November 02, 2005
The End of (Firm-Sponsored Defined-Benefit) Pensions
Andrew Samwick views the private-firm defined-benefit pension-fund death spiral as both a Capitol Hill and a union bargaining failure:
Vox Baby: The End of Pensions: There is... no need for formal pension insurance.... Every defined benefit pension plan has the opportunity to invest in Treasuries... [can] match the duration of its fund to those of its obligations... [F]unding a pension plan... [needs only] the required annual contribution under the assumption that the pension plan sponsor were following the duration-matched Treasury investment strategy. The federal government shares the cost of this investment by allowing the pension fund to accumulate at the pre-tax rather than the post-tax return. (It also defers the employee's tax liability on compensation taken through a pension plan.)...
Any deviation from this funding strategy should be examined with suspicion. The biggest deviation is to invest... in equities.... This strategy is okay, as long as the pension fund is small relative to the firm's assets, so that the firm can make up the shortfall....
[W]e are learning that this isn't necessarily the case with a lot of the airline, steel, and auto companies. Almost by definition, it is not the case when a company approaches bankruptcy.The problem is nicely illustrated by this passage from Lowenstein's article:
G.M. and other industrial companies, along with their unions, have harshly attacked the Bush pension proposal, which would force many old-economy-type corporations to put more money into their pension funds just when their basic businesses are hurting.
Well, no kidding. The industrial companies and their unions that encouraged them have no one to blame but themselves for their current troubles. They used their pension funds as speculative investment vehicles, and the combination of low interest rates, sagging stock market values, and optimistic funding assumptions put them in this position. Who but their shareholders and workers should be asked to make those additional contributions?
The government has decided through ERISA that it will permit the investment of pension funds in equities and subject plan sponsors to a set of minimum funding rules and require them to purchase (vastly underpriced) PBGC insurance. This is a bad strategy, in my view, because of the numerous ways to game it, which Lowenstein's article discusses in good detail. It creates the appearance that someone else is responsible for these companies, and that may ultimately prove to be the reality, with the taxpayers being asked to step in to make up the shortfall.
I think Andrew misses an additional important aspect of the situation. When pension funds (and health benefit programs) become large relative to the size of the firm, the retired and the sick join the bondholders and the stockholders as claimants on the firm's cash flow, but the retired and the sick don't have any place in the firm's corporate governance structure, and claimants on a firm's cash flow should have a place somewhere.
UPDATE: Andrew Samwick http://voxbaby.blogspot.com/2005/11/place-somewhere.html politely reminds me that he talked about this last April at http://voxbaby.blogspot.com/2005/04/pensions-lost-in-translation.html.
Posted by DeLong at November 2, 2005 09:52 AM