Are Pension Funds The Next To Need A Bailout?

The Administration has given both General Motors Corp. (GM) and Chrysler a very short leash to avoid bankruptcy. Chrysler has just 30 days to merge with Fiat, and GM 60 days to come up with yet more cuts and concessions from its stakeholders. GM CEO Rick Wagoner, who was opposed to the idea of going into Chapter 11, was pushed out and replaced with Fritz Henderson, who seems more open to the idea.

I doubt the Chrysler merger will happen — or that if it does happen, it will be successful. On paper, there does seem to be a good fit, but that was true of Chrysler and Mercedes as well, and just look at how well that turned out. At least Daimler AG (DAI) had a reputation of making good cars. Fiat, well, that’s a different story. (”Fix It Again, Tony,” anyone?) Just what Chrysler needs to shore up its image.

Over at GM, they have to get the bondholders to accept a big haircut and a swap of debt for equity. The current offer is $0.08 on the dollar in cash, $0.16 in new unsecured bonds and lots and lots of stock, enough so that the bondholders as a class will end up owning 90% of GM.

However, they are being intransigent. Many of the bonds are held by vulture investors who may be betting they will get a better deal if GM goes into Chapter 11. In all probability, they have a ton of CDS’s written on them, and know that they will get paid on those no matter what happens. The government will simply funnel more funds through AIG (AIG) to make them whole.

There is thus no guarantee that the bondholders will be negotiating in good faith. It is quite possible that they will make more money if GM goes bankrupt than if it survives.

The Obama team also said that the UAW must give up even more than it already has. The rejected plan called for 47,000 job cuts on top of the 100,000 that have been shed since 2005. Wages and benefits have already been cut to close to non-union transplant levels for experienced workers.

There is also a two-tiered pay structure so new workers (yeah, both of them) in the industry are getting only $14 an hour. The justifiably criticized “job bank” is long gone. Perhaps we could just repeal the 13th amendment to get labor costs down a little bit further? Its strange how those who thought that doing anything about labor contracts between AIG executives and AIG was going to undermine the entire system of contract law in this country are the ones who are most loudly demanding that the contracts with blue collar workers get drastically modified.

The only thing left on the labor side are the legacy costs, which go to retirees, not current workers. Of course, contracts where one side fulfills its side of the bargain over a lifetime — those are expendable. Contracts that are in an economic (if not legal) sense fraudulent (i.e. writing of insurance like a product with no reserves to cover probable losses) are absolutely sacred and must be honored at 100 cents on the dollar.

The thought that a bankruptcy of a company like GM could be prepackaged and it would emerge out the other side in just a few months is a dream. GM is not an airline, and while the offer to guarantee the warranties will help a bit in maintaining sales while the firm is in Chapter 11, people are still going to wonder about the availability of spare parts down the road if they buy and new car from a bankrupt company.

No automaker in history has ever emerged from Chapter 11, so GM making it through to the other side would literally be unprecedented. OK, granted, it has been a long time since a US auto company had to file, so maybe times have changed. Still, a GM bankruptcy is going to look much more like Delphi (DPHIQ.PK) than Delta (DAL). Delphi entered bankruptcy in 2005 and is still under the court’s supervision.

If GM goes bankrupt, all the retirees will go onto Medicare, and the pension obligations will become the responsibility of the Pension Benefit Guarantee Corporation (PBGC). Unfortunately, the PBGC already has liabilities that exceed its $64 billion of assets (as of 9/30) by more than $11 billion (on a present value basis).

Making things worse, in late 2007 the PBGC changed its investment policy to become far more aggressive. A side-by-side comparison of the old asset allocation and the new one is shown below (larger version is available here). It’s probably a very safe bet that there is much less than $64 billion in the fund right now. Nice bit of market timing there — too bad these geniuses couldn’t have been in charge of investing the Social Security surplus, too!

If GM and Chrysler were to go under, the liabilities of the PBGC would approximately double, especially when you figure in the likely following bankruptcies of dealers and suppliers. While the PBGC is not formally backed by the government, are we really going to bail out bankers and not middle income retirees? If GM and Chrysler — and possibly Ford (F) down the road, though they are in marginally better shape right now — go into Chapter 11, look for the PBGC to be the next institution with its hat in hand in Washington.

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