The threat is not underfunding; it is underfunding in companies that go bankrupt.

TO BE NOTED: From the FT:

"Vampire pensions could be a corporate nightmare

By Charles Millard

Published: April 16 2009 21:57 | Last updated: April 16 2009 21:57

While economists worry about “zombie” banks holding back lending, vampire pension plans may soon be stalking a company near you. The underfunding of America’s corporate defined benefit pensions poses a daunting challenge, threatening not only their 40m beneficiaries but the entire US economy.

Recently enacted funding rules require underfunded pension plans, and that’s most of the big ones, to suck needed cash from salaries and jobs just when suffering companies need scarce resources to survive. Under 2006 legislation, companies that have underfunded pensions must put extra funds into their pension plan to close the gap within seven years. After precipitous drops in assets, most plans now have serious funding gaps.

For example, according to Watson Wyatt consulting, at the end of 2008 the pension system in the US had approximately $2,100bn (€1,589bn, £1,407bn) in liabilities but only $1,600bn in assets. That was before the downward gyrations of the capital markets this year.

Closing this gap could cost $50bn-$100bn in additional annual pension contributions at a time of unprecedented reduced corporate earnings. Some large companies have stated that such funding commitments would drive them to file for bankruptcy.

The new law was drafted to help protect pension recipients from discovering too late that their bankrupt ex-employers had seriously underfunded pension plans. When this happened at Bethlehem Steel the Pension Benefit Guaranty Corporation (PBGC), the federal corporation that insures pensions, saw its funding deficit soar by nearly $4bn, while workers missed out on $600m in pension promises. Among the problems the new law sought to deal with were:

● A significant portion of pension liabilities may not be insured above PBGC’s limits.

● Pension plans rescued are frozen, so workers over 50 see no increase in benefits during their remaining working years. This means that untold billions of dollars of expected benefits are never earned and never owed – but also never received.

● As PBGC pays the benefits it does insure, its own deficit increases by the amount of underfunding in the plan.

Avoiding these situations made a lot of sense. However, like everything else in our system, these rules were not designed with the extreme current emergency in mind. The very law that was designed to protect worker pensions runs the real risk of draining the very companies workers depend on for their livelihood and retirement benefits. Congress must change the law – and quickly.

The threat is not underfunding; it is underfunding in companies that go bankrupt. Our goal at the moment should not be to force plans towards full funding at all costs; it should be to prevent companies going bankrupt. Certainly, we should prevent pension funding rules from contributing to the companies’ – and ultimately the pensions’ – demise. But the goal should be to help responsible companies succeed, so they can fulfil their obligations to workers.

Unfortunately, current law provides only one real option to a company that cannot meet its payments. Other than woefully inadequate and inflexible funding waivers, the only choice is to seek a “distress termination” and dump the underfunded plan on PBGC – a solution that is bad for everyone.

PBGC should have the situation-specific flexibility that the Pensions Regulator has in the UK. There, companies and the regulator can reach deals that provide temporary relief. If companies can afford their contributions, even in this environment, of course they should make them. If they cannot, we need the option of the UK model. The PBGC would not have to terminate and take over plans and corporations would not have to make payments on a current basis that they cannot afford.

This kind of intermediate relief would have to come with conditions that prevent shareholders and executives from improperly benefiting while pension plans are underfunded.

Inserting a quasi-governmental authority into such negotiations is problematic.

But it is far superior to enduring the burden of a misfit law designed to protect pension benefits which instead weakens them at a time of crisis.

In their 401(k) private pensions, Americans can put in less this year if they need the money to pay bills. During this crisis, corporate pensions should be allowed to do the same.

The writer was director of the PBGC from 2007 to 2009"

"zombie banks will always look more attractive than they should due to the penchant for overly optimistic estimates"

VIX And More on Zombie Banks. I'm thinking of writing a sequel to my vampire novel featuring zombie banks:

"With talk of nationalization of European and American banks heating up, I want to make sure everyone had a chance to read Paul Krugman’s Wall Street Voodoo from Sunday’s New York Times. Krugman tackles the issue of so-called ‘zombie banks’ that can still operate while technically insolvent and whose market capitalization, says Krugman, “is entirely based on the hope that shareholders will be rescued by a government bailout( TRUE ).”

Krugman lays out three policy alternatives for addressing these zombie banks:

1. sufficient government funds to support the operation of the existing entity
2. seizure of the bank by the FDIC with a transfer of toxic assets to a third party (a ‘bad bank’ or ‘aggregator bank’ along the lines of the Resolution Trust Corp. model), followed by the resale of the now solvent bank( MY VIEW )
   
3. transfer of toxic assets to a third party, without prior government seizure of the bank

The concern Krugman has is that the Obama administration is leaning toward the third alternative, which rewards bank shareholders at the expense of taxpayers and perpetuates the moral hazard problem.( I AGREE WITH KRUGMAN )

John Hempton offers up a challenge to the zombie bank solvency question in Voodoo Maths and Dead Banks. Hempton claims that banks whose liabilities currently exceed assets can earn their way back to solvency if the net interest margin is sufficient to generate enough operating income to overcome the gap between liabilities and assets, hopefully in the span of a few years.

Hempton makes some excellent points and provides a philosophical foundation for much of the current approach. Given that there a lot of moving parts, the success of these efforts are ultimately going to be the result of several key factors, including:

• the gap between liabilities and assets
• the spread (net interest margin) banks will be able to realize going forward
• the length of the economic contraction

From a government policy perspective, monetary policy will have a strong influence on bank spreads and fiscal policy will go a long way to determining the magnitude and length of the economic contraction.

Zombie banks can earn their way back to solvency in just the same manner that a homeowner who is underwater can continue to make mortgage payments until he or she crosses back into a positive equity situation in their home. The key for the banks is a healthy interest rate spread and a relatively brief recession that keeps loan losses from getting out of hand.

The problem with propping up zombie banks is that it may be too attractive of an alternative politically to prompt proper consideration of other options. Further, zombie banks will always look more attractive than they should due to the penchant for overly optimistic estimates of the gap between liabilities and assets( AND BS ) as well as hopes morphing into beliefs that the economic downturn will be shorter than what the next pundit says."

Posted by Bill Luby at 3:41 PM "

The banks are not to be believed in putting a price on the toxic assets. They will attempt to continue getting the government to prop them up while they are allowed to continue as private concerns. It's a recipe for a long and costly relationship.

Greg Mankiw's Proposal

Greg Mankiw doesn't like the Swedish Plan, basically for the same reasons as Becker and Flynn:

"Other economists have suggested that the government inject capital itself. That raises several questions. First, which firms? The government does not want to put taxpayer money into “zombie” firms that are in fact deeply insolvent but have not yet recognized it. Second, at what price should the government buy in? Third, isn’t this, kind of, like socialism? That is, do we really want the government to start playing a large, continuing role running Wall Street and allocating capital resources? I certainly don't."

Who's talking about a continuing role? Nationalize, then privatize. It seems much cleaner.

Here's his plan:

"Here is an idea that might deal with these problems: The government can stand ready to be a silent partner to future Warren Buffetts.

It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date."

I'm not sure we can wait around for new private capital. Isn't the problem that no one is lending?
Also, the government still needs to have people evaluate these private plans. If there's one thing we've learned recently, it's that there are a lot of dumb businessmen and investors. I would also worry about the problem of lobbying in this proposal, which is always a problem, but the Swedish Plan lessens the power of lobbying in my opinion.

Still, it's a good compromise plan, which I'd like better if I trusted these hybrid/compromise plans more.