In recent years there has been much alarmist talk of the impending bankruptcy of Social Security, but it is in the private sector that real dangers of default now loom. Social Security is safe through 2041 or longer, but the pension fund crisis is already squeezing corporate budgets, with disastrous consequences for jobs. If nothing is done, this pension-and-jobs crunch will intensify over the next two years.
While many CEOs sold at the top of the market, the pension funds and holders of 401(k)s were left with depreciating paper. Swooning stock markets have caused the major pension funds to lose 40 percent or more of their value since March 2000. Even the well-stuffed 401(k) has become a 201(k).
Pension funding has become so central to today’s capitalism that these developments menace the financial good health of corporate giants as well as individual retirees. Most reports on the crisis have, understandably, focused on the plight of the 42 million Americans who have 401(k)s or the equivalent. But the impact on corporate pension schemes, on which a similar number of people depend, has been just as bad. Many businesses must now forgo investment or face bankruptcy because they cannot meet their pension obligations.
In a “defined benefit” scheme (DB) the employer guarantees a pension calculated as a proportion of salary; this can be an onerous obligation for a company with many former employees. In a “defined contribution” scheme (DC), like the 401(k), only the contributions are defined, so benefits rise and fall with the market. Public-sector DB schemes are generally well and cheaply run, and are anyway guaranteed by state or federal authorities. But balanced-budget rules often force those authorities to meet pension underfunding by cutting other programs. Most large private schemes are now badly underfunded, their asset values depleted by stock declines and too many past-contribution holidays. We know this courtesy of recent reports from analysts at Merrill Lynch and UBS Warburg. Adrian Redlich of Merrill has undertaken massive research into the 348 companies in the Standard & Poor’s 500 with a DB scheme. He warned in November that these schemes would end the year with a pension shortfall of $300 billion, and this is still the best estimate. If underfunded nonpension benefits are included, an even scarier deficit looms.
The pension crunch is not simply a result of CEO misbehavior; it’s also rooted in a flawed structure that aggravates the boom-and-bust cycle. During a boom, the pension fund soars and no contributions are needed to maintain fund solvency. But when times are bad and the employer faces cash ebb, the actuaries insist there must be more dough on the table. Companies hide the unpleasant truth by fancy accounting. When they can no longer do this, they cut investment programs. This financing regime is dangerously pro-cyclical–that is, it encourages booms and aggravates recessions.
Many DB pension funds today are as large as, or even larger than, the sponsoring company, so any shortfall in the fund can have devastating effects on the bottom line. In older corporations like GM and Boeing, the pension fund is worth much more than the company. Investors who buy stock in an auto or airline concern find that they have purchased a clumsy hybrid, with pension-fund swings eclipsing the performance of the parent company. This is a big problem for employees, too. If a company or its pension scheme is in trouble, as has been the case with so many US steelmakers, the unions will often condone underfunding, reckoning that it’s better to risk members’ pensions than put them out of a job.