Tuesday, March 01, 2011

Unfunded Liabilities: Pensions & Entitlements

Karl Rove wrote in a recent Wall Street Journal weekly column, regarding the Wisconsin public sector union protests and Governor Walker's bill to repeal collective bargaining rights,

"Union demands have helped produce an estimated $3.5 trillion in unfunded liabilities for state and local government pension and health-care plans. They've also led to personnel practices that tie the hands of local elected officials, often resulting in perverse outcomes. For example, union insistence on "Last In, First Out" often means the best and brightest teachers are let go when districts downsize or schools close."

I had a long talk recently with a close friend who is a political conservative and, as a New Jersey school teacher, a member of their union.

As we discussed the Wisconsin situation, and she dutifully, but reluctantly, read the related posts on my companion political blog, she bluntly told me this had become a painful topic for her, with me. But she also admitted that her union's members needed to pay for their health care and pension benefits.

She then returned to a topic she'd ranted on in previous conversations with me, i.e., going back several administrations, the New Jersey state government had emptied her union's pension fund by 'borrowing' from it and then failing to maintain promised annual funding. In short, the State of New Jersey has already brazenly failed to fund the promised lavish retirement benefits for the teachers' union.

She railed over the likelihood that her contributions would probably be in vain, with her promised pension never to actually be paid in full.

Welcome to the club.

I vividly recall learning in Professor Peter Kundsen's 'Great Moments in Balance Sheet Accounting' course in graduate school, back in the late 1970s, how unfunded pension liabilities were confined to footnotes. The midterm for that course was a list of questions attached to the Bethlehem Steel 10K. Needless to say, one of the questions was, I am sure, related to the firm's unfunded pension obligations.

Within a few years of graduating, I saw bankruptcies roll through the steel and airline sectors. And Chrysler require a government bailout.

With the rise of hostile takeovers and raiders taking their targets private, or into Chapter 11, many more businessmen learned about the PBGC. The Pension Benefit Guaranty Corporation is the federal agency which is charged with administering the failed, under-funded pensions of bankrupt firms.

The truth is, the private sector has seen, for some thirty years, a series of sectors experience bankruptcies which dumped underfunded pension plans onto the PBGC. At the same time, many other companies switched to defined-contribution plans, terminating their defined-benefit plans and putting the resulting lump sum into the former.

In short, private industry has learned, over the past three decades, that the defined-benefit pensions are, for the most part, illusory and unworkable.

What's happening now is that public sector employees are discovering the same truth. The major difference, however, is that because state and local governments foolishly agreed to these plans, the public sector unions have, as a counterparty, an entity that cannot, as easily as a private sector company, declare bankruptcy and subsequently renegotiate the pension obligations.

It goes without saying that Social Security, Medicare and Medicaid are all federal programs which share the same foolish defined-benefit mentality. And we've all been aware for decades of the chronic insolvency of the first, and the obscene growth of the second and third.

How is it that what business people have understood for thirty years as infeasible, i.e., the defined-benefit approach to any long run pension or health care obligations,has only now come to be seen as unworkable in the public sector?

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