Friday, June 10, 2005

What is it about the pension funding crisis?

I don't know about you, but I find America's looming pension funding crisis fascinating - terrifying, but fascinating! It nicely pulls together several of my interests: politics, finance, and corporate strategy.

Look at it on a macro level. We have a several high profile, highly unionized industries (airlines and auto manufacturing) which have consistantly promised more to their employees than the companies can really afford. They were able to stave off bankruptcy several decades ago by negotiating lower wages in return for higher retirement benefits. ("We'll pay you in 20 years for the work you are doing now.") When the bill comes due, the companies say, "Whoops! I don't have that much...but the government will help." So they dump their pension plans on the Pension Benefit Guarantee Corporation. And when the PBGC also comes up short, it will be bailed out by the American taxpayers...after all, we don't want to rob these hard-working people of their earned retirement...or do we?

Who wins in this scenario? The companies involved were able to pay the workers less, enjoy the gains, and never pay the promised benefits. The workers involved still get a retirement - less than expected, but much more than most Americans.

Who loses? Competing companies that did the right thing and can deliver on their promises, because they still have to pay their retirement costs. The American taxpayers are big losers when they bail out the PBGC; this will absolutely dwarf the Savings and Loan (FSLIC) bail-out of the 1980s.

There is an important difference between the FSLIC bailout and the anticipated PBGC bailout. We can see this one coming. We know what is going to happen if we go down this road. If we stop now, we can avoid it.

The PBGC, like the FSLIC and most such government insurance groups, was not designed to cover entire failing industries, but just individual failed companies. To avoid a crisis, the PBGC cannot be allowed to bail out struggling industries like auto manufacturers and airlines. Bankruptcy judges should tell these companies, "You made your bed and now you'll have to sleep in it." It may lead to some of these companies going out of business entirely; their retirees will get a piece of the dissolving company just like other creditors. But when some companies go out of business, continued operation becomes easier for the survivors.

In hindsight, perhaps the PBGC was a bad idea, insomuch as it encourages struggling companies to default on their debts, offload their pensions, and gain a competitive advantage. A better solution might be to require companies offering pensions to obtain private insurance. The free market will set the price the companies pay, and it will remove the government, and hence taxpayers, from the equation.

In this situation, the Democrats are more on track than Republican leadership. Many Democrats are calling for a six-month moratorium on any PBGC assumption of additional pension obligations to allow Congress time to take action. Republicans seem to be supporting President Bush's proposal to raise premiums charged to employers. A premium hike at this point would be too late to really strengthen the PBGC's finances, and may even exacerbate the problem by encouraging companies to dump their obligations sooner.

Unfortunately, it appears that we will go down the bailout road again. The bankruptcy judge for United Airlines has decided to allow the company to dump its pension obligations on the PBGC. When UAL comes out of bankruptcy cleared of this huge liability - the fifth airline to do so - it will have a competitive advantage, and other struggling airlines (such as Delta and Northwest) will have no choice but to follow suit.

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