Personal Finance, Pensions, and Politics - a simple fix

My father worked for an airline. He was a pilot for 32 years, and he was forced into retirement at age 60 by an archaic FAA regulation (although wished to keep working). Now, about 2 years later, the airline he worked for has declared bankruptcy and is trying to jettison their pension obligations. He hasn't received a penny in months and likely wont for a good long while still.

There is a pension crisis in this country, a pension guarantee corporation that is going to be running at a severe deficit, social security is in the same boat. This is largely why I operate my life with the assumption that I am not going to get one penny from social security, from financial aid for my children, or from an employer pension. These are scary if you are planning on them to be your retirement and then spending your whole paycheck; but once you accept that they aren’t going to be there for you it is liberating (if you are young).

But, I digress. The topic of this post is a way to fix the under funded pension crisis in the United States. It is a simple, market based approach: make pension and payroll obligations the most senior kind of debt that a company has (that is, the first people they have to pay if they go bankrupt and there isn’t enough money to pay everyone).

What would this do, in effect? Currently the obligation to ensure that pensions are funded is held by the company and the obligation to pay in the case of default is held by the government (read taxpayers). Under this plan you would still keep the pension guarantee corporation for complete catastrophes, but it would be needed less often. Why? Because the pain of default would be held by the owners of the company’s bonds, which are mostly sophisticated investors and other Wallstreet organizations. If a company was running a pension deficit, it would have more difficulty raising money and thereby force the company to fund their pensions.

I am not going to make the moral case for this system, too many people are already making the case that a company has a moral obligation to repay money promised to workers.

The case I am going to make is an economic and power asymmetries case. Markets work, but they are imperfect. Joe Stiglitz has done some great work to prove that asymmetries of information exist in the market and that this can be detrimental to workers. You need look no further than the difference between airline executive pensions (locked in impenetrable trusts) versus employee pensions (which only get paid after bonds, and are jettisoned to the government at a reduced rate) to find evidence of this. Executives who understand the financial markets and the likelihood of a bankruptcy protect their interests, yet the pilots, mechanics, and flight attendant’s unions didn’t. Part of this discrepancy can be attributed to differences in power (the executives largely set compensation), and part can be attributed to asymmetries in information (the powerful unions didn’t know to negotiate more solid pensions until it was too late).

Regardless of which effect was strongest, or if you even believe that information had any part in the result, the solution to the problem (if you’ll grant me that it is a problem) is the same. Make pension obligations the most senior form of debt at a company. If the company goes bankrupt and shuts down because they have excessive obligations, so be it – another more efficient company will take its place. But at least the people who are largely powerless don’t have contracts broken with them.

This is a crisis for many people, and a particularly emotional one. This means that congress is likely going to respond and pass some laws. They could create more government red tape, government guarantee programs, and decrease the efficiency of the market. OR, they could do what they are supposed to do and create a system of rules whereby their intervention is not necessary.

Quite frankly, I trust Goldman Sachs, Morgan Stanley, PIMCO, and Moudy’s (the rating and acting institutions who I’ll largely call the market in this case) to adequately judge the credit worthiness of companies pensions over the US Government’s Pension Guarantee Corporation. We need a system in which the market handles as much as possible, and the way to create that is to make Pension and Payroll obligations the most senior debt of a company as opposed to the least. Do that and all those wall street institutions I just mentioned will force companies to fully fund any pension obligations a lot more effectively than more laws and red tape ever could.

This is in everyone’s best interest. It is in the taxpayer’s interest because it will shift the burden of pensions back to where they theoretically should be – on the companies. And if a company is insolvent, the taxpayers shouldn’t have to pay the pensions while the bond holders are repaid. That is tantamount to the taxpayers repaying the bond holders. If you invest in a company who can’t pay their debts, then you as the bondholder or stockholder should bear the burden of your poor investment. This burden should not be born by the taxpayer, much less the poor sap who trusted the company to actually comply with the retirement contract they had.