Asymmetrical Information

The PBGC isn't just government-chartered (which could describe any corporation). It is a government corporation. In theory it is funded by the premium payments of the corporate participants but the PBGC is already in default—it's obvious that either there must be a substantial increase in premium payments (in which case successful, well-run companies subsidize unsuccessful, poorly-run companies) or it needs a bail-out from general revenues (in which case its corporate welfare).

One of the significant ways in which the PBGC does not behave like a private insurer has to do with risk. For a private insurer premium must be proportionate to risk. The PBGC doesn't work that way. For example, your automobile insurance premium is calculated based on where you live, how hold you are, your previous driving history, and what you drive. PBGC premium calculations don't work that way.

To further clarify my point: when a company doesn't have to honor its contracts (and has reasonable confidence it won't have to honor its contracts), does not pay proportionally to the risk, the “insurer” is an arm of the government and has the prospect of bail-out from general revenues, that indemnification has value for the company. Receiving value without payment is welfare.

Defined-benefit pensions, which promise certain returns far, far in the future regardless of economic conditions and increases in life expectancy, are a form of fraud unless they are insured by an entity with bottomless coffers -- that is, the federal government. Consider a "really safe" investment plan: collect contributions in gold, put it in a vault, and then eventually pay out so many ounces a month. Of course, this plan has a slightly negative rate of return (by the gold standard): gold sitting in the vault cannot generate income, and some of the contributions went to pay for the vault, administration, and theft insurance, so at best you might get back 9 ounces of gold for every 10 put in. OTOH, it is safe against both inflation and a 1929-type economic meltdown. But even this plan would founder as a retirement plan if the retirees lived longer than expected.

So as a libertarian, I might prefer that defined benefit plans weren't allowed unless the contract clearly stated the conditions under which they payments would be reduced or stopped. Something like, "we will pay xxx$ a month for your retirement unless our investments do badly or too many retirees live too long." And who'd willingly pay for a pension with that condition? But if we're actually going to have defined benefit plans, only the fed has the resources to be the ultimate insurer.

Of course, the problem is how the federal insurance plan is run. If it calculates risks accurately and charges premiums accordingly, then it would probably end up with a slight profit, but there are possible circumstances where the taxpayers would be making good. But there will always be political pressure against charging realistic premiums. And then the taxpayers wind up paying for defaults that were not all that unlikely. (Remember the savings and loan crisis of the 80's?)

Chapter 11 is indeed, overall, an indespensible net benefit to the U.S. economy. However, just like with deposit insurance, too much of a good thing can become a bad thing. Allowing essentially limitless protection, or even excessively large protection, for bank deposits leads to much misallocation of capital. Similarly, too-easy bankruptcy terms fouls up entire industries, like it has the airline industry.

Link? To Battlepanda?

entity with bottomless coffers -- that is, the federal government

speaking of fraud...

"possibly introduces an element of moral hazard"

Jane, I love you to death, but that's quite the understatement. Coupled with the inadequate premium payments noted by Dave Schuler above, I think it's clear that the moral hazard is pretty strong. It's hard to imagine that as things got tough at UAL, people didn't immediately think, "Well, we can always save a few billion by hosing our pension obligations."
On another note, companies are encouraged, even when things are going well, to overestimate expectations for pension fund growth (we expect continued stock market returns of >10%...).
My point is that pensions are woefully inferior to 401k plans, and employees would do well (as they also should with Social Security) not to assume that they're gonna get what they're supposed to get. Because thngs change, and it's not in the interests of those in control of the money to fess up to that.

There are two "moral hazards" involved: (1) the opportunity to declare bankruptcy, which invites imprudent business decisions, and (2) the PBGC, which (however much corporations may cavil about its premiums and regulations) also invites imprudent business decisions. That's quite a one-two punch. A corporation can look to the taxpayers for a bailout of its pension fund and to the bankruptcy courts for a bailout on most of its other obligations.

The mention of the S&L meltdown reminded me that a big part of that problem was the high amount of deposits insured (100k, I think). Perhaps a reasonable reworking of the PBGC would be for it to guarantee some basic pension (24k/yr?), and then charge a reasonable premium for that level of insurance. There will still be cases where the taxpayers are hit, as Markm says, but this might minimize that while still keeping the premiums within reason.

There was a recent Cato paper dealing with this if anyone is curious. Me, I see the Moral Hazards that Tom points out above as being insurmountable.

The problem with allowing United Airlines to relinguish all responsibility for its pension fund is it sets a precedent for many other companies in bankruptcy to do the same. Of course, United Airlines couldn't have done it if U.S. Airways hadn't been able to do it. Now, companies will use the bankruptcy court to relieve them of their prior excesses in overpromising to their employees without ever really paying for these promises. This would lead to a more disastrous underfunding of the PBGC than currently exists. Of course that would eventually lead to a taxpayer bailout. There can be no argument about that!

I propose that a company who relinguishes their pension fund to the PBGC be forced to pay premiums even afterwards as long as they are in Chapter 11 and not in liquidation. This will make companies think twice about getting rid of their funds and of the promises they make. Of course there would have to be some level of premiums that provides the incentive without actually causing additional financial distress on the bankrupt company (to maintain the advantages of a Chapter 11 bankruptcy). While this will not fix the underfunding issue, it will address some of the gap while forcing companies to deal with the problems they caused, and not the taxpayer.

How about just requiring fully funded pensions?

Defined-benefit pensions, which promise certain returns far, far in the future regardless of economic conditions and increases in life expectancy, are a form of fraud unless they are insured by an entity with bottomless coffers -- that is, the federal government.

Demographics is not a science with lots of unexpected surprises. I remember reading that the actuaries in 1933 were able to predict in 2000 the portion of Americans over 65 to within a margin of less than half a percent. If you have a given workforce and you've promised them what is basically an annuity until they die you can predict within a good margin of error how much you'll have to be paying in the future (adding something like medical coverage for life gets more complicated since you will need to also predict medical prices into the future). It is possible to invest enough money to say with 98% confidence that the obligations will be meet. Of course, if you reduce that to 90% confidence you can come up with a smaller figure to invest each month or year so the temptation is always for companies to end up underfunding and letting the gov't pick up the defaults.

Wouldn't it be better to mandate that companies purchase insurance to cover, say, 80% of their pension obligations from private agencies? For companies like GM or US Air whose obligations are in the billions this may be a big bite but the capital markets are literally trillions of dollars. Couldn't insurance companies divide such large policies between each other to minimize the risk of a GM default taking down not only GM but its insurance company as well?

Private insurance would mean premiums based on the individual company's risk profile which would mean private insurers would have the incentive to raise rates on companies that have edging closer to underfunding.

First, let me just note that the managers at United could scarcely have been delighted to declare bankruptcy and dump the pension plans, as they were participants in both the United ESOP and those same pension plans and thus wrecked their own retirements in the process.

Having gotten that point out of the way, I think that the unique nature of the challenges facing United (and the rest of the airline industry) fall into a category where they should be borne by society as a whole as opposed to an individual group of employees or shareholders.

In 2000, United earned $332 million. The next year, in the midst of the bursting of the internet bubble and the building recession, they lost $1BB, but still had (if memory serves) over $2BB in cash reserves. In addition, they managed to downsize and wring more than enough concessions out of their employees to return themselves to profitability. Then 9/11 happened, and we began the global war on terror.

If it were not for the persistence of traffic downturns and high fuel prices that are associated with the uncertainties of the war on terror, United would be a healthy, going concern today.

That the nature of these uncertainties is more or less unavoidable as long as the GWOT continues, and inasmuch as our national interest requires that we do continue the struggle, it seems to me we should not begrudge extraordinary national support to those industries hardest hit. Especially not, as in the case of United, the shareholders and employees have already paid a high price as their part of the shared sacrifice.

Isn't increased fuel prices a normal risk in doing business? Didn't the gov't pass a $12B bailout bill for the airlines after 9/11? How about the airlines that are not bankrupt? They suffered no decline in bookings after 9/11? Their planes don't run on jet fuel?

I'll go along with the premise that society should make provisions so that people's pension plans are reasonably secure just as we make provisions that your bank account is reasonably secure against a bank run or failure. I'm less inclined to go along with the idea that US Air's bankruptcy deserves any special sympathy from the taxpayers. Businesses fail all the time, even when they do everything right and are run by smart people.

Boonton: I believe that the $12B package included loan guarantees, of which United received zero. The direct aid portion of that package was only $5B, and barely offset the immediate costs related to the shutdown of all air travel and the crash in volume that followed resumption of said travel a week later.

Also, the point I was making is that oil is artifically high because of the GWOT and other factors (such as the filling of the Strategic Petroleum Reserve), and no business plan can be sustained in the face of such a severe anomaly. At least in the airline business, which is unusually dependent on the cost of fuel.

All airlines are suffering because of this market distortion, not just the ones that have already entered bankruptcy. Delta and Northwest are on the short list, and even AMR can only sustain itself for so long with its remaining assets. The only two airlines that I am aware of that are not currently in meltdown are Southwest and Jet Blue, and even there the profitability is hovering around zero...scarcely a model that will encourage the long-term sustainability of air travel as a readily available service.

Two quick comments: First, ERISA requires "full funding" of pension plans. United's problems have been exacerbated by this requirement -- companies have very little room to defer making required pension plan contributions. Even in a year when a company is losing money, it must make its actuarially determined contribution. Obviously, this funding requirement increases the risk a company will go bankrupt. ERISA's funding requirements may have INCREASED the number of plans that have gone bankrupt, but should have DECREASED the average size of the problem.

Second, relatively recent tax rule changes have reduced the benefit a company may derive from "over funding" a pension plan. Actuaries determine the required pension contributions based on, among many other things, assumed rates of investment returns. If the plan assets underperform these assumptions, the company will be required to kick in additional cash. On the other hand, if plan assets exceed the investment return assumptions, the company cannot tap this "extra" cash. This creates an incentive to fund a pension plan as thinly as possible.

Memory tells me, it wasn't all that long ago -- ten years, say -- that smart corporate managers were busy lifting cash out of their pension funds with both hands, on the grounds that the funds were generating far more revenue than would ever be needed for paying pensions .... and being praised for their cleverness.

Just in retrospect, shouldn't libertarians have found reason to be disturbed by this?

Also, the point I was making is that oil is artifically high because of the GWOT and other factors (such as the filling of the Strategic Petroleum Reserve), and no business plan can be sustained in the face of such a severe anomaly. At least in the airline business, which is unusually dependent on the cost of fuel.

Really? No airline business can function in the face of the mighty filling of the Strategic Petroleum Reserve? Haven't we been filling the reserve for something like the last 20 years?

The air industry faces overcapacity. Too many planes and not enough passengers. The rational solution is to reduce capacity. The market does that by forcing some airlines into bankruptcy where their assets will be sold off. What needs to happen is an old story that has happened a million times before.

There are several bigger issues here than the behavior of United or the airlines.

Autos, auto parts, steelmakers, and airlines all have pension problems (they're probably more industries, those just came off the top of my head). They all have defined benefit plans (and interestly are all heavily unionized). These are all 'old' economy industries that must have thought they could afford heavily subsidized work forces, however obviously they can't. United is the tip of the iceberg.

The airline industry is over-saturated. The industry will continue to lose billions of dollars a year until some firms go out of business or there are mergers.

The 100k insurance for S&L's had little to do with the bailout. By law, a majority of the assets of S&L's were 30 year mortgages. In the late 70's, early 80's, w/ interest rates where they were, the spread on the interest earned on their assets compared to interest paid on liabilities (deposits, mostly) was insufficient for the industry to survive. Congress responded w/ a bill (can't remember the name), one of whose provisions allowed them to invest in riskier assets, in order to increase their spread. When those riskier assets tanked in the late 80's, many S&L's went with them.

Boonton: very funny, but cherry picking parts of an argument to respond to and leaving the rest unchallenged won't win you many debating points. The filling of the SPR was the second of the factors I cited, and clearly only intended to be one of many in addition to the GWOT, which is the main cause.

Regarding the question of overcapacity in the airline industry, that is looking at the problem through the wrong end of the telescope. To the extent that there is overcapacity, it is because volumes are depressed by such things as the GWOT, global politics, and the dollar-euro exchange rate. Even at current traffic levels the industry as it exists today would probably be marginally profitable, if oil prices were not through the roof, so the current crisis can be arguably identified as an offshoot of national policy that has unintentionally created the oil bubble. If the government accidentally blew up your house while testing some new munitions you'd expect them to compensate you for it, wouldn't you?

Finally, your idea that the industry just needs to downsize and everything will be peachy is wrong. Even the airlines with the highest load factors are only marginally profitable if at all, and few Americans would be happy if the number of flights and seats are reduced to the extent that you suggest. Airlines would be likely to drop marginal routes and still fight to the death over the more profitable ones, so air travel would wind up being much more inconvenient and/or unavailable to a large number of Americans, with no substantial increase in overall profitability for the industry. This downsizing would have the additional drawback of producing concomittant fallout in other travel-related businesses. As a business traveler, I for one would not appreciate the reduction in flexibilty or convenience that this would imply, nor would the economy be likely to benefit at all from such a change.

Which again, is why I think this is a cost of doing business in the current global environment that should be borne by society as a whole rather than any one group.

cb wrote:"When those riskier assets tanked in the late 80's, many S&L's went with them."

... and many more were forced into liquidation by federal regulators with itchy trigger fingers. My bank at the time was "given" several of the failed banks by the FDIC/RTC. When they got the balance sheets, loan records and the like, they were astounded at how few bad assets there were. Sure, some of the banks/S&Ls were as depleted as Enron, but many were taken down by a fire sale mentality in Washington. With some time to ride out the real estate downturn in the energy belt, most would have survived just fine.

ech,

interesting. it's also sad that junk bonds got the blame. i've always felt bad for milken. it's good to see him making positive contributions to society. I don't know that i would have been so inclined after an undeserved stint in jail.

HT,

I think this is the first time ever that I have agreed with Boonton on something, but I agree w/ him and your retort is unconvincing. If an industry can't provide a product/service at a profit, it won't. It is irrelevant if Americans want more flights, if they can't be provided at current prices, it won't. I am not an airline industry analyst, I don't know why they are more interested in market share than profits right now. I know that every time a carrier announces a $10 price rise, they rescind shortly thereafter because no other carriers follow. I'm guessing that it's a bit like musical chairs, everybody knows that somebody is going to go belly up (or be swallowed), it's just a matter of when.

I'm not sure I even understand your point. Is it that polital/global things are the reason for the industries problem? Say it is, what are we suppossed to do - subsidize them every year? Nationalize the industry? The airline industry has been having problems for years, 9/11 and oil are just shocks to an already sick industry. I guarantee there will be more bankruptcies and pension issues, eventually there will be consolidation.

Regarding the question of overcapacity in the airline industry, that is looking at the problem through the wrong end of the telescope. To the extent that there is overcapacity, it is because volumes are depressed by such things as the GWOT, global politics, and the dollar-euro exchange rate. Even at current traffic levels the industry as it exists today would probably be marginally profitable, if oil prices were not through the roof, so the current crisis can be arguably identified as an offshoot of national policy that has unintentionally created the oil bubble. If the government accidentally blew up your house while testing some new munitions you'd expect them to compensate you for it, wouldn't you?

Yea but the gov't didn't exactly shoot down airplanes after 9/11 did they? Consumers responded to market changes. Yes maybe the US gov't could have taken some action to reduce the increase in oil prices. By this reasoning the automakers too are entitled to aid. After all didn't the increasing oil prices harm sales for their gas guzzling SUV's? Fuel prices, war, global politics and exchange rates are not novel risk factors if you are engaged in international transportation. Nor are swings in demand due to those things. Sales of first aid kits, duct tape and other 'homeland security' items increased after 9/11. Should those manufactures be given a special tax since they did nothing to earn those increased sales? How about the increase in business for lawyers writing living wills after Federal intervention in the Terry Schiavo mess? If consumers choose to alter their demand for air travel after 9/11 that is business. Money that consumers were spending on air travel is spent elsewhere (say video conferencing, auto/train transportation, movies, etc.) increasing demand for those industries. Long story short, bad luck is bad luck.

Finally, your idea that the industry just needs to downsize and everything will be peachy is wrong. Even the airlines with the highest load factors are only marginally profitable if at all, and few Americans would be happy if the number of flights and seats are reduced to the extent that you suggest. Airlines would be likely to drop marginal routes and still fight to the death over the more profitable ones, so air travel would wind up being much more inconvenient and/or unavailable to a large number of Americans, with no substantial increase in overall profitability for the industry. This downsizing would have the additional drawback of producing concomittant fallout in other travel-related businesses. As a business traveler, I for one would not appreciate the reduction in flexibilty or convenience that this would imply, nor would the economy be likely to benefit at all from such a change.

Like the collapse of the telecons after the Internet bubble, the result was a lot of fiber optic cable being sold at rock bottom prices. If several airlines go out of business their assets will likewise be sold at rock bottom prices allowing the purchasers to pick up assets and make them profitable. This might mean some routes will be eliminated. So what? Let's imagine a route that cannot generate enough consumer demand to pay for the fuel, pilots salary and wear and tear on the plane. How can such a route survive without taxpayer subsidy? Why should such a route survive?

As a business traveler I'm sure you'd find it much more convenient for someone else to pay your tab. However if business and tourist travel demand is insufficient to maintain current capacity the fair thing to do is to either insist that business & other travelers pay high enough fares to cover the costs of their routes or to let the industry downsize until demand matches supply. It may be inconvenient to you and other business travelers but unfortunately the inconvenience is not sufficient to motivate you to pay the price required to keep the entire industry flying.

I don't often agree with Boonton, but he is spot-on here.

Mike -- in retrospect, absolutely we should have been worried about this, whether or not we're libertarians; it was a bad idea. I also should have been worried about all those financial statement analysis classes I took, teaching me to back out all the funny things corporate managers liked to do to "smooth" their earnings. I don't know why I didn't think, "hey, I bet people who are too ignorant to back this stuff out are actually trading on these bogus numbers!" but in my defense, it's a lot easier to see problems when you've already got the result in front of you.

Also, the point I was making is that oil is artifically high because of the GWOT and other factors (such as the filling of the Strategic Petroleum Reserve), and no business plan can be sustained in the face of such a severe anomaly.

And that skyrocketing Chinese demand?

And that current speculation that the Saudis are going to lose primary production capacity much sooner then they are claiming?

Methinks the high price of oil, while possibly somewhat inflated by the factors you listed, isn't going to decline much in the forseeable future. IMO higher fuel costs are a new reality, not a temporary anomaly, and the airline business will have to adjust accordingly.

Would we be having this discussion if United had offered 401(k) plans instead?

Randy, United does offer a 401K plan. And your point is....? A 401K is different from a pension, in that it is a way to invest current earnings, while ESOP's and pensions are offered in exchange for lower current earnings. My point is that United's structure, pensions and all, would have been sustainable except for the impact of the exogenous factors of 9/11 and the GWOT, so a little assistance from society as a whole is not unwarranted.

Anony-mouse: the factors that you cite make my point. In fact, global inventories are not that much different from historical averages; only the fevered speculation brought on by current geopolitical uncertainties has driven the price of oil to its current anomalous level. As just one example, your "speculation" regarding Saudi oil capacity is just that...idle speculation. If we were living in a pre-GWOT world, such an unsubstantiated rumor would not have had the power to move the market; now, day traders are using it as fuel for their momentum plays.

It is amazing to me that the guy that delivered mulch to my house could charge an extra ten dollars fuel surcharge, but my airline can't seem to raise prices in spite of all the turmoil in the financial world since 9/11. I don't think the problem is so much overcapacity, but an unwillingness to let the market prevail over those carriers that have been unable to create a working business model. How long have USAir and United been in Chapter 11? Consider also, the false subsidies some of the low cost carriers enjoy in the cost of their airplanes. Airbus has been particularly generous in providing airframes to companies at low cost to keep the production lines open in Toulouse.
The underlying question really is how long will the airline employees continue to subsidize low fares before they cry uncle. I think we are rapidly approaching a point where employees (younger pilots especially) will look to other career options rather than put up with the uncertainty of the retirement situation.
One other question for the libertarians out there. Doesn't this underfunding of pensions amount to breech of contract with the unions? Pilots had a certain expectation of a comfortable retirement after 30 years of travel related family separation, long hours, all night flying, and bad weather. Now they are looking at $3800/month from the pension guarentee board. Not quite the comfortable retirement they were promised when they came to work in the 70s and 80s.

Scott:

Yes, it does seem to be a breach of contract, but what chapter 11 `relief' isn't? You go into chapter 11 when you can't meet your contractual obligations.

I would expect that the intervention of government to delay or absolve contractual obligations would be something a strict libertarian would be against. Bankruptcy seems to be more about mercy than justice, more Jerusalem than Athens, and maybe because I agree that it makes sense, even though I have been burned a couple of times as an unsecured creditor, is why I am a conservative and not a libertarian.

"The only people who lose out are the stockholders."

Jane, the stockholders usually do fine; they get far more than they deserved under the absolute priority rule, which is nothing. It's the bondholders who get screwed.

HT,

Re; "My point is that United's structure, pensions and all, would have been sustainable except for the impact of the exogenous factors of 9/11 and the GWOT, so a little assistance from society as a whole is not unwarranted."

Exogenous factors happen. My point is that higher paid workers at United would have been better off with a defined contribution plan.

As for the exogenous factors you discuss, these created higher costs for the oil industry too. They raised their prices and are doing fine now. Society is paying the costs - via the price mechanism. But in addition, society is getting smarter about the way it uses oil - society is becoming more efficient.

Government support of the airline industy is one method for society to pay the costs of exogenous factors, but it is a high cost method. The difference is the efficiency gain lost by not letting the price mechanism work.

"First, let me just note that the managers at United could scarcely have been delighted to declare bankruptcy and dump the pension plans, as they were participants in both the United ESOP and those same pension plans and thus wrecked their own retirements in the process."

Before you start crying for the top managers, check on how much they were getting in salary and bonuses for the five years before the bankruptcy. Someone with $10,000,000 in the bank doesn't need a pension. Heck, if I had $500,000 in the bank I wouldn't need a pension.

Mark W: Since I try to stay in contact with reality (unlike some libertarians and conservatives, and most liberals), I am aware that sometimes it simply isn't possible to meet all of one's contractual obligations. At the point where one files bankruptcy, the issue isn't whether one will default on some obligations, but how to minimize the damage overall. Chapter 11, which leaves a company running if there is a potentially profitable business in there somewhere, is better for virtually everyone than firing all the employees, auctioning off the physical assets, and tossing the boss in debtor's prison. In regards to the creditors, they'll usually get paid more this way than from auctioning assets which aren't much use without the employees and organization that operated them.

My employer, an electronics manufacturer, went through chapter 11 a couple of years ago. The stockholders got about 1 cent on the dollar. We stayed up and running the whole time. If we'd shut down, it wouldn't have just affected us; a dozen customers would have been nearly shut down for 6 months while they found other places to get their boards built.

HT,

My point is that United's structure, pensions and all, would have been sustainable except for the impact of the exogenous factors of 9/11 and the GWOT, so a little assistance from society as a whole is not unwarranted.

I'm a little closer to the issue than you are on this one. My sister has worked for United for 15 years, the last two as secretary/treasurer in the IAMAW local. United's structure was absolutely not sustainable in the long run, and everybody involved with the company has known this for years. Look at the past actions of United over about 10-12 years. Employee buyout, Chap 11, etc. UAL was floundering for years before 9/11. Anybody that says otherwise just hasn't been paying attention.

re Scott:

"Only" $3800 a month? Come now! Don't you guys need some perspective? For someone making $23,000 a year, that sounds like a fine retirement to me. I'll take one of United's "failing" pensions any day!

It's true, even a stopped clock is right twice a day;

Previous post should have read:

It's true, even a stopped clock is right twice a day:). Good posts Boonton.

T: I am not going to get into a discussion about my qualifications to conduct a financial analysis of the airline business, although I will clarify that I do not work for United. But your sister's assertions and conclusions are wrong. I will point out again that UAL made $332MM in 2000, and has made substantial progress with regards to its cost structure since that time. Without 9/11 and the GWOT (and the concommitant speculation in the oil market), UAL would already be back in the black.

I am also not going to continue this argument ad infinitum, so I will just close with the thought that, before I'm willing to see 60,000 people thrown out of work and major disruptions in the employment of hundreds of thousands of others, I'd rather compromise my conservative principles a bit and see society intervene to provide a little protection during the storm.

In a war, things are just different.

Mark W:
Good point on the mercy aspect of Chapter 11. My company has been through the wringer too, and emerged stronger and more viable. I don't wish the demise of United, especially as a result of having been targeted by the 9/11 terrorists. There is a place for government to provide assistance to severe and unexpected injury. (Coast Guard rescue comes to mind.) But just when does this assistance become enabling? Is government (justice/bankruptcy court) smart enough to know when to stop? Mercy for the employees of one company becomes injury to the employees of other companies who continually take pay cuts and work rule changes in an inane race to the bottom of the cost curve.
The nature (and purpose) of Unions is to warp the supply/demand picture for labor. Most of the time this is actually a good thing. It is good for the individual (sort of pro-libertarian thinking in a twisted way) who is a member of the Union. I don't think we want to go back to the days of the Trusts. The whole underlying idea of taking a Union labor position was that you gave up flexibililty and lateral mobility for some modicum of security and retirement stability. Now suddenly we have government enabling management to unilateraly change that equation.
I will grant that it is not all management's fault. 9/11 and much of the financial outfall that followed could not have been predicted. Government must shoulder a good portion of the mess as well. They had the regulatory responsiblity and horsepower to keep the pensions from becoming underfunded and didn't.
I am afraid the bottom line is that the commitments made to the Boomers, and the expectations thereby created, are way beyond the fulfillment capabilities of the post-Boomer economy. The "me generation" is going to be disappointed.

Well, Jane, I guess I'm just more pessimistic about human nature than you. I think in retrospect we can all see now that for pension coverage the day-to-day feedback mechanism (premium payments) is too weak to begin with, and in times of crisis there is effectively no feedback mechanism, thus, whopping moral hazard. The additional outlet for accounting shenanigans is another point against the whole setup, but in most situations neither issue will amount to much - no imminent bankruptcy, no wild stock market fluctuations giving CFOs diabolical ideas - and both you and I will think it's nice that pension plans exist, and pretty much stop there. I should add that when I retire I fully expect to receive my (final yearly salary)x(years employed)/100 per year, although I don't work for an airline. Or GM.

I think this otherwise astute piece misses two key points. First, that the risk-rating of premiums by the PBGC is woefully inadequate – underfunded plans do pay more than fully funded plans, but the difference is not at all commensurate with the difference in risk borne by the PBGC. And second, as a consequence of the first, the PBGC has a very high likelihood of going bust and leaving its obligations at the foot of taxpayers. The ongoing rationalization of heavily unionized industries (which tend to have the largest DC pension plans) makes it a near certainty, in my view. The clock is ticking on PBGC and it is only a matter of time before it requires its own bailout. If not after United, then Delta, or inevitably GM. Just my two cents.

Bonnie,
Be careful of the class warfare arguement. It doesn't really apply. I hope you have the education, skills and drive to make a whole lot more than you do now. The question is more of expectations and commitments. The pilot that retired five years ago on an annuity (think fixed income) has the right to expect that fixed income to remain fairly steady into the future. He (or she) has financial commitments balanced to that income. Now, suddenly the income is slashed by 30 to 60 percent. Wouldn't you be dismayed if you retired on $1000/month and suddenly it was $380?

It is amazing to me that the guy that delivered mulch to my house could charge an extra ten dollars fuel surcharge, but my airline can't seem to raise prices in spite of all the turmoil in the financial world since 9/11. I don't think the problem is so much overcapacity, but an unwillingness to let the market prevail over those carriers that have been unable to create a working business model. How long have USAir and United been in Chapter 11? Consider also, the false subsidies some of the low cost carriers enjoy in the cost of their airplanes. Airbus has been particularly generous in providing airframes to companies at low cost to keep the production lines open in Toulouse.

We could also consider the indirect subsidy of the armed forces, many pilots get their training in the armed forces before they go to the airlines. If the airlines had to pay for this training (or if the pilots themselves had to pay for it) labor costs would be much higher. The whole economy is interconnected so if you look hard enough you can find thousands of 'exgenerous' causes of a particular company's success or failure.

But a more blatent subsidy has been bankruptcy protection itself. Airlines in bankruptcy continue to operate but do not have to make timely payments on their back bills. Other airlines are rightly annoyed at having to compete with someone who doesn't have to pay his suppliers or creditors while they do. Business failures are a normal part of a dynamic economy. They do not have to happen because someone did something wrong. What's important, though, is that they happen so the economy can adjust to changing needs as quickly as possible.

One other question for the libertarians out there. Doesn't this underfunding of pensions amount to breech of contract with the unions? Pilots had a certain expectation of a comfortable retirement after 30 years of travel related family separation, long hours, all night flying, and bad weather. Now they are looking at $3800/month from the pension guarentee board. Not quite the comfortable retirement they were promised when they came to work in the 70s and 80s.

Indeed it is a breech. Like all contracts, though, they are only worth the ability of the parties to actually live up to them. All consumer debt is financed with the risk that the consumer will not be able to pay it off. Even secured debts like house and auto loans may be unpayable even after repossession. Risk is either something you have to live with or something you pay someone else to live with. This is why I still wonder if it wouldn't be more sensible to require pension plans to purchase insurance from the private sector? In essence paying an insurance company to take on part of the risk.

I would agree with you Jane if I...had not reading articles about a potential pension plan crisis because of unrealistic expected returns in the plan for about a decade now. If GM and Ford debt had not been recently downgraded to junk status because of pension liabilities.

Didn't Buffet mention this about 5 years ago? Lots of others did too. You must remember those late 99 WSJ articles about how the stock market boom was finally getting these pension plans to fully funded status. Why did it take 14 years of 15% returns to get these guys fully funded?

This is not a 1 year miscalculation by one or two firms. It's 15 years worth of bad assumptions by many firms. Its pretty difficult to be wrong for that long, unless its deliberate. Remember, these guys somehow overestimated the greatest bull market in history. A historicaly typical 4 year sideways market has pushed them to the brink of bankruptcy.

Assuming 10% returns when long term stocks give you 8% and a substantial portion of your port is bonds anyway is not defensible. Its criminal.

Interesting comments, everyone.

Jane,
As many commenters pointed out, if the FBGC is not direct corporate welfare, it is de facto corporate welfare. Just as bad.

You speaks favorably of bankruptcy protection for firms as a price worth paying in exchange for economic stability. What do you think about the recent bankruptcy bills which will take away that stabilizing option for families all across America?

I'm absolutely not suggesting that we abandon the pensionees. The government should pick up the tab -- after auctioning off the carcass of United to pay it down first.

Would the dissolution of United cause massive disruption and misery? Yes. But of all people I would expect libertarians to understand that for the free market to work companies must be allowed to fail if they are not sustainable in the long run. There is good reason to believe that United's problems are long-standing and irreversible. To prop them up with taxpayer's dollars is irresponsible and ultimately futile.

Boonton,

Good points. I wonder if private companies had the capacity to take on that risk back when these DB plans were put in place. I don't know the history of pensions, but if you look at the industries that are having problems with them now, they were a much bigger portion of the economy decades ago. Our financial markets are much larger and more efficient and could probably do it now, but I'm not so sure 50-75 years ago.

At any rate, it appears most new economy sectors are more DC oriented. It's going to be ugly, but if at the end of the day pensions are DC, that's better for everybody.

I'm curious about your thoughts about SS reform. To me, DB pension problems are the same as SS and Medicare problems. As a post-baby boomer, I'll end up paying for the me-first generation's retirement w/o getting much in return. To say I'm pissed would be an understatement.

To Jane and all: very interesting post and comments. Lots of good stuff to think about. I write only to question one thing that Jane wrote: "It's pretty generally recognized that Chapter 11 bankruptcy is one of the great strengths of the American economy, allowing companies in hard times to restructure rather than expire, salvaging something for workers, creditors, and the company." Is this really generally recognized by economists? It's far from clear to me that ch. 11 results in net savings in jobs and economic growth versus a regime of liquidation. It seems to be the case that the airline industry as a whole would be much better off if United and US Airways were to liquidate. Have any economists tried to quantify this?

cb,

I made a comment on DB versus DC on the 'Regulating Risk' post....it's hard to keep track of the SS debate when it is popping up on at least 3 or 4 threads.

In the past, there were 3 'legs' of retirement. Social Security, pensions and private savings. IMO this was smart since it combined the strengths and weaknesses of the 3 providers; gov't, companies and individuals. The mix was bout 2/3 annuity type (you get a certain amount every month until death) and 1/3 'nestegg' (you have a lump sum that you can pass on to your heirs or spend as you please but when it is used up its gone).

Now the shift appears to be for pensions to be replaced with 401k's and private savings to mostly take the form of real estate. However the balance is now 2/3 nest egg (in theory you could take your 401K and buy an annuity but my impression is that the industry is still rather undeveloped and expensive in most cases) and 1/3 annuity (social security).

IMO there should always be a mix of both. People are bashing social security because it 'leaves nothing' to pass on to their heirs and that is indeed a weakness. However a strength is that Social Security doesn't run out. If you live to be 110 you may easily discover your 401K has been depleted to nothing but you get a social security check until you die. A good system combines the strengths and weaknesses of both 'nest egg' plans as well as annuity types.

I don't think that's accurate. Corporate welfare is something that's exclusively directed at the corporation, and most outrageously (I think even libertarians would agree) at well-connected managers. The PHGC was set up in 1974 to bail out workers who had, through no fault of their own, seen their pensions destroyed when their companies blew up.

The PBGC isn't funded by taxpayers; it's funded by the companies themselves. Now, the premiums that those companies pay are too low, and I might be willing to argue that this is corporate welfare (and I'd certainly be willing to argue that this is a legislative failure that should be rectified immediately), but that doesn't change the fact that this bailout is a bailout of workers whose unfunded pension obligations have been discharged by the bankruptcy court, not a bailout of the company itself. United is not being "propped up by tax dollars"; it's being propped up by its own insurance premiums, and those of other companies. Now, ultimately, the underfunding of the PBGC may result in other companies being propped up by tax dollars, and I think that we should move immediately to rectify that problem, but this particular case is simply not a case of corporate welfare.

I know that some on the left view Chapter 11 as a form of corporate welfare, a view I think is pretty economically ignorant, but even so, in this case it's pretty obvious that it's the airline employees who will really get the shaft if United goes under--there's something of a glut of airline employees already, and any new jobs that were found would almost certainly be at budget airlines for lower pay and benefits than they're getting even under their restructured contracts. Whether or not we should be bailing out airline employees with unrealistically high wages is an argument I won't get into, but I don't sense that you're against protecting unionised workers from the fallout of union value-claiming.

What do I think about the new bankruptcy law? As it happens, you've stumbled onto something I know about; I wrote extensively about it when it happened. Personally, I think that the new bankruptcy law is unnecessary; the economy is doing just fine without it. I also think that many of its provisions are poorly thought out and structured. However, with the exception of one provision, which requires people to fill out detailed budgets even when they've already means-tested into Chapter 13, I don't buy the moral outrage that most of the opponents were trying to provoke with misleading or unlikely disaster stories. Almost everyone will qualify for Chapter 7, and it doesn't strike me as outrageous that the richest 5% of bankruptcy filers should have to try to pay something back, rather than discharging all their debts. Nor do I think that it's ridiculous to prevent people from serially filing Chapter 13 in order to stave off evictions and foreclosures; force people to provide tax returns and drivers licenses before they file; prevent judges from marking down the value of secured loans that Chapter 7 filers wish to keep paying (in order to keep their car, etc); or many of the other items that consumer advocates were peddling.

I'm assuming that you're unaware (as are most people who got their information from news stories and blogs) that there were actual substantial provisions in the bill making Chapter 11 less corporate-friendly. Most notably, Congress radically cracked down on Key Employee Retention Programmes (KERPs) which allow companies to pay bonuses to managers in order to keep them at their jobs during restructuring. I'm ambivalent about this provision--it is true that the most likely folks to leave are the ones the company most needs, but on the other hand, this can turn into a management slush fund--but it's definitely not corporate welfare. There were also numerous other provisions making Chapter 11 less attractive.

Both sides of the debate on bankruptcy were trying to cast the debate as a moral one-- the reformers claiming egregious abuses by bankruptcy filers, the anti-reformers claiming that evil credit card companies were trying to throw innocent victims out on the street. I didn't buy either side. After all the hoopla, America still has, by far, the most debtor-friendly bankruptcy law in the world. At the same time, that doesn't seem to be hurting either the economy, or access to credit. My take was "if it ain't broke, don't fix it", plus I thought a lot of it was poorly written. But I didn't have much emotional investment either way.

Boonton:
"Demographics is not a science with lots of unexpected surprises. I remember reading that the actuaries in 1933 were able to predict in 2000 the portion of Americans over 65 to within a margin of less than half a percent." I'd like to see a reference for that - if they predicted the advance of medical science that precisely, they were amazingly prescient. Especially if the invention of penicillin and other antibiotics in the 1940's didn't throw them off for a couple of decades. But aside from the first antibiotics, medicine's improvements in the last century have been large but always incremental; you can't tell exactly what is coming next, but something was always coming, and no one improvement (except penicillin) materially affected more than a few percent of the people. (As for antibiotics, many years of research aimed at finding something like them had only produced the moderately successful sulfa drugs, so the surprise factor was penicillin showing up by accident after most researchers had given up.)

Don't count on it staying that way. It wasn't that way in the past. If Jenner's smallpox vaccine had been marketed the way drug companies market new drugs now, a disease that was killing more than 10% of each generation would have been virtually eliminated within 5 years. An alert actuary might have known the possibility 10 or 15 years earlier, when the vaccine testing began, but you don't know if it's going to actually work right up until the last test passes; all that actuary could have done was to present two possible future actuarial graphs, with and without the vaccine, and no likely middle ground between them.

"Wouldn't it be better to mandate that companies purchase insurance to cover, say, 80% of their pension obligations from private agencies?"

Just suppose researchers somewhere are just about to stumble upon a cure to aging. It will take twenty years to get it to market - but then it will utterly destroy the actuarial predictions for older people. Suppose you've just contracted to pay a 45 year old X$/month starting from his 65th birthday. You aren't going to be able to keep that promise. And if insurance companies contracted to back up pension plans for millions like him without any escape clause, they'd be filing bankruptcy soon after the plans did. For that matter, I doubt that the government would ultimately pay pensions to someone who was going to be 65 forever - but the government could pay enough to support those who really were permanently too sick to work, and has other ways of getting out of deals that turn sour.

In one thing you are quite right: it would be better if DB pension plans were required to buy private insurance. The insurance companies would be better than gov't bureaucrats at assessing the risks and appropriately pricing the premiums. But if you don't have a system whereby the private insurers can turn around and buy gov't insurance, then the "defined benefits" are really only defined benefits until something goes really haywire...

Not that I have any problem with that - provided the workers understood that huge chunks of money that could have been in their paychecks were instead going to pension plans with a less than 100% guarantee.

Jane, you've proven that paying a portion of the promised pensions to workers isn't corporate welfare. But undercharging the companies for this insurance is.

DBL, as far as I'm aware, that's not a very controversial position among economists. Most foreign countries are trying to make their bankruptcy laws more like ours, precisely because they recognize the advantages it holds both for workers, and for economic competitiveness.

With industries like airlines, it's not clear that either liquidation, or non-liquidation, will make things better. The big problem is the planes and the landing slots; whether or not United liquidates, those won't go away. Eventually, if we've reached some kind of new lower equilibrium demand for air travel, excess capacity will be absorbed by companies ordering fewer planes. But it's not like, say, steel, where there are a lot of outdated plants out there that will just be mothballed, or even like telecomms, where companies just left a huge amount of fiber dark.

As I say, Markm, quite possibly so. But the bankruptcy, and the pension assumption, aren't corporate welfare. I've been yelling about the PBGC for quite some time. But Battlepanda is angry that United is being allowed to limp along, and seems to believe that they're being bailed out by the taxpayer to do so, when the discharge would have taken place (AFAICT) with or without the PBGC.

"Demographics is not a science with lots of unexpected surprises. I remember reading that the actuaries in 1933 were able to predict in 2000 the portion of Americans over 65 to within a margin of less than half a percent." I'd like to see a reference for that - if they predicted the advance of medical science that precisely, they were amazingly prescient.

I haven't updated it recently but take a peek at my 1/16/05 entry on my blog; http://theeverwiseboonton.blogspot.com/ The source is Roger Lowenstein's piece in the Sunday NYT Magazine. I hate to say, though, that the NY Times has put this behind their 'archive wall' so I can't cite you the specific paragraph. I know I've mentioned it on other comment threads so you might find a direct quote there.

Just suppose researchers somewhere are just about to stumble upon a cure to aging. It will take twenty years to get it to market - but then it will utterly destroy the actuarial predictions for older people. Suppose you've just contracted to pay a 45 year old X$/month starting from his 65th birthday. You aren't going to be able to keep that promise. And if insurance companies contracted to back up pension plans for millions like him without any escape clause, they'd be filing bankruptcy soon after the plans did.

That's true but it's something of a long shot. Perhaps it might be simply addressed by making a 99% estimate for lifespans and insert a clause stating that the pension plan has the right to alter benefits if X% of members live past, say, 105 or something.

Not that I have any problem with that - provided the workers understood that huge chunks of money that could have been in their paychecks were instead going to pension plans with a less than 100% guarantee.

Well back during the Cold War people understood there wasn't a 100% guarantee the world would still exist in 20 years. I suppose people and companies could learn to live with the risk that we might uncover eternal youth.

CB,

Re; "I'll end up paying for the me-first generation's retirement w/o getting much in return."

The boomers didn't create the problem with social security, and honestly I'm getting tired of being blamed. We've been paying for our parents like good little socialists, and we've been paying extra money into the trust fund for most of our working careers because we realize there are quite a few of us. It is not our fault that the government spent the so-called "trust fund" money. We're not trying to screw you. We have recognized a problem and are trying to do something about it. You want to blame someone, blame your grandparents. It was they who voted themselves the outsized benefits and who are now fighting tooth and nail to keep needed change from happening.

It is up to the boomers to shoulder the burden, not because we created the problem, but because we have realized the problem. Fixing it is the right thing to do. Then again, if we don't fix it, calling us the me first generation would be absolutely correct.

Interesting question for those who allege the trust fund money has 'been spent'. Suppose you could go back 10, 20 years whatever and had complete control of both the Fund and the general budget. Assuming you had to keep Social Security and the trust fund surplus, what would a 'money was not spent' scenero have looked like?

Randy,

Ok, perhaps there are some boomers who want to fix the problem, ie white house resident and yourself. Perhaps I should be angry at the leftish boomers, krugman, et al, who either say it isn't a problem, or are represented by a bunch of politicians who are doing nothing but taking shots at the prez. Whatever. I have, because of your post, now shifted SOME blame to WWII generation, but I still don't like boomers, nothing personal.

Boonton,

Great points, again. Your post is the first time I have questioned personal accounts, and I've been reading econ blogs for months, unfortunately :) I would support reform w/o personal accounts if SS was changed from a gov't retirement account/security to just security, which would entail a cutback in benefits/rise in retirement age. An expansion of the private saving mechanisms would be nice too. Then again, one might argue that a change of SS to just a social security net would entail cutting the tax, or allowing me to put a portion of that tax into a personal account. Hmmm.... sounds like the current proposal.

I would go for a 'universal savings account' on top of what we currently have. Require that 2% of payroll to into an IRA type account. If you already contribute to a 401K your requirement is waived.

I would, however, let people access money in this account that is 5-7 years old or older. It would become something of a 'rolling nest egg' that could be tapped for emergancies (like losing a job) or opportunities (starting a business) as well as serving as a way to shore up the private savings leg of retirement.

Boonton: I went to the 1/16/05 entry in your blog, and searched through it for "actuar"(-y or --ies or -ial), and all I found was lots of references to uncertainties in the current projections. Not that these amount to a big percentage - but the predictable things never do.

Yes, the article I cited had the figure but it is now locked behind the archive so it can't be reached unless you're willing to pay for it. I've tried to search some other places to see if I could locate another blogger who cited the part of the article with the passage but I've been unsuccessful.

I know I've cited the exact paragraph before as comments (probably here).

I did find this:

In 1934, when Franklin Roosevelt formed the Committee on Economic Security to design what was in effect the first federal safety net, the committee hired three actuaries to stargaze into the future. The actuaries predicted that the proportion of Americans over 65 -- then only 5.4 percent -- would rise to 12.65 percent in 1990, meaning that retiree costs would soar. They were just a tad high; the actual figure would be 12.49 percent.

It appears on http://www.thinkingpeace.com/pages/arts2/arts343.html

Sorry HT, I still don't buy that argument. Here's a graph (low-res, sadly, but mostly legible) that explains why:

Inflation-Adjusted Crude Oil Prices, 1946-2005

(from here)

Inflation-adjusted crude prices ARE at a local maximum but that maximum is not excessively out-of-line with previous averages and spikes in the past twenty years. ($10/barrel at the end of the roaring nineties was no doubt a happy time to be flying passenger aircraft, but it was also anomalous.) Moreover, China's oil consumption outstripped it own internal production sometime in the mid-1990s and has been rising ever since, and that country has huge, yet-unrealized growth potential.

I reiterate: the cost of energy is not going down significantly in the near future, and the airlines will have to adjust to the new reality. But even more to the point, attitudes toward airline travel have changed, even apart from 9/11. Air travel has become significantly commoditized. A low-cost ticket is all that matters, even for many business travlers these days, which cuts margins. Reduce margins mean reduced profits, and that exposes the excesses the airlines have previously enjoyed (you DO know what senior pilots make per year in salary and benefits -- and how few work hours they have to put in -- at the union shops, right?)

Randy -- "It is not our fault that the government spent the so-called "trust fund" money."

Really? Last time I checked, the Baby Boomers were the largest single age cohort of eligible voters for at least the last twenty years. Are you going to try to tell me the government stopped spending the trust fund money back in 1985? Or was their a coup, and the army stopped you from voting the spenders out of office?

I'm not one for collective responsibility, but don't tell me it's "the government's fault". The government is elected, and you were the people with the power to do the electing.

Jane,
Potayto potahto. I don't care if the value transfer to corporations comes in the form of too-low premiums, it's still taxpayer's dollars subsidizing poor corporate performance. Whenever profits (what there is of it, in United's case) are privatized and the costs are borne by the public, that's coporate welfare in my book.

Again -- I have nothing against the government pick up the tab, as long as United liquidates first to pay it down as much as possible first. This sets a good precident to prevent more companies abusing the PBGC system by underpaying into their pension funds when times are good and coming round hat-in-hand when times are bad.

And how would one less company in an overcrowded airline industry not make things better? Look around -- eventually it's gotta happen. If not united, then some other company is going to go down. Same fallout.

As for unions -- they do renegotiate their contracts in bad times. The problem is, they are often reluctant to do so because once the good times starts rolling again management is often not quite as willing to hike their wages back up again.

Battlepanda - Your arguments are fine in theory but fall apart when they come up against the hard realities of the United Airlines case. In general, should a company be made to fork over as much as possible before the PBGC takes over any of the company's pension obligations? Of course! The reality is that is EXACTLY what happened in United's case. Had the court forced United into liquidation ALL the proceeds from asset sales would have gone to United's secured creditors leaving NOTHING to go to the pension fund and the other unsecured creditors. A liquidation may have made feel better in some sort of cosmic way, but it wouldn't have generated ANY extra money for the unsecured creditors. (All of this assumes the court is doing its job -- which is to maximize the amount creditors receive. The reason United is still flying is because the court believed that, in the long run, flying is the best way for United's creditors to receive as much of what they were owed as was possible under the circumstances.)

Warmongering Lunatic,

You've got a good point. We f'd up. We trusted them. That's a major part of the reason I'm saying its up to us to fix it - now that we know we can't trust them.

Re; "Suppose you could go back 10, 20 years whatever and had complete control of both the Fund and the general budget. Assuming you had to keep Social Security and the trust fund surplus, what would a 'money was not spent' scenero have looked like?"

As soon as it became clear that existing revenues could not pay promised benefits, we should have immediately cut back on promised benefits. The trust fund sounded like a good idea - mostly because they called it a trust fund. It wasn't - a good idea or a trust fund. So we should do now what we should have done then - cut promised benefits to match expected revenues.

Yes, Battlepanda, you don't seem to understand how bankruptcy works. This is exactly why chapter 13 (the human equivalent of Chapter 11) is less attractive than Chapter 7 (the human equivalent of liquidation) -- the creditors get more, not less. As I, and others, have pointed out, United's assets are secured by debt, or in the case of landing slots, non-tradeable. Other than some inventories of frozen meals, a liquidation would produce nothing for the pension plan. United is almost out of cash, and from news accounts, there seem to be quite a lot of senior claims.

If the too-low premia are a problem (and I agree they are) then United is not getting any more corporate welfare than all the other companies out there. United's pensions will be paid by the PBGC, not the government; how is that special corporate welfare for United?

The reason that I don't think failure will reduce surplus capacity is that my understanding is that other bankruptcies in the industry haven't, other than very temporarily. The landing slots revert to the port authorities and are immediately resold, while the planes get sold on the open market at whatever price they will fetch, and, after a quick paint job, enter service for those airlines. Overall capacity stays the same. Since most of the airlines that will buy the planes have already realised any economies of scale, this doesn't even increase profit margins.

This could change if the planes are bought abroad, or if the landing slots are used to open new, profitable routes. But my understanding is that there is just as big a glut abroad as at home (and growing developing areas can't afford the relatively new American planes), so #1 doesn't happen, and that if #2 were profitable, airlines would already by jumping on those routes with both feet. Plus, at least a significant plurality of United's landing slots are at airports that only handle domestic traffic.

As for what unions do in downturns, no industry analyst or economist would agree that the problem for airline unions is insufficient ability to claim value in good times. Or rather, the problem isn't that unions are afraid that the company will keep excess profits to itself; for one thing, in United's case the employees owned half the company, and any attendant profits, and for another, the major airlines have never generated excess profits for more than a couple of years running, precisely because every time they do, a union contract comes up for negotiation, and the money goes out the door again.

What the unions are afraid of is the other unions. When you have four or more unions on a single operation, any one of whom can stop the operation with a work action, the negotiating power rests on the side of the union. This is particularly true for airlines, because lost production cannot be made up later--if a flight doesn't fly, that revenue is permanently lost. Since a large proportion of airlines' costs are fixed--the airplanes, landing slots, and associated equipment--missing a lot of flights means big trouble. The unions have what one might call extreme bargaining power; a labor action can easily push them into bankruptcy, as it did at Eastern.

The problem for the unions is thus not getting more money out of the companies; it is that all of the unions have exactly the same power to maximise the value they extract from the company. I won't go into boring math, but say that the company makes an extra hundred dollars this quarter. The first union up for contract negotiations knows this (since companies have to publish financial statements). Since any of the unions has the power to shut down operations, and the union knows this, the company ends up giving them the whole hundred rather than face a strike or other work stoppage.

The problem for unions is that if they leave any value on the table, the next union will claim it. The problem in down times, and why airlines are so vulnerable to bankruptcy, is that when good times return, the union that gives up the most (generally the pilot's union) will not necessarily be the union that reclaims the most value, particularly if the negotiations are staggered. In that case, the union that gets to claim all the value is simply the one who happens to be up first. With four unions, there's also substantial temptation to free ride on the others, hoping that they'll make deep concessions so that you don't have to. This may be why the flight attendants, whose equivalent non-airline job (waitress) is probably the worst paid, seem so often to be making the deepest cuts.

Everyone I know who works in the industry, from raging lefty to radical libertarians, is in concerted, 100 percent agreement that the reason that the airlines are so unstable is the unions. A few of them are mad about the PBGC because they believe that the unions should get what they so richly deserve for forcing the company into bankruptcy in the first place, draining reserves and refusing to make sufficient concessions to let the airline operate profitably. But no one (and none I know work for United or USAir) think that United is getting some sort of super deal here. The only super deal is that tens of thousands of workers still have jobs, and a lot of travelers still have valid tickets, and their frequent flyer miles.

There are no clean hands here. UAL employees, through their various contracts, demanded these pensions that UAL can no longer afford. That the UAL agreed to these pensions is wrong, but the employees were wrong as well.

I know that the PBGC limits the payouts, but that limit should be based upon the funds they are able to obtain from the employer, not on the employer's obligation to the employee.

Employees have an equal responsibility for the success of their employers. They are responsible for the health of the firms they work for and should not assume that they are innocent victims of corporate greed.

That an employer is not forthcoming with fair and affordable wages and benefits should give the employees reason to move on, not to demand unaffordable contracts.

As soon as it became clear that existing revenues could not pay promised benefits, we should have immediately cut back on promised benefits. The trust fund sounded like a good idea - mostly because they called it a trust fund. It wasn't - a good idea or a trust fund. So we should do now what we should have done then - cut promised benefits to match expected revenues.

Dodging the question Randy. What would a 'money not spent' scenero had looked like? Are you telling me it is impossible to save today to prepare for a large expected expense tomorrow?

Jane
The reason that I don't think failure will reduce surplus capacity is that my understanding is that other bankruptcies in the industry haven't, other than very temporarily. The landing slots revert to the port authorities and are immediately resold, while the planes get sold on the open market at whatever price they will fetch, and, after a quick paint job, enter service for those airlines. Overall capacity stays the same. Since most of the airlines that will buy the planes have already realised any economies of scale, this doesn't even increase profit margins.

I tend to agree with your analysis of the pension board but I disagree here. If other airlines have already realized economies of scale then why would they purchase United planes? Liquidation of United would keep its most valuable assets in service (such as landing slots). Planes can and are mothballed for parts or can be purchased by other industries (such as cargo hauling, foreign air fleets etc.). If nothing else liquidation allows someone else to pick up the asset on the cheap. A plane that was losing money when it had a $20M mortgage attached to it might be quite profitable when its mortgage is only $2M. If effect this is a reduction of $18M even though the plane remains in the industry working.

Boonton, I agree that the planes may be profitable in another airline's service, if they are purchased cheaply enough. But as long as they stay in service as passenger liners, the problem of overcapacity in the industry is the same. It would only change if there were significant economies of scale, which would allow fewer airlines to profitably run more routes than a larger number of airlines. As far as I know, there aren't.

If economies of scale have already been exploited then what value would an airline see in buying additional planes? Even if they were very cheap?

Besides, overcapacity is a relative term. There may be over capacity in terms of trying to service the debt on $20M planes but capacity might be just fine for $2M planes. After all, the fares have to at least be paying for the planes' fuel consumption, wear and tear, and payroll otherwise it would be cheaper for the airlines to have simply grounded them.

Boonton,

Re; "Are you telling me it is impossible to save today to prepare for a large expected expense tomorrow?"

Yes, it is impossible - at least in the form of a government run trust fund. In a government run private account, maybe. Though to be honest, a quick review of Social Security and particularly the trust fund gives me little reason to trust the government even in the form of private accounts. It seems to me that a prudent investor would give the government as little of his or her money as possible.

Let's say the gov't in 1938 expected a major war in 1941. They could do nothing today to save (even if only partially) for the major expenses expected to happen in 3 years unless they did it with 'private accounts'?

Boonton,

WWII is a good example. The government simply borrowed money - lots of it. I guess it could conceivably purchase equities or maybe land. But it seems to me the government would be better off leaving these in private hands and living off the taxes generated. No, I don't think the government has any real method of piling up assets for a rainy day. The theory of the trust fund was to pay off debt in the 80's so more could be borrowed in the future. Hard to say whether it worked - some say it did, others that it made the debt worse. But it was all debt - never assets.

Suppose gov't had ran a surplus in 1938-1941 of $1B. Never mind that WWII cost much more than that. Let's imagine two sceneros:

1. The surplus was used to purchase bonds from big corporations, foreign gov'ts etc. that paid 5%. In 1941 these bonds were cashed in for $1B + $50M.

2. The surplus reduced US Treasury borrowing by $1B...whose rate was also 5%. In 1941 the interest payments had been reduced by $50M plus US borrowing was $1B lower than what it otherwise would have been.

Are either of these sceneros different?

Boonton,

IF the government has the fiscal discipline to use the surplus to pay down the debt (as opposed to using it to enable further spending), then there is no difference. But its a very big IF, and it contains a great deal of risk for those who would trust their hard earned dollars to a government that has shown no propensity whatsoever for fiscal discipline. It makes all the difference in the world.

This is interesting, but we're totally off subject. Let's pick it up again the next time the subject comes up.

So you agree the two situations are functionally the same. Now here's the question for you, why would running the $1B surplus cause other spending to increase?

Let me be more specific. There's an obviously an incentive for the gov't to spend money. Politicians need votes and people want money so if politicians get money to the right people they will get votes. However the US and most democratic countries have reasonably stable gov'ts. There's obviously some incentive that goes in the opposite direction against more gov't spending. If there wasn't then every democratic gov't would have bankrupted itself long ago.

What is the counter incentive(s)? I can think of lots of ideas. People don't like taxes so will not like spending if they think other people will get the money and they will get the taxes. The bond market likes stable fiscal policies so will campaign against reckless spending. The financial community too doesn't want to compete with massive borrowing by the gov't. Whatever the truth is let's just call this mysterious counter incentive(s) X.

Clearly X's power grows as gov't spending goes up. If X was strong at all times then the gov't would never spend anything. If X was weak when spending was high the spending would never stop and explode into infinity. So there's a balance where the incentive to spend goes down as spending goes up and X goes up. Where the two are equal spending stops.

Let's say, however, that gov't was able to divide its budget. Have one portion dedicated to a particular type of spending and another to everything else. This already happened long before Social Security. Every state in the US has its own budget which is different from the Federal Budget.

If this distinction was really meaningless then we would see a piston type of effect. If Federal spending goes up state spending would go down. Why? Because if the incentive to spend's power equals the X's power at a spending level of, say, $3T then total spending will be $3T. If the Fed spends more there's less room for the states to spend. In effect people will say something like "with the Fed spending an extra $100B in Iraq I'm going to say no to my state spending $1B on a new bridget accross the Hudson".

However I think if you look at the record you won't necessarily see this pattern. You'll see spending going up and down together more often than not. Why? Because while spending is driven by many things I suspect most of discretionary spending has been checked by X. The remainder has been put on autopilot. If you look at the budget you'll notice intense fighting over amazingly small amounts. Right now I think Congress is about to defy Bush and pass a highway bill that's something like $10B more than Bush wants.... This drama is over a bill that lasts for 5 or ten years! So the difference amounts to $2B a year. If long term interest rates move just 1% in an unexpected direction the amount of money spent or saved could easily jump ten times that! If unemployment is a bit higher and growth a bit lower spending on unemployment, welfare, Medicaid and SS Disability might easily leap by more than $5B without anyone raising a fuss.

In other words, in the great battle between the incentive to increase gov't spending and X 70% or more of the battle has been surrendered to what is essentially auto pilot!

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