Is Your IRA Going To Be Raided?

The notion of government raiding personal retirement accounts for funds may seem extreme.  Perhaps it shouldn't.  Other governments have done it.  Argentina did in 2008.  Ireland has indicated it might.  The worsening financial crisis may eventually move other countries in that direction.

Surely the US would never do so.  

Actually, there is little basis for assuming they would not and factual evidence they would.  Here are three good reasons to believe they would:

1. Financial Ratios The US financial ratios are arguably as bad as the weakest countries in Europe.  Unlike Europe, the US government has shown no willingness to meaningfully cut government spending and/or balance the budget.  Europe has signaled austerity programs, although time will determine whether they adhere to such programs.
2. Rule of Law All modern governments believe they are above the law.  They justify violation of the law on the grounds it is necessary for the "good of the nation."  The US government has frequently demonstrated that property rights should not stand in the way of public policy.  Abuses of eminent domain are numerous.  The automotive bailout was a flagrant example.  Not only was the bailout without legal precedent, but US bankruptcy law was violated in order to reward unions at the expense of bondholders.
3. Behavior Pattern The US government has a despicable record with regard to honoring retirement obligations.  The government raided the Social Security trust fund so that politicians could spend at higher levels.  That continuing raid put Social Security in a liquidity crisis that should not have occurred for another couple of decades.  President Clinton and Congress reneged on the promise that Social Security benefits would never be taxed.  Now Treasury Secretary Geithner routinely raids public pension plans in order to allow government to continue spending.

Most politicians in the US believe (or behave as if they believe) they can continue to kick the spending can further down the road.  Apparently many believe the spending/debt problem will somehow magically go away or at least metastasize after they have left government.  Unfortunately, the problem is not going away and will get much worse unless political courage and will is found to enact substantial spending cuts.  These cuts must be larger than numbers discussed in current political discussions. 

What About The Debt Ceiling?

The debt ceiling problem will eventually be resolved with an increase in the ceiling.  Unfortunately, that solves nothing, as previously discussed.  The problem is not debt; it is spending.

Raising the ceiling does not mean that markets will provide funds at interest rates acceptable to the government or its financial condition.  In my opinion, QE2 was never expected to stimulate the economy.  It was a holding action to protect government from the bond vigilantes who might have refused to purchase government debt at current interest rates.

Some politicians might have naively believed that the economy would begin to grow during the six-month QE2 period.  Instead, the economy deteriorated.  QE3 or QE10 will not solve underlying economic problems.  Reductions in spending and regulatory uncertainty are necessary.  Companies will not hire or invest when they cannot determine future costs and taxes.

When the ceiling is increased, government will be able to lawfully issue new debt.  Depending upon the market's reception, three outcomes are possible:

1. There will be enough buyers in traditional credit markets to absorb the debt at "reasonable" interest rates.
2. The Fed will institute QE3.
3. A combination of 1 and 2 will be necessary.

My guess is that number 3 will be required.  There will be demand at reasonable interest rates, but probably not enough to meet government requirements.  The amounts required are truly enormous.  For example, in August the financing required is about $600 billion -- about $130 billion of new debt and almost $500 billion of debt rollovers (see detail).  Subsequent months are comparable.  Credit markets are unlikely to be confident or deep enough to provide the this level of funding for long. 

Why Raid IRAs?

The simple answer was provided by famed bank robber Willie Sutton: "That is where the money is."

Total market capitalization of the US stock market is about $16 trillion and 40% of that is estimated to reside in IRAs and 401Ks.  They are big, visible, vulnerable, and mostly immobile targets.

This $6 trillion, if it were grabbed in some fashion, would satisfy the next 4-6 years of government deficits.  Whatever can be used from IRAs lessens the amounts needed from sources 1 and 2 above.

Before proceeding, it should be noted that the term "IRA" as generally used in this article generally refers to Individual Retirement Accounts and self-directed retirement accounts such as 401Ks.  Many of the comments pertain to both even though the IRA abbreviation is used.

How Might Government Go After This Money?

There are innumerable ways.  Here is some speculation regarding what might happen.

It is unlikely that government confiscates IRA funds, at least directly.  That is likely too big a step, at least as a first move.  More likely, government mandates that a percentage of IRA funds be invested in Treasury securities.  The percentage would start out small and then likely increase as government insolvency worsened.

Let's imagine a scenario.  After proper citizen conditioning, the government would require that all IRAs must be at least 20% invested in Treasuries.  The rationale would be that we must all do our share in assisting the country out of its economic hardship.  Those with IRAs certainly are better off than those without.  Therefore it is only fair that they invest in the future of their country.

The reason to enact such legislation is that markets are driving up the costs of borrowing for the government.  By forcing investments from existing IRA funds, the government achieves two objectives:

1. It reduces the amounts necessary to raise in capital markets and/or
2. It reduces the amount of new quantitative easing necessary.

Although unnecessary, a special series of Treasury bonds called "Patriot Bonds" could be created.  These bonds would be the only ones that counted for IRAs and could have lower interest rates than traditional Treasuries.  If so, you would be coerced into funding the government by purchasing bonds for more than how the market values them.  But, after all, you are a patriot and one of the "winners in life's lottery."  So it is the least you can do.

Over time the required percentage would be raised to, say, 40 or 60 or even 100% as financial conditions worsen.  Finally the government defaults, making whatever portion of your IRA represented by government securities worthless.

In effect, that part of your IRA has been confiscated by government.

Is This Possible?

Those who believe our government is too honorable to raid private retirement accounts had better wake up!  The seriously dangerous and wounded animal we know as government is fighting for its survival.  It will do anything short of dying, reducing spending, or revealing itself as the Ponzi scheme it truly is.

Your notions of integrity, law, and morality do not apply to this animal.  The biggest, meanest man in town is trying to escape death and will use whatever means possible.  Rightly or wrongly, he believes you are his antidote and he is going after whatever he can get.

One hurdle to preventing government from taking such action might be the stock market.  The shift in asset allocations required in retirement accounts would presumably be detrimental to the stock market.  Whether it would crash or not is moot.  Any such action would certainly reduce its value, which might be the best protection retirees have.

Unless government spending is reduced to the point that new debt grows slower than GDP, most retirement accounts will diminish dramatically.  This conclusion is independent of whether government raids your IRA account.  Hyperinflation will eventually result from continued quantitative easing (printing of money).  That will destroy most savings and all fixed income obligations like bonds and pensions whether these funds are in or out of IRA accounts.

Things are going to get ugly.  Prepare for the worst and hope for the best.

Monty Pelerin blogs at Economic Noise.