This week's bipartisan White House Conference on Social Security produced a consensus by default on one big issue: If President Clinton and Congress reach agreement next year, hundreds of billions of payroll-tax dollars will flow into private equity markets instead of Treasury bonds for the first time in history.

While any grand compromise could easily fall victim to partisan posturing or interest-group vetoes, investing Social Security reserves in the stock market has emerged as the political path of least resistance for both parties. Public assets, private markets Without reform, Social Security's reserves will disappear in 2032, leaving the system with only enough revenue to pay 75% of promised benefits. There are only three ways to restore the system's long-term solvency: raise taxes, cut benefits or generate a higher return on the system's growing trust funds. Because Republicans have ruled out taxes and Democrats have ruled out significant benefit cuts, both sides are relying on Mr. Market to make the deficit disappear. At present, 85% of the payroll-tax revenue flowing into Social Security pays benefits to current retirees. The surplus ($100 billion this year alone) is credited to a trust fund expected to grow from $760 billion today to more than $2.5 trillion by 2010 -- a reserve equal to 3.4 times annual benefits. Unlike every other pension fund, Social Security is required to park 100% of its ballooning reserves in the safest and lowest-yielding investment of all: special-issue Treasury bonds. Instead of earning the average return on private investment, which has exceeded inflation by about 7% a year over the past 60 years, Social Security's public bonds are projected to pay a paltry 2.8% return. Capturing this extra yield would close at least 70% of the system's funding shortfall without resorting to an unpopular benefit cut or tax hike. The deep ideological divide that remains centers on the question of who will do the investing. Conservatives, including some Democrats, propose diverting payroll-tax contributions equal to roughly 2% of each worker's wages into individual accounts. One version, embraced by a bipartisan group of senators, would require participation in a sort of government-administered 401(k) plan modeled after the Federal Thrift Savings Plan (TSP) that already invests $70 billion for federal employees. This 401(k) model would allow individuals only the choice to allocate their assets among a set of broad stock and bond index funds. An alternative model, pushed by the libertarian Cato Institute, would allow individuals to roll their contributions into self-directed individual retirement accounts and invest however they choose. By contrast, most Democrats and progressive groups are determined to prevent any undermining of the social insurance concept at the heart of Social Security. Progressives have coalesced around the traditional pension-plan model of collective investment. Instead of asking every worker to bear the risks and costs of managing their own tiny account, the government would channel some reserves into passive-market index funds managed by private firms. Individual accounts vs. guaranteed benefits Proponents of collective investing emphasize that this is the only option that avoids a reduction in guaranteed monthly benefits. This is because individual-account plans siphon revenue that is earmarked to pay promised benefits. For example, a Congressional Research Service study in June concluded that the 401(k)-style plans noted above would reduce guaranteed benefit levels between 11% and 48%. Of course, many retirees will invest wisely (or luckily) enough to enjoy an increase in total benefits -- but the unsophisticated or unlucky will invest poorly and fare worse. One reason that collective investing would yield larger returns, on average, is lower costs. According to Lipper Analytical Services, the average annual fee on no-load stock mutual funds was 1.2% last year. By comparison, CalPERS -- the $100 billion government-run pension fund for California state employees -- actively manages its assets at a total cost of 35 basis points (0.35%). As a larger and purely passive index trust, Social Security would pay even less -- probably 0.2% in fees. Over the typical 40-year career, that 1% a year difference in management fees alone would consume 20% of the assets in the typical individual account, says Massachusetts Institute of Technology economist Peter Diamond. In addition, life-insurance companies charge 5% to 10% of assets to convert an individual account into the sort of insured annuity (that is, a stream of monthly payments) that Social Security is already providing far more efficiently. The most vehement opposition to collective investing Social Security is the fear of inappropriate political influence over private companies. Critics point to the handful of instances when state and local government pension funds sold shares in companies with objectionable business practices or products, or used their shareholder voting power to support corporate governance reforms. While the specter of Big Brother in every boardroom is alarming in the abstract, in reality mechanisms to eliminate the risk of political interference are tried and true. In a book released last week by the Century Foundation, Brookings economists Robert Reischauer and Henry Aaron propose an independent board, modeled after the Federal Reserve Board. Private financial managers would be hired to invest on a mechanical basis in broad market indexes that include virtually every public company. Proxy voting also could be delegated strictly to the private managers, who would act under standard fiduciary law obligations to vote solely in the long-term economic interests of beneficiaries. A 'Third Way' for Social Security Ironically, individual accounts face a different kind of political risk. Dallas Salisbury, president of the Economic Benefits Research Institute, notes that if account assets are personal property, like IRAs, it will be extremely hard for politicians to resist demands for hardship withdrawals. In a pooled fund, nobody can withdraw his "share." But in personal accounts, it will be tough to tell the long-term unemployed, or the gravely ill, that society has a larger interest in ensuring that they will not end up in poverty should they live long. Unfortunately, the current debate portrays individual accounts and today's collective system of guaranteed benefits as an either/or trade-off. A better approach would preserve Social Security's income floor and add a second tier of voluntary accounts to supplement the system's meager benefits (last year's average monthly benefit was $765). A supplemental account system would make it far easier for small firms to contribute a pension benefit, for workers to make IRA contributions by payroll deduction, and for Congress to realign tax incentives to encourage saving by lower-income earners who typically have no pension benefit other than Social Security. Michael Calabrese directs the Public Asset Program at the New America Foundation, a non-partisan policy institute in Washington, D.C. His e-mail address is calabrese@newamerica.net.