The Next Big Bailout?
Thursday, April 20, 2006; 12:00 AM
The Pension Benefit Guaranty Corporation (PBGC) is not a household name, but it should be. By protecting some individual pension beneficiaries it has become exposed to huge financial risks and has put all American taxpayers at risk.
The PBGC guarantees the financial obligations of companies for the liabilities of their defined benefit pension plans, just as the former FSLIC (Federal Savings and Loan Insurance Corporation) guaranteed the obligations of savings and loans for their deposits.
In the 1980s, as the American public realized that many savings and loans were insolvent, they discovered that FSLIC, a government corporation, was itself insolvent. Now as the public is realizing that many pension plans are deeply underfunded and that companies obligated to remedy the underfunding can- and in a number of cases do- go bankrupt instead, they are also discovering that the PBGC is also insolvent.
Indeed, the PBGC's liabilities exceed its assets by $23 billion. The Center on Federal Financial Institutions projects this deficit is likely to grow to $78 billion.
The PBGC and FSLIC represent the same risky structure: open-ended government guarantees of liabilities dependent on financial performance, other peoples' financial risk decisions and the behavior of interest rates and asset prices. Both represent mandatory schemes designed by, and with non-market "insurance premiums" set by, the political processes of Congress.
A Brilliant Idea
The existence of the PBGC reflects conflicts inherent in defined benefit pension plans. Its origins go back to the end of the Packard Motor Car Company in 1958, the termination of its underfunded pension plan, and the loss of "vested" pensions by its employees. This made it plain that all employees of companies with defined benefit pension plans in fact have a large, concentrated credit risk exposure to the company. To the extent of any underfunding, they are unsecured lenders. Indeed, this risk runs a very long time- 30, 40 or 50 years- into the uncertain and unknowable future.
The risk is compounded by the fact that when a company is struggling or failing, putting its shrinking cash into the pension fund will always be a low priority compared to trying to save the enterprise. As a 1958 observer wrote, "When a pension plan is terminated, its funds are never better than inadequate."
This was a big problem for the United Auto Workers. In 1961, they came up with a brilliant idea to address it: get the government to guarantee the pensions just as it had done for government deposit insurance. Their idea ultimately became law in the pension reform of 1974.
Alas, one generation's reform is the next generation's problem. Having had vast, very long-term risk imposed upon it, the government's pension guarantor is now insolvent, too.
Pensions and Creative Destruction
In the dynamic creative destruction of a market economy, companies which seem unassailable may in time fail, and credits which seem impeccable may in time turn out to default.
The biggest potential additional loss to the PBGC today is the threat that it would be forced to assume the liabilities of the General Motors pension fund, with constant media speculation that GM may in the end declare bankruptcy. But as the idea which became the PBGC was developed in the 1960s, it was reasonable to view GM as presenting virtually no risk.
Imagine a 20-year-old going to work for GM 40 years ago, in 1966. It was the preeminent industrial company in the world. It was #1 in both revenue and profit in the Fortune 500. Its bond rating was triple-A. Its U.S. market share was about 50%.