Social Security Trust Fund, Explained

I've been hearing a lot about the Social Security Trust Fund, and how it's 'backed by the full faith and credit' of the US government. I've spent a bit of time trying to understand how that works. Here's my best try at an analogy. Please let me know if I'm wrong in any important detail.... I really hope I am.

You want to invest in a retirement plan. Peter Ponzi's Retirement Emporium has a sweet deal - you pay in every month while you're working, and Peter Ponzi will pay you every month when you retire. Even better - Peter will pay your parents a monthly sum even though they haven't paid him a red cent. How can you say no to such a deal?

Of course, you and your peers won't retire for a while. That means Peter Ponzi is getting a lot more in each month that he has to pay out. He could do several things with that money:

  1. Invest it in something where it can earn income
  2. Put it in a safe
  3. Spend it on fast cars, expensive booze, and other short-term priorities

Not too surprisingly, he goes ahead and chooses option #3. However, to make the books balance, he drops an IOU in the box. That way the books balance when he gets audited. He can say quite honestly that he has all that money locked up in a 'trust fund'. Here's the first wrinkle - the IOUs are made out to himself - "I, Peter Ponzi, promise to repay $xxxx to Peter Ponzi".

I'm no accounting wizard, but I'm pretty sure that if any real financial institution tried this they would be having some pretty serious discussions with law enforcement.

Our friend Peter Ponzi does have one argument in his favor. He's never defaulted in the past - an absolutely unimpeachable financial record.

However, there's a second wrinkle: Peter Ponzi's ONLY source of income is you, the taxpayer.

These IOUs are backed by YOU. You (or your children) will have to make good on those IOUs. Peter Ponzi does not have the money. It has been spent. The only way they can be redeemed is by taking money from you to redeem them.