Friday, May 20, 2005

The Bankruptcy Gamble: Punting Pensions Doesn’t Solve Everything

May marked a strange turn in the history of UAL. Eleven years after UAL completed a massive corporate re-capitalization where it became 53% owned by its employees through an Employee Stock Ownership Program, the company went the opposite direction by getting its bankruptcy judge to allow it to terminate its four employee pension plans. On top of that, the company is asking the judge to throw out its labor contracts but force employees to keep working.
Extreme, but not unusual. The last few years have marked the start of a popular trend whereby companies have begun thinking of bankruptcy as a strategic choice that will help them remove legacy liabilities granted to employees during more prosperous economic times and emerge as better companies. Initially the steel companies did it. Now UAL and many of its airline brethren are either doing it or contemplating it. In fact, some argue General Motors should follow this path.
Are all these companies correct that bankruptcy is somehow a strategic nirvana for them? Hardly. The problem with this trend is that bankruptcy is not a strategic solution, but rather a calculated gamble that the legal structure of bankruptcy, combined with the government sponsored PBGC, can fix the problems that have pushed them toward bankruptcy. The reality is this hardly qualifies as strategic, in the sense of it being “an elaborate and systematic plan of action.”
Instead, it is a short term band-aid for the companies to quickly eliminate costs. For instance, UAL claims it can cut $625 million annually from its costs by shelving the plans, but that would only reduce the costs reported in the first quarter by 10%. Of course what UAL fails to see is that in the sincerest form of flattery, others will follow. For an industry where the competitive dynamics have kept consumers in control and prices at levels that don’t allow for sustained profitability, it is fair to conclude that others will shed their liabilities to match UAL and further destabilize the industry’s profitability. This means consumers, not the corporations, will probably gain the economic value of the shelved pensions.
While UAL is also trying to cut labor costs, the bottom line is the industry is still positioned to compete the same way it did before deregulation. In fact, most of the companies who have chosen this route are in legacy industries where the competition has passed them by. In steel for instance, LTV, National Steel, and others disappeared after mini-mills such as Nucor and Steel Dynamics changed the rules of the game.
In the auto industry, as others have written about on this page, the Big 3 have long ago ceded the role of innovators to the Japanese and Europeans, hence GM’s slide from 60% market share to 25%. The discussion of GM filling for bankruptcy comes mostly on the heels of high fuel costs killing the SUV sales that have accounted for most the company’s profits. Although GM had started to devote resources to developing more rear wheel drive sedans, they continue to focus the majority of their resources on large SUVs in a bet that sales will rebound in spite of $2.20 gas. This doesn’t even begin to assess the strategic blunder GM made post 9/11 by staying addicted to its “Zero Interest” programs, which got consumers hooked on only buying American cars when they were cheap. GM apparently it thought it could keep this successful plan forever. While bankruptcy could help eliminate the $1,500 per car GM spends on retiree benefits, it doesn’t eliminate managements’ mistakes over the last 25 years.
This tunnel vision is probably best seen in the current airline mess. The discussion of bankruptcy in both UAL and Delta hardly mentions mirroring the only profitable airline, Southwest. The industry has spent little time in discussing gate turnover time, long versus short haul flights, outsourcing repair work, or improving labor flexibility. The latter actually seems to be the issue facing the auto industry where it is estimated the industry pays over $1 billion to workers who don’t work.
While United Airlines has tried to fight the low cost carriers with its own discount airline, the verdict on TED is still out. For UAL to survive, what it really needs to become is TED instead of TED becoming UAL. In its short existence, there does not appear to be compelling evidence that it will buck that trend. In fact, the lessons of US Air may be the most educational. US Air entered Chapter 11 August 2002, got the court to dump some of its pension plans, emerged from bankruptcy leaner and meaner, subsequently re-entered two years later, and is now selling itself to America West, a lower cost airline.
In the end, all of this assumes the courts will allow the petitioners out of their liabilities. While the legal rules are written in favor of the petitioners, they are still at the mercy of the courts. This also presupposes that the rules don’t change. Congress has responded by introducing legislation that would limit companies’ ability to punt employee benefit obligations in bankruptcy (which may force people to act sooner but still not solve their problems).
All of this leads to the question of whether the cost savings are worth the damage to employee relations. Employee morale in the industry as a whole continues to take a nosedive as workers, the clear losers in this battle, worry about the status of their benefits. In some ways, the move to dump the labor contracts may be a brinksmanship move that pushes the labor costs down, but can the airlines, and potentially the automakers, solve their problems by punting their pension and health plans in bankruptcy? The answer is no. United Airlines may see initial cost savings and a get some financial advantage, but that will be short-lived and doesn’t address their real problems.
Catherine Canman, Patrick Schott, and Lars Von Kingdale


Blogger W.C. Varones said...

Most of the PBGC commentaries avoid getting at the root cause of the problem: unrealistic pension assumptions. Extremely loose accounting standards basically allow companies to make up whatever numbers they want when forecasting investment returns. So if a company wants to stop putting money into its pension plan, it just says, "No worries! We believe our pension investments will grow 10% per year forever. So we don't have to fund the pension plan any more!"

To see how unrealistic these return assumptions are, do the math. Assume a typical 60% stock / 40% bond pension plan. If the fund is earning 5.1% on its bonds, a full percentage point over the 10-year Treasury yield, it has to earn more than 13% annually on its stocks to make the total fund return 10%. With dividend yields at a sickly 2%, that means we'd need earnings growth of 11% annually for the long term. How the entire stock market grows earnings 11% annually in an era of 3-4% GDP growth is beyond me.

If you are an employee of a company with a traditional pension plan, or if you are a shareholder, find out what your company's pension return assumptions are. They are in the annual report. If it's anywhere near 10%, you're not dealing with an honest company.

More here.

11:41 PM  

Post a Comment

<< Home