Implicit government obligations represent the lion's share of government liabilities in the U.S. and many other countries. Yet these liabilities are rarely measured, let alone properly adjusted for their risk. This paper shows, by example, how modern asset pricing can be used to value implicit fiscal debts taking into account their risk properties. The example is the U.S. Social Security System's net liability to working-age Americans. Marking this debt to market makes a big difference; its market value is 23 percent larger than the Social Security trustees' valuation method suggests.
The authors argue that an estimate of Social Security's unfunded liabiltiy should account for the uncertainty of wage growth. (It's wage growth that largely drives both SS benefits and taxes.) After accounting for that uncertainty, they estimate the unfunded liability in 2005 at $10.4 trillion, almost $2 trillion more than estimated by the Social Security Administration.
$2 trillion: but what's a couple of trillion among friends? We need to update the famous wisecrack attributed to the late Sen. Everett Dirksen as follows: "A trillion here, a trillion there, and pretty soon you're talking real money." (But note that Senator Dirksen never actually made the wisecrack. How disappointing.)
Most economists who have studied the issue think that in a few decades the government will have a substantial problem funding currently promised Social Security and Medicare benefits. (Especially Medicare.) A short. non-technical summary of the problem by distinguished economist Edgar Browning is here. His longer, more detailed paper is here. And if you find that useful, you can buy his recently published book, Stealing from Each Other: How the Welfare State Robs Americans of Money and Spirit.
Maybe a good outcome from our current financial problems is that more people will believe that the future eventually arrives.
Finally, if you haven't seen it, you should read the incredible story of how Congress has mandated that if taxpayers ask to see the Social Security "trust fund" they be shown fake bonds printed on a laser printer.