Counterparty Risk Is Now In Prime Time

I feel like I’m watching a real-life version of the movie Cassablanca play out in front of me this week, as if Claude Raines said, “I am shocked, SHOCKED that there is underfunding for pension liabilities going on among US large-cap industrial firms!”

The notion of counterparty risk, usually found in financial enterprises, has recently become much more widely understood, albeit under a different name. GM’s pension liabilities, for example, are now realized to be at risk of being unpaid, as its debt yield exceeds that of at least one South American country. The reason it’s finally a hot topic, as evidenced by CNBC’s week-long focus on “lie now, pay later,” is that a major industrial firm is now judged to be an unreliable counterparty in the pension arena.

Truth be told, this is not really news. The topic was very au courant in the early ‘80s, when I was fresh out of graduate school. During the roaring inflation of that era, and subsequently, FASB introduced the first changes in pension liability accounting, to begin to accurately portray these unfunded obligations.

But before concluding that GM and its ilk are lying, cheating and despicable pension thieves, let’s revisit what actually occurs in an employment situation.

Imagine someone offers to hire you for $100,000 per year of compensation, but they will only pay you $80,000 in cash. For the remaining $20,000, they promise you that they will pay the cumulative amount at a time in the not-so-near future. No escrow account, promissory note, bond, or anything like that. Just a written promise. So, in effect, you have bought, or in financial parlance, “gone long,” your employer’s counterparty risk- the risk that they might not actually be able to deliver on their financial promise.

This is typical behavior of employees in the US. Thanks to the federal government’s expansive pension benefit legislation, what individuals would ordinarily consider too risky is judged safe because of governmental policy. But the truth is that because of governmental meddling, people take far more risks, as well as leave of their senses, when agreeing to accept unsecured future payment promises from companies whose legal resources are so vast as to nullify any possible means an individual realistically has to make said company satisfy its pension obligations.

I find it ironic and sad that, thanks to governmental interference, yet another area of compensation has been mucked up. Rather than mandate a company cash contribution into individual retirement accounts, our government allows companies to run the private equivalent of the Social Security mess- undivided, massive pools of pension funds which are unequal to the claims against them.

In all probability, Congress probably thought it was “protecting” workers from their own naivete in managing their pension savings. But do you really think most individuals would have done this bad a job on their own? Winding up with their entire pension held hostage to the probable bankruptcy of a once-large manufacturer, GM?

Who can afford much more of this kind of “protection” by our federal government?