GM’s pension promises sucked it down the drain

Did pension debts ruin General Motors?

I said they did in ‘While America Aged’, a book published last year. The thesis was that many decades of inflated pension and healthcare benefits forced the company to redirect its free cash flow to retired workers. As a result, there was little or nothing left for the shareholders.

It was as if, I wrote, the company had secretly been sold and now belonged to the retired workers and their dependents.

That turned out to be only partly right. When GM is reorganised, the United Auto Workers (UAW) union will probably end up with 17 percent of the stock. The government will get most of the rest.

But among the obligations that caused GM to file for bankruptcy, two are directly related to worker entitlements. In 2003, GM sold $13.5bn in bonds, one of the biggest debt offerings ever, and plowed the money into its pension fund.

Then, in 2007, after the UAW went on strike, the global automaker agreed to funnel more than $30bn into a special trust for retiree healthcare.

Both the pension bond and the retiree-trust obligation helped topple GM into Chapter 11 bankruptcy. Of course, they weren’t the only causes. The great recession, which cut deeply into sales, was the biggest proximate cause. You can add years of poor engineering, corporate bureaucracy and a culture that was too hidebound to change.

Though the country has rightly focused on the mortgage mess, retirement obligations still loom as a daunting obligation. Thanks to plunging stock markets, which have decimated retirement accounts, they are more pressing than ever.

And of all GM’s problems, the retiree burden provides the most trenchant lessons. Some companies will always design better cars than others. But at least, if a company builds a lemon, it can try again. Or it can close a factory and shrink to a size appropriate to its sales.

Pensions are different. Once promised, they can never be rescinded. GM’s pension hailed from a negotiation with the UAW in 1949. The result, known as the Treaty of Detroit, produced a pension of only $125 a month. GM was selling cars like hotcakes, its labour force was young, and the pension was easy to afford.

But observers such as Peter Drucker, then a young consultant, wondered what would happen if GM’s business turned south while its pension obligation remained. And the pension didn’t just remain, it steadily grew, and so did healthcare.

With each new labour contract, GM management found it easier to grant sweeter future benefits than to raise current wages. Over time, benefits went up much more quickly. That left GM with a daunting unfunded healthcare obligation. As retirees lived longer — one died in 2006 at age 111 — and the cost of providing healthcare mushroomed, the expense grew beyond anything imagined in 1949.

GM stayed current on pensions, but the money it funnelled into retirement plans left less for engineering and restyling. And shareholder dividends? Forget ‘em. Over a 15-year stretch, GM plowed $55bn into pensions and only $13bn into dividends. That’s why I said that the shareholders had been disenfranchised.

Eventually, when the competitive landscape turned, GM fell behind on pensions too. By 2002, GM’s pension fund was $20bn underfunded. It borrowed to make the pension fund whole, but that merely transferred the problem to the balance sheet.

GM tried to unload some of its retiree obligations by spinning off its auto parts business, Delphi Corp. But Delphi preceded it into bankruptcy, and GM’s continuing obligation to the Delphi workers was another factor leading to its demise.

The Pension Benefit Guaranty Corp, the federal agency that may have to bail out GM workers, is now $33.5bn in the red. Many more private pension failures loom.

Pensions also pose a huge problem for many cities and states.

California’s government, one of the most profligate in awarding pensions, is on the verge of going broke. In many other states, pension funds are grossly underfunded. And even more so than in the private sector, public pensions, once agreed to, are impossible to modify.

Last but not the least, retirement is a daunting problem for the federal government. Last month, the social security administration announced that deficits will occur sooner than thought for social security and medicare.

Those obligations are on top of the skyrocketing federal deficit, estimated at $1.75 trillion for the current year. These are all symptoms of the same disease.

I am not against retirement benefits; older people need to be able to retire with dignity and a decent life.

The lesson of GM is that benefits must be paid for as they are incurred. Corporations with underfunded pensions should be brought to heel. Otherwise, as with Delphi and other failed companies, pensions agreed to by private parties will end up being paid for by the public.

At the government level, pensions are a subset of a rampant fiscal virus: promising goodies without funding them. States that are behind, such as Illinois and New Jersey, must recognise that either they raise taxes and fund their pensions, or they reduce benefits for future employees. No other solution exists.

Congress also must bite the bullet and get social security on a sounder footing. That probably means raising the payroll tax. In the case of medicare, fiscal prudence will likely demand higher taxes and service cuts.

Neither private nor public pension sponsors can keep making promises that are above their means, or that they fail to fund. General Motors proved it.

(Roger Lowenstein, author of ‘When Genius Failed’, is a Bloomberg news columnist. The opinions expressed are his own.)

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