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Is the 401K a Ponzi Scheme? Discuss

As of this writing, the Dow has slipped -111 points.  As Atrios would say: “Weeeeeeeeee!”  Update:  It’s back up again, “whhooooAAA!”  Update: Annnd back down again.  “Weeeeee!”  Isn’t this fun?

I was amused and irritated to see the question “Is Social Security a Ponzi Scheme?” at Room for Debate in the NYTimes recently.  (Fortunately, no one debating said it was, not even the rabid Republicans)  We are only discussing this because Rick Perry, Mr. Goodhair himself, brought it up.  The answer is “No”, it is not a Ponzi scheme.  The system has been working for something like 80 years now.  It’s an insurance system.  Participants pre-pay into it through deferred wages and withdraw it when they need it.  The money collected is used to buy Treasury Bonds.  Social Security is not an investment scheme that promises to return a huge bang for the buck.  It’s a modest retirement program, a fallback in case everything else fades.  It’s supposed to be solvent for decades to come.  The only issue is whether there will be anyone still employed to pre-pay.  The more people out of work, the fewer of us paying our share and, ironically, the more we’ll come to depend on it down the road.

The 401K, however, IS a Ponzi scheme.  No doubt about it.  Investors are told that if they save in a 401K, their money will grow.  How much it will grow depends on how much your 401K managers are willing to bamboozle you.  The investor is told that whatever it is you think you can afford to put into the system is not going to be enough to retire on.  The more you put in, the greater your payoff 30 years from now when you retire.  You’ll be rich, rich, rich!  And it certainly looks like that, doesn’t it?  That little pile of cash just keeps growing and growing, until there is a market “correction” and it doesn’t anymore.

One of the characteristics of a Ponzi scheme is that it requires a lot of new investors to support the returns of the older investors.  In this game, it helps to get in early.  There are a lot of older babyboomers who didn’t get in while they were young but when they did start contributing to their 401Ks, they were in their prime earning years and were able to set aside a nice chunk of change.  Pretty soon, they’re going to want to take that money out to live on and as we all know, there are a lot of babyboomers.  And they can do that once they’re old enough.  They won’t be socked with a punitive tax when they withdraw that money.  The rest of us who are unemployed and may need those funds to live on will pay dearly.

Please do not tell me about how prudent it is to put aside your money for retirement and not spend it no matter what.  We’re not stupid.  But that money could be used to stimulate the economy at a time when the Republicans stand in the way of doing anything helpful, and could theoretically provide more jobs, and with jobs we can start socking money away again.  When money is tied up in some illiquid 401K that you can’t get to without undergoing a hemorrhage, the only people it benefits are some testosterone poisoned fund managers and their bonus loving banks.  Funny how the Obama administration and Congress are so willing to cut a break on the payroll tax but not the excise tax for withdrawing 401K benefits.  It almost sounds like they were trying to undermine social security while forcing people to stay in a 401K where there is no guarantee of a return and much, much more risk, tying up those funds for decades to come.  Now, why would they do that…?  I only ask.

A market “correction” could wipe you out.  That’s harder on a soon to be retired senior than a younger worker.  But if you don’t have a job, you can’t contribute.  So, the money that was supposed to guarantee your retirement at Millionaire Manor doesn’t really grow.  Over time, the mutual funds will require more investments coming in to offset the money taken out.  There’s bound to be a plateau, unless the fund managers find bigger and better scams, but won’t that entail more risks?

So, to recap: the 401K promises gigantic returns to people who get in on the ground floor.  More and younger investors are required to also contribute to prop up the stock prices of the companies your funds are dumped into.  Older investors can withdraw all of their funds penalty free; younger investors cannot.  The savings are not guaranteed and can be wiped out by market conditions, or diminished by the withdrawal of the generation above you.

Sounds fairly Ponziesque to me.

That’s my theory and I’m sticking with it.



33 Responses

  1. Your problem is you’re not “too big to fail.”

    But the people who lost your money for you are, so they get bailed out – with your children’s taxes.

  2. and the CEO,s just get richer!!! 😡

  3. I still have a problem with “having 6 months worth of living expenses in savings” in case of emergencies. This 401K thing? Meh. My school has /something/ like it and I HAVE to put something in it each check…assuming I keep working here until retirement at 70… will I be able to retire on it? No effing way. If I made enough to put in the damn thing sure, but really who, besides CEOs and other phantoms make enough?

    • I think my contributions were pretty substantial. It kind of pisses me off because, in retrospect, I should have used some of that money to pay the principle of my mortgage. Now, my 401K manager has the money and I still have a mortgage and no job. I think it’s the worst idea we under 55’s have ever been snookered into. We’d be better off with pensions and if some people want to risk it all on the stock market, they should do it without dragging the rest of us in.

      • If you’re vested in it, part of the money is your employer’s contribution. You might want to take the penalty on some of it (which will likely be only slightly more than your employer’s contribution was so in reality you’ll only pay 3-4% net on the withdrawl) and use that money to pay down your mortgage somewhat. It might be wise to roll some of the money into an IRA, meaning you’ll have no penalty and can put the money into safe investments, even CDs!.

        IMHO That’s a better solution than letting it ride in a market that is going nowhere.

        • Thanks for the suggestion, TA. I will definitely look into it. I hope I don’t have to break into the piggy bank but moving to a safer and more boring option in an IRA seems like the way to go. I’m done with risking my money.

      • Well, your 401(k) manager gets their commission, and they can pay down their own mortgage, even if you can’t pay down yours. So it all nets out.

      • I see it the way you do, RD. And this is a GREAT post.

        I’ve often wondered why Social Security always has a target on its back while those stupid effin’ 401(k)s are worshipped as the bestest retirement scheme ever. Accent on the scheme.

  4. Great article, very insightful.
    And let’s keep an eye on Mr. Retro Perry, a 19th century man.

  5. From the Wall Street Journal:
    “Even a pyramid system such as this could be solvent if it took advantage of compound interest. But the overriding problem is that not a dime of the payroll contributions the government collects over a lifetime is saved and invested for a worker’s retirement. Social Security’s pay-as-you-go financing model means that 12.4% of all wages are transferred to current beneficiaries, the surplus dollars are spent by Congress on other things, and Social Security gets an IOU from the Treasury.”

    • The trust fund currently has a surplus. It will not become a pay as you go system until 2037, at which point of time, it will still pay 3/4 of what was promised if nothing is done. And all that needs to be done is tweak the system slightly to raise the cap on income covered by the payroll tax. Go read the Room For Debate contributors, particularly theresa ghilarducci, robert reich and that dude from UC berkeley.
      Social security works and has been a successful, well run retirement insurance program for nearly 80 years. That’s why the Republicans hate it. It obligates them to the rest of us and makes government look good. We can’t have that. It makes us question our zeal to privatize everything.
      Don’t read the WSJ. It’s bad for your teeth. Or something.

  6. Yes, think you have a germ of an idea there, RD..Before reading your article, was on the assumption that SS could be a ponzi scheme, but you make a valid point there on your article..and your point of saying that 401(K) is a ponzi scheme has a valid point too..kudos to your clear explanation..

  7. Show me another “ponzi scheme” that has ever been $2.4 trillion in the black.

  8. Oooo, GOOD one! Why don’t Democrats ever think of witty retorts like that?

    • Because the Ds want to loot Social Security just as much as the Rs do they have the same owners, and the same incentives, so why wouldn’t they?

      • Both parties have already looted social security over the years, to the tune of 2.6 trillion, replacing the money with non-negotiable paper – and they just don’t want to pay it back. So instead, they did what any out-of-control government does.. they devised a plan to punish their victims. They should all be indicted and have their personal property seized like you and I would suffer once we were caught embezzling. Nobody asked us if it was okay to ‘borrow” that money.

        • yep, I call it fraud. We paid up front. If I’d known the bastards were going to try to get out that deal, I’d have put my money in a different savings plan or paid off my house.

  9. My apologies since this is off topic, but the increasingly shrill defense of Obama in netrootsia is getting pretty extreme. At Newshoggers, one of the main guys linked to this lady from Balloon Juice posting a long rant about how Obama is so misunderstood, etc. You’ve heard it before, I won’t bore you, the link’s below. The interesting thing is that I found it hilariously OTT as a defense of Obama and said so in comments, and the guy responded back in comments like I’d shot his dog, betrayed my team, whatever. Newshoggers isn’t a very tribal sort of place, it’s heavily policy oriented and some of the other main guys are very critical of Obama. It just struck me as very weird and out of place and seemed to betray some strange “dark night of the soul” that some of O’s followers are going through. Bizarre.


    • Let’s face it, Obama didn’t really have to run very hard in 2008. He knew pretty early on that the game was rigged in his favor. 2012 is going to be a totally different animal. If the GOP nominate someone like Romney or Huntsman, it could be a very hard race because Romney and Obama have more in common than they should. How do you decide between Republican lite and moderate Republican? They will both be aiming for the same population. The exciting races will be for Congressional and Senate seats.
      So, if you are a Democratic loyalist, a weak and defensive Obama is not what you want right now. I’m always struck by the loyalist’s complete lack of imagination. Why aren’t they looking around right now for a back-up candidate? That’s what we do in pharma research. We never pursue just one chemical series in a project. If the lead series fails, and they nearly all do, there’s got to be a ready backup to work on or the whole project is a tremendous waste of time and money for the company. The Democrats are not developing their bench. They’re pinning all their hopes on one guy to the exclusion of all the others with the expectation that voters will see the Republican candidate as so horrible that electing him would be tantamount to murdering the Republic. But that’s a lot less likely scenario if the Republican candidate is someone like Romney.
      So, they’re scared. And stupid. And unimaginative. C’est la vie. We don’t always get what we deserve but we almost always get what we choose.

  10. Just dropping in to say HI as I sip on a little of my fine boxed Merlot.

    HI, Riverdaughter and everyone!

  11. Pensions are to be desired, but government for the Corp. doesn’t want that association with former employees.

    The way to keep a 401K in my experience is to put most of it in money market funds, assuming they are available. Then there isn’t a gain other than the percentage that is not directly taxed, so whatever the tax rate would be is yours free. That is usually more than the going interest rate. If you had taken the same money in your paycheck, it would have been taxed at your current rate.

  12. Scott,
    I read your link and I remember reading that shortly before 2008 Obama himself felt he wasn’t ready to run for President yet. Heavy hard convincing from Harry Reid that this was Obama’s one AND ONLY opportunity finally convinced Obama to run THIS TIME. If that is true, then what was Reid’s motive and what class power economic interests was Reid working for to get Obama to run THIS TIME? Does anyone have any theories?
    About TA’s advice on Riverdaughter’s conundrum . . . I wonder whether a very knowledgeable accountant could raise all the right questions and provide
    the needed answers. I have never been in that situation facing that choice, but if I were I would find out whether prepayment of a huge set of principal payments would pre-zero-out the interest attached to each of these payments. If it would, I would then wonder whether the interest thereby not ever needing to be paid would add up to as much money saved as I would lose through taxes and penalties on the 401k pullout and partial rollover plus the return not recieved in future on the money not left in the 401k. If it did, I would then have to decide whether my house was valuable enough to me
    as shelter and subsistence-survival platform to me that I would want to be able to live in it at the expense of having very little spendable money in retirement. (I would assume that house prices will never “recover” to their Greenspan-Credit-Bubble peak, and the only value the house would ever have to me would be its shelter and survival value.) If all those answers came out yes, then I might well set aside caution and roll over the 401k to divert enough of the money into principal prepayment to make the process pay and to protect myself from looming homelessness.
    About ponzi schemes . . . in a world of depleting nonrenewable resources, economic growth itself is a ponzi concept and a ponzi pursuit.
    So any “fund” requiring economic growth to increase its value rests on a ponziconomic foundation and will come to a ponzi end. Only in this case the enpoint won’t be running out of money. It will be running out of food, water, oil, etc. to buy with the money.

    Back to Obama . . . I wonder when people will start referring to him as:
    “the race card Wall Street played on a nation. The race card Wall Street played on us all.” If anyone here thinks that little meme could attrit Obama’s image so fast that the Democratic Party is forced to accept a cadidate-transplant in time for the election, feel free to use it. Or if not,
    then not.

    • My theory? After losing in 2000 and 2004, the Democrats wanted to make damn sure they won this time. They were afraid Hillary wouldn’t be able to pull it off because of the crazy CDS of the 90’s. So, they knifed her. But, had they been paying attention, they would have seen that by the end of the primary season two things were working strongly in her favor: 1) the media assault on her was having no effect anymore. Voters had a “been there, done that” attitude towards her. She was becoming immune to the right wing noise machine. She had figured it out. 2) The economy was starting to take center stage even back then in the primary season. The Democrats could have run Elmer Fudd and he would have run. So, there was no need to take her out. But the party had developed a very short term mindset. They saw the money Obama was pulling in and all they wanted was to win in November 2008. To do that, they made some deals with the devil, tacked hard right to appeal to conservatives and then lucked out when the stock market tanked. They almost didn’t pull it off. 2012 is going to be much harder for them.

  13. One thing you left out of the analysis – why would anybody believe that the favored tax treatment will still be in place for retiree withdrawals twenty or thirty years down the road? Congress can change the tax treatment of these plans any time they want.

    In the unlikely event you have a substantial positive balance in the plan when you reach retirement age, you and your tiny cohort will be walking around with giant bullseyes painted on your wallets. Right at the exact time a very large cohort of social security recipients is looking for a source of funds to make up a shortfall. The owners of largish 401Ks will be a perfect target – they’ll look rich to the masses, but will not be able to protect themselves politically the way actual rich people do.

    The 401K was essential to trick wage slaves into believing they were petit bourgeois for the last 30 years, so they would support the rentier economic program. There is absolutely no reason to believe the rentiers will pay out if they can avoid it. Your money will either go to the rentiers directly, or to the government so taxes on the rentiers can be reduced.

  14. Off topic: 12 years have passed since that awful day, but I still miss the Moon. :mrgreen:

  15. Lately, I have found myself musing over what sort of cardboard box I will need to find to live in when I am older….

  16. Off topic, but this is something from a reknowned trader, The Mad Hedge Fund Trader John Thomas, who is actually a pretty sharp guy and not a knee-jerk Republican by any means…

    He thinks Obama may step down and says Hillary has been in the “safe” cabinet post in the wings as backup…this is a FASCINATING analysis of how the election may turn out, even if his speculation about HC doesn’t come true…



    To believe that President Obama is anti-business and bad for the economy is lunacy of the highest order. Barack knows more American history than either you or I will ever forget. He is well aware that a poor economic performance has been the primary creator of one term presidents since WWII.

    Kennedy was assassinated, Johnson retired early, Carter was demolished by the stagflation caused by the Iranian revolution and the second oil shock, and George H.W. Bush was turfed out by a minor recession, despite winning the first Gulf War. Therefore, the economy had to be Obama’s top priority from the first day in office. To do otherwise was for Obama to risk becoming one of the countless jobless himself.

    I believe that the economy that Obama inherited was so broken that it will take decades to fix, if ever. It is easy to forget that virtually the entire financial system was bankrupt, the credit markets had seized up, and the ATM’s were two weeks away from failing to dispense cash. The government newly found itself a major investor in the country’s 20 largest banks, General Motors, and AIG.

    But the reflationary measures he was able to get through a reluctant congress were too small to engineer the recovery he needed. The boldness of the moves seen during the Great Depression was sadly absent. Remember, Franklin Roosevelt directly hired 3 million men during his first two years through the Civilian Conservation Corps, immediately preventing 5 million from immediate starvation. This was when the population was less than half of what it is today.

    To a large extent, Obama has become the fall guy for the excesses of earlier administrations. The big problems facing the country are long term and structural. The $15 trillion national debt is the product of 30 years of tax cuts and spending increases, primarily for defense.

    Our runaway health care costs can be traced by our failure to nationalize health care when the rest of the developed did so in the late 1940’s, enabling them to keep their medical expenses to two thirds of ours, with better results. Social security and Medicare were financially flawed from the day they were launched, and modern day politicians were loath to touch them once they became sacred cows. None of these intractable problems are amenable to a quick fix.

    All of this leaves Obama’s popularity in the polls falling, going into one of the most acrimonious and hard fought elections in American history. Obama has become the Jackie Robinson of American politics, the first African-American to play in major league baseball. The better the job he does, the more people hate him. Robinson died at 53, largely due to stress.

    If he can’t pull out of his tailspin, I believe the president will withdraw his candidacy, and throw it open to other contenders. That is what Lyndon Johnson did in 1968 due to declining health and an unpopular war. When you try to push history forward too quickly, sometimes it bites you back. The election of Obama was such a generational leap in so many ways that some retracement was inevitable. Blame it all on the excesses of the previous administration, which were many. After all, the Democrats don’t want to commit suicide.

    There are two potential candidates. I believe that Hillary Clinton was given the safe position as Secretary of State precisely to hold her in reserve as a backup candidate in 2012 in case something happened to Obama. People of both political parties agree that she has done a spectacular job managing America’s role in the Arab spring, providing military support to drive Khadafy out of power, and keeping the Chinese buying out gargantuan debt issues. But as a presidential candidate, she is not without baggage.

    MORE as he talks about potential candidates…says Bloomberg is the dark horse candidate, Perry may have peaked already, etc. etc. and how it all boils down to Ohio and Florida again and how the Democrats could lose 94 electoral votes and still win…

    • There are too many op/ed “journalists” in the print and broadcast media who will not walk back their CDS/Al Gore hatred to get behind a candidate Clinton. They have no choice (and are probably under orders) other than savage her again as the did in 2008.

  17. insightanalytical,

    Your comment deserves a better longer reply than I have the energy to offer right now. For now I can only say that I suspect those Democratic Party commanders on the bridge and experts in the engine room will be disappointed and planless when they discover that Senator SecState Clinton has had enough of officeholding politics and will seek the same personal liberation and world-scale achievement that Al Gore has found outside the officeholder arena.

    In which case, the Democratic Party’s only hope is to throw the nomination open to a wide open runaway primary process without any stealth-wiring or pre-selecting by the Democratic Party leaders. If that happens in time, I will wait till the last minute before switching party registration so I can vote for the Least Scary Republican in their primary. The only way I will stay registered Democratic is if one or more of the primary contestants would be an aggressive New Deal 2.0 Liberadical for Fair Trade against Free Trade; and for hardest possible re-imposition of the recently repealed New Deal Era legislation against the formation of Bussiness Fascist Cartels like the post PUCAH deregulated electric power companies and the post Glass-Steagall multifunctional banks. Those two industries should be submitted to a hardest possible sudden re-imposition of PUCAH and Glass-Steagall re-regulation and re-breakup.

    If no Democratic primary contestant is willing to call for that, then I will vote for the Least Scary Republican. If the Least Scary Republican wins the Republican nomination, then I will feel set free to vote for my most desirable Liberadical Socialist alternative choice.

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