The Administration’s negotiations with Chrysler and their stakeholders have a Thursday deadline. Friday’s Wall Street Journal reported a rumor:
Chrysler and the UAW agreed in 2007 that the auto maker would put $10.3 billion into a union-managed retiree healthcare fund. Half of that would now be paid in equity, with the rest coming over time in cash, either from Chrysler or the U.S. Treasury Department, according to people familiar with the talks.
… Even less clear is what will happen on the pension front. Chrysler’s pension is under-funded to the tune of about $9.3 billion, according to an estimate by the government’s Pension Benefit Guaranty Corp. But it’s unlikely Fiat would agree to take on those obligations as part of any alliance.
It seems compassionate to help Chrysler retirees by having taxpayers subsidize these unfunded promises made by their employer. Doing so would also help facilitate a Chrysler/Fiat deal. There are two significant long-term costs to such an action. It would set an expensive precedent for taxpayers, and it would harm future retirees of other firms. Using taxpayer funds to help Chrysler retirees now would create a perverse incentive for management and labor leaders of other firms to behave even more irresponsibly than they have in the past, by jointly agreeing to underfund future pension and retiree health promises.
Defined benefit pension plans claim to guarantee workers a specific benefit when they retire, but that promise is good only if it is fully funded. If a firm with a defined benefit pension plan goes bankrupt and if the plan is underfunded, then a government-run corporation called the Pension Benefit Guaranty Corporation (PBGC) covers some of the losses:
- Start by paying benefits up to a ceiling defined by PBGC ($54,000 per year in 2009 for a 65-year old).
- If you have money left over, keep paying benefits up to the amounts promised to retirees.
- If you run out of money before paying everyone’s benefit, then PBGC will fill up the remaining gap, but only up to the ceiling. Above the ceiling, workers lose their pensions.
So if you are a retiree with a promised $40K annual pension, you will get the full amount. If you were promised $80K and the fund runs out at $50K, then the PBGC will top you off to $54K. You lose the remaining $26K.
PBGC is designed to be self-sustaining: premiums paid by insured firms are supposed to cover expected PBGC losses as it pays benefits to workers of bankrupt firms with underfunded pensions. Taxpayers do not subsidize these benefits (yet).
PBGC insurance creates a moral hazard that encourages management and labor leaders to underfund their pension promises. The negotiators maximize the amount of current compensation, and they negotiate greater pension or retiree health benefits, but the firm doesn’t fully fund those new promises. Both sides agree to make overly optimistic assumptions about the investment returns on the funds. This results in unfunded promises to future retirees. You end up with a situation like Chrysler: management and labor leaders left the plan $9.3 billion short, and the government has insured only $2 billion of that amount.Chrysler retirees will lose the other $7.3 billion. Both Chrysler management and UAW’s leaders are jointly to blame for shafting Chrysler retirees.
Dr. Zvi Bodie describes a long-term risk now facing taxpayers and the Administration:
“If one of these companies solves its pension problem by shunting it off to the federal government, then for competitive reasons the others have to do the same thing,” said Zvi Bodie
I assume that Administration negotiators are being pressured fiercely by UAW to pay these unfunded promises. UAW has a huge long-term incentive to set the precedent that can apply to parallel situations.
The long-run problem has a simple solution: firms must fully fund their promises. We could tighten the rules so that as a condition of receiving PBGC insurance firms (1) must fully fund their pension promises, (2) may not make new promises until the old ones are funded, and (3) must make transparent and realistic assumptions about investment returns.
These were the principles that President Bush pushed for when Congress changed the PBGC laws a few years ago. We made headway but were far from completely successful. There were a few responsible Members: House Leader Boehner (R), Senator Grassley (R), and Senator Baucus (D) were strong, but they were outnumbered. Management (especially of the airlines) lobbied Republican members, while labor unions lobbied Democrats. We were forced to compromise by this political alliance at the expense of taxpayers and future retirees.
The President’s negotiators appear to be in a tough spot. I hope they recognize the long-term harm they could do to future retirees and taxpayers if they set a bad precedent this week.