced to participate.  On the other hand, the program would not continue without a substantial degree of support from voters.

How does the government obtain that support from voters?  See the "Afters" section.

Fraud is not an essential aspect to the Ponzi scheme.  It is an optional element used by entities unable to force participation in their financial/insurance products.  Regardless, the government has arguably misled its citizens about the financial soundness of their social insurance program.

In fact, Social Security was set up in the midst of the Depression to serve as an insurance plan of sorts for the elderly. Since then, participants and those who pay into the system have been well aware of how the program is run.

 It wasn't too long ago that a commenter on PolitiFact's FaceBook page stated that she was entitled to get back what she paid into Social Security.  Apparently she didn't get the memo as to how Social Security works.  I mention that because Needham is using a technique discouraged in journalism:  She's stating something as a fact and leaving herself as the authority behind the truth of the claim.  Reporting journalists customarily refer facts to trusted third-party sources.

Is Needham's claim solid?

From a 1997 report (page 6) from the Social Security Advisory Board:

One survey found that 79 percent know that current workers pay for the benefits of current beneficiaries (EBRI, 1994).  However, in the same survey, nearly two thirds thought that current workers pay for their own retirement.

Wouldn't it be nice if Needham had substantiated her claim by citing a dependable source?

Needham did rely on an expert source to substantiate the claim that the lack of fraud keeps Social Security from being fairly compared to a Ponzi scheme.  Rick McIntyre, an economics professor at the University of Rhode Island, provided assurances that Ponzi schemes require deceit.

I had difficulty reconciling McIntyre's remarks with an abundance of professional literature in his field that talks about "Ponzi game" and  the "no-Ponzi game condition" in reference to government fiscal policy without any apparent reference to the critical nature of the deceit question.

To Kindelberger and other writers on financial scams, the essential feature of Ponzi's activities was 'misrepresentation or the violation of an implicit or explicit trust' (1978: 79-80).  In economic theory, however, the label 'Ponzi' survives largely stripped of its connotation of fraud. 

(The New Palgrave Dictionary of Money & Finance)

PolitiFact used one other expert source, Mitchell Zuckoff.  Zuckoff is a journalist who wrote a book about Charles Ponzi's original rip off.  Zuckoff agreed that fraud is essential to Ponzi schemes.  I'm supposing that Zuckoff is unfamiliar with the relevant professional literature.  I'd hate to make that assumption of McIntyre, but it may be the case.

Apparently unaware that her analysis lacks a secure foundation, Needham concludes:

Without that key element of deceit, we find it hard to find Loughlin's analogy -- or that of anyone who uses it -- credible.

But there's one more thing. Loughlin doesn't just compare Social Security to the Ponzi scheme concept, he takes it a step further and draws a parallel with the specific case of Madoff, who is believed to have run the largest fraud of this kind in history.

Publicly measuring a 75-year-old U.S. government program against such a massive crime is not only overstating the issue, it's bordering on irresponsible.

False. 

Leaving aside the problem of the false essential feature for Ponzi schemes on which PolitiFact rests its case, it isn't difficult to suppose a legitimate use of the Madoff example.  Madoff is now a well known figure, and using his name immediately brings to mind a recent and concrete example of Ponzi financing in action.  Ordinarily that's just good and effective communication.  Is it possible to fault Loughlin for invoking the comparison with Madoff's specifically criminal actions?  Sure.  But it's difficult to argue that as Loughlin's main point.  And Needham doesn't argue the point, instead allowing it to enter the picture by implication.

PolitiFact Wisconsin graded a similar claim "Barely True" using the same fallacy of equivocation present in the PolitiFact Rhode Island effort.  The latter story provides no explanation why the ratings differed.

The grades:

Cynthia Needham:  F
Susan Areson:  F

I've applied the tag "Journalists reporting badly."

Needham should have used more than two expert sources to substantiate the notion that fraud is essential to Ponzi schemes.   And whatever his familiarity with the original Ponzi scheme of Charles Ponzi, the journalist Zuckoff probably should not have been chosen a key expert source.  Ignoring the professional literature, which has quite a bit to say about Ponzi financing, helped lead Needham down the wrong path.  Using herself as the expert source for the claim that people understand the nature of Social Security financing was unacceptable.

As for the editor, Areson, she should have told Needham everything I just did but prior to publication.


Afters:
Government misrepresentation

The government misrepresents the financial picture surrounding Social Security with statements like those that follow.

Franklin D. Roosevelt:

This law, too, represents a cornerstone in a structure which is being built but is by no means complete. It is a structure intended to lessen the force of possible future depressions. It will act as a protection to future administrations against the necessity of going deeply into debt to furnish relief to the needy. The law will flatten out the peaks and valleys of deflation and of inflation. It is, in short, a law that will take care of human needs and at the same time provide the United States an economic structure of vastly greater soundness.

Does that sound like a fair description of a pay-as-you-go structure?  Does it include recognition of the pitfalls of demographic shifts?

Dwight D. Eisenhower:

By enabling some 10,000,000 more Americans to participate in the Old-Age and Survivors Insurance Program, it gives them an opportunity to establish a solid foundation of economic security for themselves and their families.

Eisenhower did not speak about the funding structure of the program, but he did go on to emphasize "These Acts and the Social Security amendments I have approved today will bolster the health and economic Security of the American people. They represent one of the cornerstones of our program to build a better and stronger America."

Lyndon B. Johnson:

Social security has become so important to our lives, it is hard to remember that when it was first proposed it was bitterly attacked--much as Medicare was attacked and condemned before it came into being 2 years ago.

Today, for the second time in 30 months, I am signing into law a measure that will further strengthen and broaden the social security system. Measured in dollars of insurance benefits, the bill enacted into law today is the greatest stride forward since social security was launched in 1935.

President Johnson extolled the benefits of the program and skipped over any and all description of its funding.in this speech.   Indeed, his speech encourages the listener to measure the success of the program in terms of how much was spent for benefits.

Richard M. Nixon:

I recommend an acceleration of the tax rate scheduled for hospital insurance to bring the hospital insurance trust fund into actuarial balance. I also propose to decelerate the rate schedule of the old-age, survivors and disability insurance trust funds in current law. These funds taken together have a long-range surplus of income over outgo, which will meet much of the cost. The combined rate, known as the "social security contribution," already scheduled by statute, will be decreased from 1971 through 1976. Thus, in 1971 the currently scheduled rate of 5.2% to be paid by employees would become 5.1%, and in 1973 the currently scheduled rate of 5.65% would become 5.5%. The actuarial integrity of the two funds will be maintained, and the ultimate tax rates will not be changed in the rate schedules which will be proposed.

Nixon's speech primarily talked about the benefits of Social Security, but he waxed technical about financing toward the end.  The "hospital insurance" he talked about was Medicare, which now constitutes close to a fifth of the federal budget.  Social Security itself takes up another fifth.  We are assured of "actuarial integrity."  The presidents do not spend much time emphasizing that today's worker pays the benefits of today's beneficiary.  That part constitutes the fine print.

Jimmy Carter:

The Social Security system affects the lives of more Americans than almost any other function of government. More than 33 million people currently receive benefits. Another 104 million people are making contributions with the expectation that they will receive benefits when they retire or become disabled, or when their survivors need help.

Today, the Board of Trustees of the Social Security Trust Funds is submitting its 1977 report to the Congress. The report tells us that the system critically needs financial support in the short term. The high unemployment of recent years has curtailed Social Security's revenues, while benefits have risen with inflation. Since 1975 expenditures have exceeded income; and existing reserves will soon be exhausted.

Existing reserves will soon be exhausted?  How did that happen?  Just two presidents ago we were assured of "actuarial integrity."  Carter comes the closest thus far to offering a picture of the financing structure.  The 104 million are paying in expectation of receiving benefits.  Why the 104 million pay in expectation of receiving benefits is the question.  Perhaps their trust in government outweighs their fiscal sensibilities.  Carter goes on to explain how the system has crashed, forcing the need to curtail increased benefits and bring in additional revenue. 

Social Security was fixed, in a manner of speaking, on separate occasions under Reagan and Clinton.  How good are the finances if a periodic bailout is often needed?


Ponzi games and schemes

Though the terms "Ponzi game" and "Ponzi financing" occur more frequently in the professional literature than "Ponzi scheme," I am unable to detect any difference between the terms when used in the context of economics.

Economists argue over the concept of the "rational Ponzi game"--the idea that Ponzi financing may work perpetually under certain sets of conditions.



Oct. 7, 2010:  Added link to PolitiFact Rhode Island story on Loughlin, replaced the second incidence of "game" with the word "scheme" in the next-to-last paragraph to match authorial intent. 
Oct 8, 2010:  Added a previously absent "s" to "Representatives" in first paragraph.  The Loughlin campaign should not get excited at the prospect of ultimate rule in the "House of Representative."  Also belatedly added a page break I had intended to insert from the first.