You’re out of your mind!!!!

This is the reaction that many corporations are having to yesterday’s Senate Finance Committee’s monumental decision to approve the forcing of firms to fully fund their defined benefit pension plans.

After years of shorting the coffer on these plans, which guarantee employees regular monthly checks when they retire, corporations and their lobbyists are now sweating in their power suits, pounding down the door at 219 Dirksen to convince the Senate Committee that the idea is insane.

Insane, eh? Try imperative.

Last year American companies underfunded their pension plans by $600 billion. This means that employers promised to pay (and employees are expecting to receive when they retire) about $17K per worker more than what is available. This underfunding has been going on for decades, and is no longer sustainable.

To the benefit of the lobbyists and their clients, missing a funding target here and there is sometimes inescapable. Companies have bad years. Stock prices plummet every once in a while. And sometimes certain bills, like pensions, just can’t get paid.

Lucky for us, Uncle Sam has already taken this into consideration. About 30 years ago, our government created the Pension Benefit Guaranty Corporation (PBGC), a kind of massive insurance company to help smooth out things in those bad years so that the innocent retirees can still get their checks.

The PBGC collects insurance premiums from employers that sponsor insured pension plans, and guarantees monthly retirement benefit payments. Like any insurance agency, the PBGC collects enough premiums to cover estimated underfunding risks. The PBGC currently pays monthly retirement benefits to about 518,000 retirees and is responsible for the current and future pensions of about 1,061,000 people. This way, when the car factory that Grandpa toiled in for thirty years goes belly up due to that darn outsourcing thing, he can still get his monthly check and pay his well-earned bowling league dues.

Quite a noble cause.

Unfortunately, this cause has been taken advantage of by reckless money management to the point of bringing the PBGC down to its knees. Knowing that their pensions are insured, companies don’t take the responsibility of funding them properly, and leave the burden of ever increasing defaults on the shoulders of our government.

The reasons why companies are able to do this are frighteningly reminiscent of the causes of the Savings and Loan crisis of the 1980s.

This crisis remains one of this country’s best examples of how costly poorly designed government insurance operations can be.

Savings and loan institutions (S&Ls) were originally created back in 1831 to accept savings from private investors and to provide home mortgage services for the public. The government’s Federal Deposit Insurance covered the institutions in case of default to prevent bank-run style tactics in bad times and to protect individual investors.

Events in the 1980s led to the bankruptcy of hundreds of these institutions, followed by a necessary $150 billion bail-out funded largely by U.S. taxpayers. The full set of causes of this crisis have been debated for decades, but two are crystal clear.

First, the insurance behind the S&Ls was poorly designed to adequately cover risk.
Federal deposit insurance insured savings and loan institutions using a uniform price structure, which meant that each institution paid the same price for insurance regardless of how creditworthy they were. Good drivers are incentivized to adhere to speeding limits because otherwise they’ll pay higher insurance premiums. But if prices are regulated to be uniform, good drivers end up paying as much as drunk drivers. So why shouldn’t they push it a bit on the freeway once in a while?

Second, the assets and liabilities of the institutions were out of kilter. Regulations that dictated what kinds of investments the S&Ls were allowed to pursue resulted in the institutions using short term savings to fund long-term mortgages. This led to a severe “maturity mismatching”. In good times, an S&L would pay depositors 3% on their savings accounts and use that cash to fund loans to borrowers for houses at a rate of 7%. In simplest terms, this meant a nice 4% profit for the S&L. The problem was that the 7% agreement was a 30-year contract, whereas the savings accounts were very short term. As time progressed, interest rates rose, and the S&Ls would need to pay rates of 9% to 11% to attract depositors to loan them cash. This meant that the S&L would end up paying more interest to the depositors than it was getting from its borrowers. This is what is referred to as a “mismatching” of assets and liabilities.

The PBGC is ill with the same two sicknesses. It too has too uniform of a pricing structure. The premiums it charges don’t change according to the credit ratings of the institutions it’s insuring. This means that companies hovering near the bankruptcy cliff are still paying the same premiums as everyone else. As an example of how severe this mismatch can be, UAL has paid a total of approximately $50 million in premiums and now threatens to claim of over $6 billion from the PBGC.

In addition, companies are suffering from a severe mismatch between the assets and liabilities of their pension plans. When a company collects money tagged for future pension payments, it doesn’t just sit on it, it invests it. As with any investor, the company can choose where to place this money, and often the choice can be as simple as stocks vs. bonds. During the recent heydays of the late 1990s, this was a no-brainer. Stocks were outperforming bonds by a ton, so that’s where the money with Granny’s name on it went. The problem is, the payment due is at a fixed rate. So the liability remains fixed whereas the asset is variable. All is fine and good when the stocks were doing well. But then comes the dot com collapse, the airline industry fall, and the GM plummet. Now stocks are crap, but the company still owes its fixed 9%. Once again we have a mismatch.

Anyone good in finance knows this is a big no-no. But when the company knows that the downswings will be insured, they go for the high stock return potential anyway.

The pattern is striking, and begs not to be repeated. Lucky for us, the Senate has done their homework and recognizes this. And it’s acting appropriately.

So to the corporations and the lobbyists: stop wasting your time ruffling up your suits. The PBGC needs to be fixed, and the longer we wait, the harder it will be. Let the Senate do its job.

Because Grandpa needs a new pair of bowling shoes, and Uncle Sam is making damn sure he’s gonna get ‘em.

Posted by Michelle Smith on July 28, 2005 12:15 AM