NEW YORK (CNN/Money) - Federal Reserve Chairman Alan Greenspan told a Senate panel Wednesday that he is in favor of introducing private accounts into Social Security, but that lawmakers should take it slow.
Action is needed on Social Security reform before the first wave of baby boom retirements -- starting in 2008 -- threaten the resources of the system, Greenspan told the Senate Banking Committee.
"Because the pay-as-you-go system will be very difficult to manage, we need an alternative," Greenspan said. "Real progress on these issues will unavoidably entail many difficult choices," he added. "But the demographics are inexorable, and call for action before the leading edge of baby boomer retirement becomes evident in 2008."
Nevertheless, he acknowledged that individual accounts do not address the shortfalls the Social Security system will face over the next 75 years.
In fact, they would create additional costs because workers who opt for accounts would divert a portion of their payroll taxes away from the system.
Since Social Security is a pay-as-you-go system -- meaning the payroll taxes you contribute are used to pay today's retirees -- the government would need to borrow additional money to meet its obligations to current retirees.
But once the transition costs are paid for, a Social Security system with an individual account element would add to the net national savings rate, said Greenspan, which would strengthen the economy and help retirees.
Greenspan warned, however, that if accounts are introduced into the system, "We have to do it in a cautious, gradual way. ... (We) should go slowly and test the waters."
Here's why, he said: We don't know how the financial markets would react. The worry is that markets would respond to increased borrowing with higher interest rates, which could slow economic growth.
Given this unknown, Sen. Charles Schumer, a Democrat from New York, asked Greenspan if he thought President Bush's proposal to introduce individual accounts was risky, and whether the Fed chairman thought it was worth the risk.
"It is risky," Greenspan said. But, he added, "It's risky doing nothing. It's risky doing any other solution. ... I know no way to resolve this without risk."
Greenspan headed up the 1983 bipartisan commission that enacted a hike in the Social Security payroll tax and an increase in the retirement age, with the intention of creating a surplus to fund the retirement of Baby Boomers.