The Next Union Victims: US States

Last November, amidst the dust up regarding the US auto maker's, and UAW's plea for a Federal bailout, I wrote this post discussing that union's chief's surreal press conference.

I closed that post with this thought,

"This, sadly, is a fact. It's clear that Gettelfinger's UAW is salivating at the prospect of raiding the Federal Treasury, courtesy of the Illinois rookie, Frisco Nan and Harry Reid, without taking any wage or benefit cuts whatsoever. So desperate are they that Gettelfinger is trying to mau-mau President Bush to cough up the funding in advance. The greed and lack of a sense of reality on the part of the UAW's senior officials is just mind boggling."

In discussing this whole mess with my partner recently, I noted that, thankfully, the entire range of Federal bailouts of late 2008- banks, insurance firms, auto companies- don't seem to involve any of America's highest-growth, innovative and/or superior value-adding companies or sectors.

For this, we should give tremendous thanks.

In truth, as is often the case, the economy's laggards and commodity providers are seeking relief. So, aside from wasting our society's scarce resources on these inefficient, dying or low value-added producers, the bailouts don't seem to be hampering the creation of new value on the cutting edge of our economy. It's not like Washington is getting into bed with Google, Intel, HP or Gilead via financial investments and coercion.

Unfortunately, we have seen substantial evidence that the stream of entities heading to Washington for relief has not yet ended.

Rather than companies, it seems the next beggars will be profligate US states, brought low, economically, by their own spending and, of course, promises to unions.

It's become widely understood recently, including being a subject of a Wall Street Journal piece, that California, Illinois and New Jersey- blue states all- are on the brink of bankruptcy.

California has its own myriad reasons for financial distress, from what I read. However, regarding Illinois and New Jersey, I have, sadly, more personal acquaintance with and knowledge of their travails.

In both cases, lush benefits promised to AFSCME are proving to be unaffordable.

Speaking personally, I noticed this trend as far back as when I was a VP at Chase Manhattan Bank in the 1980s, during the radical transformation of the steel industry. What occurred to me then was what I expressed in this first post on this blog in 2005. Specifically,

"What I find ironic is that, while so much of this week’s, and many prior years’ focus, is on union leaders squaring off against company managements, nobody has bothered to ask how it is that the unions got themselves in this mess in the first place?

Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?

In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame."

The same goes for public workers and their union. They foolishly accepted inflated promises of future benefits from various governmental entities, beginning in lavish style in the 1960s.

However, what has befallen private sector unions such as the steel and airline workers since then is surely coming soon to the AFSCME chapter near you.

How many voters will actually accept much higher taxes to pay for retirements they don't, themselves, enjoy? That's the crux of the lack of support by most Americans for the UAW in the recent Detroit bailout.

But, as my partner and I noted, there is a major problem looming for states such as California, Illinois, New Jersey, and their ilk, and their AFSCME locals. We've already begun to see it in the worst-off state, California.

People can leave states which have overwhelming financial obligations. They can choose to walk away from a financially bankrupt state entity, leaving fewer residents to shoulder the fixed pension obligations promised so many decades ago.

What will happen when a state like Illinois watches younger, more productive and higher-earning citizens depart, along with the companies that employ them, for lower-taxing states with better financial health?

Don't think it can't or won't happen. Look at the diaspora of industry and residents from California over the past decade. Washington, Oregon, New Mexico and Nevada have all grown due to emigration from the Golden State.

As an economic dilemma, this one will rank up with the great ones for the US. We've seen school boards like Chicago's taken over, and even New York City endured a form of Chapter 11 reorganization under 'Big Mac' for several years.

But we have yet to see an entire state seek the governmental equivalent of Chapter 11 bankruptcy. California seems close, in that, last month, it began to issue paper script IOUs to vendors, in lieu of cash, so it could husband funds to pay its bondholders, thus avoiding defaults, and severe credit rating consequences.

To me, it just makes sense that each group of parties in our society which promised, and accepted, unrealistically lavish financial benefits decades ago, at the height of the post-WWII American prosperity, will have to eventually reduce the magnitude of those promised benefits.

Whether through private corporations and their unions, or governmental entities and their unions, our society has to face the fact that a lot of unwise, irredeemable financial guarantees were foolishly given and accepted years ago by people who should have known better.

As we saw in the steel sector collapse of the 1970s and '80s, then the airline reorganizations and, now, the auto sector, economic realities typically, if painfully, trump unrealizable contractual obligations.

I don't think the case of states and AFSCME demands will be any different, in the end. But the process of our society, on a state-by-state basis, acknowledging the reduction of pension and benefit promises from decades-old pacts between governments, as agents of their populations, and employees of those governments, will likely create watershed economic events heretofore unimagined in our society.