In recent months, there has been a renewed focus on the interest income earned by the social security trust funds. The impetus comes from the fact that the trust funds have faced some serious financial difficulties, and still do.

Obviously, it would be both attractive and wise to improve the income to the trust fund in a way that would require neither increased payroll taxes nor benefit reductions if we can do so. Some words of caution are in order at the outset, however. First, even the most optimistic claims about the amount of money we could gain by improving trust fund interest earnings do not amount to enough to erase the problems we now face.

If trust fund reserves continue to go down in the future, this avenue will provide even less assistance. We need more reserves, pure and simple, before the interest we earn on them can be of sufficient amount to have a major impact.

Second, we should keep in mind that increased income to the trust funds must be paid by the general fund, so we would be in reality making intragovernmental transfers. We would not be creating new money that would reduce the unified budget deficit. Finally, we must be careful that any changes we suggest will hold up over the long run. What looks expedient now may not prove to be so in the future.

With that said, however, the current policies and practices involving trust fund investments are not inviolate. Over the 45-year history of this program we have tried many different approaches, with the single overriding factor that we have always invested in government securities and we have invested primarily in special issue bonds available only to the trust funds and redeemable at par at any time.

The Social Security Act provides that any funds that are not needed immediately for benefits or administrative costs are to be invested by the Secretary of the Treasury, acting as the Managing Trustee of the social security trust funds.

The act provides both some very tight restrictions on the Secretary which allow him little latitude, if any, in the location of and return on investments, and some very broad discretionary powers concerning maturity dates and redemption practices.

For example, the assets of the trust funds must be invested solely in U.S. Government obligations. The funds must be invested in special public-debt obligations of the United States, except where the Managing Trustee-the Secretary of the Treasury-expressly determines that the purchase of other Government securities is in the public interest.

These "special issues" must bear an interest rate which is equal to the average market yield of all marketable interest-bearing obligations of the United States with maturities of 4 years or more. On the other hand, however, Congress has granted the Secretary much discretion by stating that obligations purchased by the trust funds "shall have maturities fixed with due regard for the needs of the trust fund." This discretion extends beyond authority to fix maturity dates to authority to specify practices regarding the redemption of trust fund securities.

The principal issue concerning trust fund investments and management is, of course, the rate of return on those investments. This

issue extends beyond consideration of only the statutory interest rate formula and includes policies and practices regarding the assignment of maturity dates to special issues, the redemption of investments, and the purchase of securities other than special obligations.

From the beginning of the program, the general policy goal in this area has been to make the return to the trust funds equitable to both the trust funds and the general fund from which interest payments are made, providing neither special advantage nor disadvantage to the trust funds as compared to other investors in U.S. Government securities.

Today's hearing is the first step in the subcommittee's review of all current policies and practices concerning the investment of trust fund assets. Specifically, the subcommittee is seeking to determine:

(1) The appropriateness of the current statutory interest rate formula in light of both current high interest rates on short-term investments and the fact that many trust fund securities are now held for only short periods before redemption;

(2) The advisability of increasing trust fund purchases of marketable U.S. Government securities in the open market and decreasing purchase of special issues;

(3) The appropriateness of Treasury's policy of establishing maturities for new special issues given the fact that long-term special issues are often redeemed before maturity when trust fund outgo exceeds income, as in the case with the OASI and the DI trust funds today; and

(4) The appropriateness of Treasury's redemption policies which today is resulting in the redemption of the highest yielding special issues while lower yielding special issues are maintained in the portfolio.

That is a rather involved analysis of the problem we face.

We are anxious to hear from the two witnesses this morning. The first will be Mark Stalnecker, the Deputy Assistant Secretary for Federal Finance, and Mr. Robert J. Myers, Deputy Commissioner for Programs, Social Security Administration.

I believe Mr. Myers is scheduled to go first and be our first witness. If that is agreeable to Mr. Stalnecker, we will proceed in that order.

Mr. Myers, welcome to the committee.

STATEMENT OF ROBERT J. MYERS, DEPUTY COMMISSIONER FOR PROGRAMS, SOCIAL SECURITY ADMINISTRATION, DEPARTMENT OF HEALTH AND HUMAN SERVICES

Mr. MYERS. Thank you, Mr. Chairman.

I am pleased to be here. I would like to condense my statement. I request that the full statement and attachments be put in the record.

Chairman PICKLE. Without objection your request is granted. If you do make reference to it, try to indicate to the committee where and on what page so we might be able to follow you, also.

Mr. MYERS. Thank you, Mr. Chairman. What I have done is condense it considerably. I will not read the tables or the attach

ments.

I am pleased to be here today to discuss the investment policy of the four social security trust funds. Although the investment of the assets is the responsibility of the Secretary of the Treasury, as Managing Trustee, the Social Security Administration has a great interest in this matter. For many years, I have studied the subject with considerable diligence.

Although the interest income of Social Security is not a major factor in its financing-whereas in funded private pension plans investment income is very significant-neither is it of negligible importance. For example, in 1980, the interest income of the trust funds was only 2.46 percent of the total income. However, such interest income was the not insignificant sum of $3.85 billion, which incidentally was 1.5 times as large as the system's administrative expenses.

Since the program began operations, the method of investing the assets has changed little. The trust funds receive the tax income and pay the benefits and administrative expenses. The excess of income over outgo is invested in government obligations, and the interest augments the system's income.

Since 1940, social security taxes have been automatically appropriated to the trust funds as received. Before then, a slightly different procedure was followed.

The investments can be either in special issues or in any other government securities. Some regular issues have been boughtboth on the open market and when offered to the public.

Legislation has provided that certain semigovernment issuessuch as those of the Government National Mortgage Association, can be purchased, even though not guaranteed, by the Govern

ment.

Most investments, however, have been special issues. As of mid1981, 92 percent of the assets were in special issues. More details are given in attachment A in my formal statement.

Before 1940, special issues bore an interest rate of 3 percent. From then until 1956, they carried an interest rate slightly below the average coupon rate on all interest-bearing obligations outstanding at the end of the month preceding their issuance.

In 1956, the interest basis was changed to the average coupon rate on all long-term obligations issued initially for 5 or more years. In 1960, this interest basis was changed to the average market yield rate on obligations not due or callable for at least 4 years from the date of determination. The historical interest rates of special issues and the durations until their maturity are shown in more detail in attachment B in my formal statement.

For some years, the maturity dates of newly issued special issues have been set by a definite procedure. This was established by the managing trustee, with the agreement of the other trustees-and not by the law.

Specifically, funds available for investment in special issues at times within the investment year, which runs from July 1 to the following June 30, are put in certificates of indebtedness. These certificates mature at the end of the investment year. Such investment into interest-bearing obligations is made very promptly as the taxes are received by the Treasury Department.

Then, on June 30, the proceeds of the certificates are put into long-term bonds with maturity dates of various June 30's, whose durations until maturity are spread, as much as is possible, so that the total portfolio of special issues-including those bonds on hand on the June 30 date-is equally spread over the next 15 years. When, during the investment year, securities must be sold to meet benefit obligations-which peak at the beginning of the month for the OASI and DI trust funds, but not for the HI and SMI trust funds-this is done by selling first the special issues with the shortest durations until maturity. Thus, any certificates of indebtedness are the first to be so sold. If several securities have the same duration until maturity, those with the lowest interest rate are sold first.

When special issues are thus sold, they are redeemed by the Treasury at their purchase price. This is a feature not available to other purchasers of Federal securities who might wish to sell them. This is a considerable financial advantage to the trust funds, especially in times of fluctuating or rising interest rates-and one that would not be present if the investments were required to be made. only in marketable obligations. If the securities were redeemable only on a market-value basis, losses of principal would often be involved, especially when securities with low coupon interest rates are redeemed. Under certain circumstances, relatively unusual, this procedure could produce an unfavorable result for the trust funds as compared with a market-value basis; namely, when the securities to be sold had a higher interest rate than the average market-yield rate at that time.

In summary, however, the procedure followed as to redemption of securities prior to their maturity is an advantageous one insofar as the trust funds are concerned. And it is equitable as well. Further, because of the prescribed rules, it eliminates all elements of conflict of interest insofar as the managing trustee is concerned. Although there has been some opposition to investing the assets in Government bonds, no positive support has been offered for any other investments, all of which have seemed objectionable for overwhelming reasons.

One possibility would be securities of private concerns. There are several objections to this approach. First, the Government would control a considerable portion of the private economy, which would, in effect, result in socialism by the backdoor method. Another disadvantage would be the need for a far-reaching investment policy to provide an adequate rate of return, with reasonable security of principal. The Government would, in effect, be setting itself up as a rating organization.

Another procedure would be to invest in social and economic activities such as the construction of housing, dams, hospitals, et cetera. This would be open to some objection as Government entry into private fields of activity.

Also, any use of public funds for such purposes should be under the control of the Congress, rather than a social insurance organization.

Accordingly, it may properly be concluded that investment of the assets of the the trust funds can feasibly be invested only in securities of the Federal Government.

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With current high interest rates, the investment results of the trust funds have been criticized. It has been pointed out that, during the year ending June 30, 1980, the effective annual rate of interest earned by the OASDI trust funds was only 8.4 percent, whereas private money-market managers currently earn about 13 percent. This is not a valid comparison, because it contrasts the investment return of a portfolio of securities purchased over a long period of years with the current, relatively high new issues rate. The interest rates on securities bought by the trust funds in the past were proper and equitable at the time of purchase.

On the other hand, the high interest rates quoted for private money managers are those obtained for securities purchased currently. Any private investment organization which has prudently built up a portfolio over the years would currently have a much lower average rate of return for its total portfolio than for securities bought currently.

In comparing investment managers, one should not simply measure the average rate of return on their total portfolios, but rather other factors should be considered.

The trust funds have been obtaining relatively high interest rates on current investments. For example, the rate on special issues acquired in June was 13 percent. Some $20 billion of new issues were acquired at this rate, with maturities of up to 15 years. Moreover, as old securities mature and as new higher interest securities are purchased, the average effective rate of return will rise. As compared with the rate of 8.4 percent for the year ended June 30, 1980, the rate for the next year was 8.8 percent. Attachment C in my formal statement shows these effective rates of returns for various years.

The rate of return on the OASDI trust funds in calendar year 1980 was about 8.6 percent. At the same time, the net rate of investment income-before Federal income tax-of all U.S. life insurance companies was 8 percent. Thus, the trust funds had an investment experience closely comparable with that of life insurance companies in the aggregate.

A life insurance company formed in 1980 would, of course, have had a much higher rate of return, because it would be holding only new high-rate investments, but this would not prove that it was a sagacious investor or that the older companies were stupid investors.

It has been proposed that the trust funds be invested only in short-term rather than long-term obligations. At present, this would have the advantage of the high current short-term interest rates. In hindsight-just as with other investment experience-this might have proven to be more advantageous.

The general experience in the past, however, has been that longterm interest rates are somewhat higher than short-term ones, although not at the moment.

Accordingly, over the long run, the long-term interest rate procedure would seem preferable. Attachment D in my formal statement compares the average market-yield rate of all Government obligations with the corresponding long-term rate received by the trust funds on new special issues.