The Fed’s Artificially Low Interest Rates Are Eating Away at Social Security
The Federal Reserve has held interest rates artificially low for decades. This causes all kinds of distortions and misallocations in the economy.
And it’s creating quite a problem for the Social Security Administration.
The Social Security Trust Fund, also known as the Old-Age and Survivors Insurance (OASI) Trust Fund, closed fiscal 2021 with a balance of $2.76 trillion. That was down by 2.0% from a year earlier. It was the second annual decline of Trust Fun since 1990. The first occurred in 2018.
The fund balance had strong growth through the 1990s and early 2000s, but began to plateau after the 2008 financial crisis and Great Recession.
So, what is causing this dropoff in funding?
OASI invests exclusively in US Treasury securities. It primarily holds what are known as interest-bearing long-term special-issue Treasury securities. The Trust Fund purchases these instruments at face value, and the US Treasury redeems them at face value. The interest from these investments, along with Social Security taxes, funds OASI.
The trust fund is being hit with a double-whammy.
Payroll taxes are down. According to the 2021 Trustees Report, 55 million people drew Social Security retirement benefits at the end of 2020. That same year, 175 million people paid into Social Security via payroll taxes. That was down by 3 million from 2019. Changing demographics will likely continue to shrink payroll taxes unless Congress raises rates.
But the drop in payroll taxes is just one part of the problem. The other issue is Fed interest rate suppression. OASI’s investment in Treasury securities isn’t kicking out enough interest to keep up with the fund’s outflows.
According to WolfStreet, the weighted average interest rate earned on the securities in the Trust Fund dropped to 2.40% in September. Before the 2008 Financial Crisis, the Fund was earning over 5%.
In fact, the average interest earned by the trust fund has been dropping since the 1990s. Cooling inflation in the 80s naturally pushed rates lower. But things really got hinky when the Fed started artificially driving down interest rates to “stimulate” the economy. In the midst of a mild recession in the early 90s, Alan Greenspan began cutting interest rates. This ultimately blew up the dot-com bubble. When it burst, the Fed cut rates again. With each subsequent crisis, the central bank pushed rates lower and during each recovery, rates failed returned to the previous level. After pushing rates to zero in the wake of the 2008 financial crisis, “normalization” only managed to raise rates to 2.5% — hardly “normal.” The central bank began cutting rates in 2019, even before the coronavirus pandemic.
In effect, we have a downward ratchet effect on interest rates, and that is steadily eroding away interest income for OASI.
According to WolfStreet, despite the 13% growth of the Trust Fund assets since 2010, annual interest income has dropped by 35%, from $108.5 billion in 2010 to $70.5 billion in 2021. And the latest round of interest rate suppression is just starting to enter the pipeline.
The Fed’s interest rate repression since March 2020 is just starting to be reflected in the Trust Fund’s average interest rate and will hound it for years to come, even if long-term interest rates rise.”
As interest income continues to decline, at some point Congres will have to raise Social Security taxes, or benefits will get trimmed, or both.
The Social Security fund is in trouble. It was always inevitable that it would be. Ponzi schemes are unsustainable by their very nature. But the Fed’s artificially low interest rates are exacerbating the problem. A normal interest rate environment wouldn’t likely fix Social Security, but it would help stem the bleeding.