May 21, 2009
by Bradley Belt , Charles Blahous
Congress received unwelcome news from the Pension Benefit Guaranty Corporation this week: the deficit in the pension insurance system has skyrocketed, from $11bn last year to over $33bn.
The amount may be a shock but the basic story should not be. The stock market plunge has ravaged the assets of US workers’ pension plans. A struggling economy has left pension plan sponsors on shakier ground. Weaker sponsors with severely underfunded plans will lead to an even bigger hit to the pension insurance system.
Pension insurance suffers from the same toxic combination of moral hazards that undermined mortgage lending – the gains are privately held; the losses publicly held. When plan sponsors’ investment risks pay off, reported earnings improve and they contribute less to their plans. But when they do not pay off – and an underfunded plan terminates – the costs are passed to others: to workers, the pension insurance system and potentially taxpayers.
Pressure will build on Congress to do something about pension finances. But what? With so many employers struggling, no Congress will pass legislation increasing employers’ near-term contributions. The worst thing would be to dig the hole deeper, by providing funding relief for plan sponsors while allowing unfunded pension liabilities to continue to accumulate.
Creative approaches are needed. Given the government’s intervention in the car industry, its pensions are a logical place to start. Although the recession has exacerbated automotive pension underfunding, these plans are not in disproportionately bad shape. But size distinguishes them from others. The big three’s plans cover 1.2m workers and over $150bn in benefits. The termination of one or more of these plans would mean big losses for participants and impose severe stress on the pension insurance system. That is a stress test we must avoid.
Everyone would lose if an automotive plan terminates in bankruptcy. This week, the PBGC estimated that workers associated with the automotive industry could lose $35bn (€25bn) in the retirement benefits they had been promised, based on what the agency can pay out under current law.
Lenders would lose too, as the PBGC would join them at the creditor table. In GM’s case, this would involve huge sums – $20bn plus of these pension claims would greatly dilute the $28bn in unsecured bondholder claims. Taxpayers would also face great risks. The administration would be under pressure from the unions to cover all of autoworkers’ promised pension benefits, beyond the PBGC guarantee.
Using taxpayer dollars to pay all such benefits would be an unqualified policy disaster. Observers would reasonably conclude that the government was implicitly guaranteeing not only the PBGC’s current $33bn deficit, but all pension benefits in all sectors. Airline and steel workers, who lost billions in benefits when their plans terminated, would be justifiably outraged and seek equal treatment. The already pervasive moral hazard problems would grow by an order of magnitude.
Instead of viewing pensions solely as a problem, they should be seen as part of a solution. For example, plan assets could be used as a source of financing for companies that are restructuring. There is no reason why taxpayers should be the first source of financing for car industry restructuring. GM’s pension, with nearly $90bn in assets, could provide debtor-in-possession loans to the parent. Some might argue that it is imprudent for the pension fund to invest in the restructuring of GM. If so, then taxpayers should not be put on the hook either.
Moreover, if a car company could be made into a viable entity separate from its pension plans, then officials should explore having them administered by a capable successor entity. These would require waivers from current regulation but those waivers exist precisely to deal with such situations.
The PBGC should also be empowered to negotiate a restructuring of the pension obligation if it believes that it would lessen the long-term risks to the insurance programme.
These approaches could better serve the interests of car workers and taxpayers: preserving jobs whilst avoiding a further toll on taxpayers weary of bail-outs. The aim should be to forestall unnecessary terminations of underfunded plans in the near-term and avoid larger losses in the longer term.
Bradley Belt is CEO and Charles Blahous senior advisor of Palisades Capital Advisors. Mr Belt was executive director of the PBGC and Mr Blahous deputy director of the National Economic Council.
Charles Blahous is a Hudson Institute senior fellow.
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