If you earned less than a 3% real return on your private account, your total combined retirement benefits would be less than under the traditional program. So private accounts would be a gamble: Fall short of that 3% hurdle, and you lose.
A 3% real return may not seem like much of a hurdle, if you're looking back over the last 25 years.
From 1980 through 2004, long-term government bonds produced an average real return of 6.7% a year, according to data tracker Ibbotson Associates in Chicago.
Stocks did better than that: The blue-chip Standard & Poor's 500 index scored an average real return of 9.5% a year in that period.
But as everyone knows, the 1980s and 1990s were spectacular decades for financial assets. The stock market soared as the economy boomed. And even as inflation declined, long-term interest rates were extraordinarily high for much of the period, providing a hefty payoff for bond owners.
Measured over longer periods, however, returns haven't been nearly as generous on government bonds. From 1946 through last year, the average annualized real return on long-term Treasuries was slightly less than 1.6%, according to Ibbotson.
The current return also is well below the administration's 3% long-term expectation, if you use the benchmark long-term government bond -- the 10-year Treasury note -- and subtract inflation as measured by the U.S. consumer price index.
The yield on the 10-year T-note was 4.27% as of Friday. The CPI was up 3% in the 12 months through January. That means the real annual return is about 1.27% at the moment (we're simplifying here, to make the point).
Current government bond returns are low because long-term interest rates have come down dramatically since the mid- 1980s. And even though the Federal Reserve has been raising short-term rates since June, long-term bond yields have continued to fall for much of that period (although they have rebounded somewhat in recent weeks).
Fed Chairman Alan Greenspan referred to the relatively low yields on long-term bonds as a "conundrum" when asked about them during congressional testimony in mid-February.
The question is: Are there good reasons to believe that real returns on long-term government bonds could rise to at least the 3% level in the rest of this decade and beyond?
One way to get there would be for interest rates to rebound substantially, of course. But that would be bad for the economy and, most likely, bad for returns on competing investments like stocks held in private Social Security accounts or elsewhere.
