May 14, 2005
From the desk of Jane Galt:More on the PGBC and corporate welfare
I think I have discovered the source of one of the arguments I've been having about why the Pension Benefit Guaranty Corporation's assumption of United Airlines' pension funds is not corporate welfare.
The PBGC premiums, my interlocutors argue, are too low. This, they say, is corporate welfare.
Why yes, I say, it is. But that doesn't make the pension bailout corporate welfare.
Huh? They say. Let me explain.
Imagine that congress made a law forcing GEICO to underprice car insurance. We can build a simple model in which GEICO has five customers, all of who have a 1-in-5 risk of having an accident, meaning that, on average, there will be one accident in the insurance pool a year.
Now, let's say that the cost of every accident is $500. GEICO should be charging us each $100, which will just cover the cost of the accident. (This assumes, of course, that GEICO neither needs to make a profit, nor can invest the premiums. But this simplified model works perfectly well in this case.)
Let's say that instead, Congress sets the premium at $50. GEICO collects $250 from the five of us. Then my friend and co-insuree Ual (he's from someplace in central Asia you've never heard of) gets into an accident. GEICO, living up to its excellent reputation for service, immediately cuts him a $500 check. GEICO is out $250. If this keeps up, GEICO will need to be bailed out by the congress that forced it to underfund.
Is this $500 worth of welfare to Ual? No; he's paid premiums. Is it $450 worth of corporate welfare? Again no. To see why, look at the payouts with or without the mandatory pricing:
With congressionally-mandated price ceiling: $500 payout - $50 premium = $450 benefit to Ual
Without CMPC: $500 payout - $100 premium = $400 benefit to Ual
Benefit of CMPC to Ual: $450 benefit w/CPMC - $400 benefit w/o = $50
GEICO is out $250, but Ual only got a $50 benefit! Where'd the rest of the money go?
Why into my pockets, and those of the other 3 insurees. We each received a $50 benefit: we were insured for $100 worth of risk (a 1-in-5 chance of suffering $500 worth of damage to our cars) for only $50.
Now, this is complicated in the real world by several things. First, UAL has a higher risk than other companies of going bankrupt, and its pension fund is larger, so the artificially low premiums, capped by congressional fiat, are more valuable to UAL than many other companies. However, that doesn't change the fact that the benefit of lower premiums is several orders of magnitude smaller than the size of the pension bailout, and took place mostly in the fairly distant past. That's why I'm not excercised about the bailout as an example of corporate welfare.
The second complicating factor makes this look even less like an example of corporate welfare: the PBGC payments in no way benefit the company. They benefit the employees.
The PBGC takes over company pension plans when the companies are in bankruptcy. There is no benefit to the company here; the company can discharge its unfunded pension obligations whether or not there is someone to pick up the tab, because bankruptcy is the legal recognition of the existing fact that the company does not, and will not in the reasonably forseeable future, have enough money to meet all its obligations. The number of companies that did, in fact, discharge their unfunded pension obligations in the early 1970s (often after looting the pension funds to stave off bankruptcy) is the reason that the PBGC and the ERISA regulations governing pensions were put in place.
Rather than benefiting companies, the PBGC forces them to pay premiums in order to insure their workers against underfunded pensions in the event of a bankruptcy. Now, I don't say that the PBGC shouldn't do this; I think it's a rather good idea. But it's obvious that the PBGC in fact hurts "the corporation" as an entity, forcing it to pay premiums for insurance against an event that cannot harm the corporation itself--as if congress had passed a law forcing GEICO to collect its premiums from the estates of your deceased neighbours.
In other words, congress has decided to bail out pensioners whose companies go bankrupt, and to stick corporations with part, but not all, of the bill. There may be an argument for sticking them with more of the bill, but (on the assumption that few companies are planning to go bankrupt), not a very strong moral one (I am assuming that ERISA, which forbids companies in trouble from dipping into the pension plan, is still in force; otherwise the PBGC would be corporate welfare.)
Nor, I think, can the decision not to raise what is essentially a tax on pension plans be construed as "corporate welfare" in the same sense that paying Dole to go abroad and market the hell out of its pineapple, or giving oil companies special income tax abatements, is "corporate welfare".
Posted by Jane Galt at May 14, 2005 6:15 AM | TrackBack | Technorati inbound linksJane,
I agree that this is not corporate welfare in the sense that the shareholders of United are getting a great deal.
Let's call it enterprise welfare. The United Airlines enterprise consists of shareholders, management, workers, flyers, and hangers on. This enterprise is being kept afloat by government intervention presumably for the benefit of the enterprise and the public.
But demand for air travel is high. Therefore, assumptions that the loss of this particular enterprise will result in the loss of millions of jobs, horribly higher prices for flights, and the end of air travel as we know it, are incorrect.
If government support for this particular enterprise is pulled, there will indeed be a period of creative destruction. But the end result will be the creation of a more efficient supplier of air services in a very short time. Demand is high, prices will rise, assets can be purchased dirt cheap, and there is no shortage of investment capital looking for something useful to do.
In short, we are using government in a situation in which the price mechanism will work just fine.
Again, however, you're confusing the pension bailout with Chapter 11. The pension bailout is an independant event which would take place whether United liquidated, or gets Chapter 11 protection--if you look at United's balance sheet, you'll see there's really no money there to top up the pension plan very much. As I say in my most recent post, I think there's an interesting question as to whether Chapter 11 should be modified in industries with high fixed costs and substantial overcapacity. But I think Chapter 11 is generally agreed to be basically a sound idea; and at any rate, the PBGC has little to do with United's decision to terminate its pension plan.
Jane,
You're writing faster than I am. I can't keep up :)
What I'm saying is that both the pension bailout and chapter 11 are elements of "enterprise welfare" (see above). If neither involved public support in any way, then all well and good. But both of them do. The pension bailout will most likely involve a taxpayer bailout of the PBGC. Chapter 11 costs the public the benefit of the creation of an efficient provider. Both are therefore, "enterprise welfare".
The United Airlines pension funds are severely underfunded and have been for many years. It has been obvious to both management and labor that it was very likely that the PBGC would eventually be stuck with the bill. Knowing this both acted to benefit themselves at the expense of the PBGC and ultimately the taxpayers. I don't think this should be allowed whether you call it corporate welfare or something else. And I don't see any reason not to call it corporate welfare even if it is just a transfer from some corporations to other corporations (which is doubtful since it seems likely that taxpayers in general are going to end up paying most of the bill).
One tweak to your GEICO example: if you're modeling PBGC payouts to all UAL pension participants, your pal Ual doesn't wouldn't really get the full $500 benefit, does he? The participants don't get the full benefit, do they? There's an element of taxpayer subsidy, but also one of (at least constructively) knowing underinsurance by the plan participants and their collective bargaining agents.
The PBGC isn't designed to make everyone whole, just to ameliorate a loss of benefits. The real problem seems to lie more in legal underfunding of large DB plans. Legally and, I'd argue, morally, the only pension obligations we should worry about are those accrued (and vested?) as of the BK date. Past contributions in the pension trust are out of reach of the sponsor's creditors, right? So maybe the right question is just how the UAL DB plans came to be underfunded. Surely DOL/IRS and the unions were watching. How did any legal and political controversy about underfunding play out, back then?
RCS, United Airlines pension funds were severely underfunded for the same reason many other pension funds are, namely the laws requiring funding are full of ridiculous loopholes. The companies are allowed to use extremely optimistic assumptions when accounting for the health of the plans. Even when plans are determined to be underfunded the requirements for adding money are very lax. If I recall correctly United Airlines hasn't put any money into its plans for years although they were obviously underfunded and continuing to accrue additional obligations.
Right, James. I understand the regulatory regime's weak. The more interesting question is, who raised hell at the proper time? Unlike, say, marketed tax shelters, with big DB plans there's a discrete class disadvantaged by the weak regulation, and the shenanigans are pretty well set forth in public documents. One might think that the time to attempt a labor/political fix to the weak regs and to UAL's availing itself thereof would have been a while ago. Did I sleep through something?
RCS, the people disadvantaged by the weak regulation are taxpayers in general and as usual they weren't paying much attention. In theory the honest companies with healthy pension plans who might be forced to fund PBGC deficits should have objected but they seem pretty confident they won't actually be stuck with the bill. The United Airlines company and unions both benefited from the plans continuing to operate for years running up additional obligations which the PBGC has now been stuck with rather than having the plans turned over to the PBGC much earlier.
Accounting and actuarial loopholes aren't the main problem. A hugely disproportionate part of PBGC claims come from steelmakers and airlines (carmakers may well be next.) The battering those sectors have taken from deregulation and globalization dates from around ERISA's enactment. The airlines' current pension crisis stems from a combination of poor operating results and low interest rates, which of themselves require increased funding. The final element is the sink-or-swim treatment of plans in bankruptcy. Sponsors essentially must either keep funding under adverse conditions or terminate the plans. There are multiple proposals for changing funding rules, but not primarily to eliminate perceived loopholes. Instead, the proposals would let sponsors defer some funding in low-interest recessions, and make plan funding workouts easier in bankruptcy.
A rough cut at the numbers suggests that most preemptive plan takeovers by the PBGC would ultimately cost more than deferral until sponsor termination. The value of non-subsidized benefit payments usually outweighs that of freezing future benefits, over the likely timespans.
Finally, given the low percentage of benefits that the PBGC actually pays, I'd say the disadvantaged are the plan participants. If old-school firms keep foundering, and aren't allowed to defer plan funding, there will be an eventual, substantial taxpayer impact. But that's down the road.
RCS, I don't believe for a minute that addressing this problem later rather than sooner will be cheaper for the taxpayers. This is the S&L fiasco all over again, the longer you wait the bigger the bill.
Your beliefs are your own business, of course.
Well, let's look at United Airlines. As of 12/31/2000 it had pension funds assets of 8.511 vrs obligations of 9.252 so it was underfunded by .741 (all numbers are billions of dollars). By 12/31/2004 assets were down to 7.152 while obligations had grown to 13.577 for a deficit of 6.425. Some of the increase is because the 2000 estimates were not realistic. However in the intervening four years employees accrued another 1.287 in benefits from service time and the plans were amended to give them .484 in additional benefits. During this period United Airlines contributed .382 to the plans (not all of it in cash). So it would appear the delay in taking over the plan cost the PBGC at least 1.389. A billion here, a billion there, pretty soon you are talking about real money.
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