Underfunded Pensions

What brought down GM and the US auto industry was not so much superior foreign competition, but the dead weight of legacy pensions due to the legions of former union workers that GM had promised pensions to until death do them part. Unfortunately, GM's actuaries did a poor job in projecting life expectancy and thus (depending on whose figures you want to use) it costs GM $1,200 per car more than the competitors simply because they have to pay nearly 1 MILLION FORMER employees a pension, not to mention health care. This is why pensions and health care coverage were more or less cut in this most recent negotiation GM had with the United Lazy ...err... I mean Auto "Workers."

Regardless, GM exemplifies what can happen to an entity that was presumably unassailable. GM was king in the golden age of America, but since those days have come and gone, so has GM's prominence.

Another entity that is presumed to be unassailable or infallible is government. Every basic college finance class assumes there is zero risk in investing in government securities because the government is all powerful and can just tax it's way out of debt (completely ignoring the Laffer effect). But this is not true. A perfect example of a government going belly up is Argentina where it owed the western world over $130 billion and one day decided not to pay.

People, or at least the markets, do not assume such irresponsibility on the part of the US government and still assume it will always pay back its debts, but like GM, governments' solvency (state, federal and local) may be threatened by pensions.

Usually it was assumed that social security or medicare/aid would be the programs to bankrupt the US government. And for the most part, this is true. Osama Bin Laden might as well have just stayed at home because for all the hubbub and tragic loss over 9-11, he could never hope to wreak the havoc that FDR's demon child will upon the US. I mean if you think about, if you REALLY want to destroy a country, don't fly planes into a couple buildings, institute socialism. Just ask Lenin, Stalin, Mao, Jong Il, and Pol Pot.

Regardless, it is not just medicare and social security that will take its toll on the US economy in the near future. It's also the pension problem.

Public pensions, the money promised to government workers when they retire, are underfunded. meaning they don't have the money to make good on the promises they made to everybody, ie- they can't afford the pensions. This means one of two things. Either the government cuts the pension benefits to their employees (heh, good luck) or they tax the American people more (ding ding ding, correct answer).

But this creates a problem and a scenario I see to be more and more likely. Given the housing crash occurring and the increased likelihood of recession, I don't care how many times they cut the interest rate, I think this country is heading for recession (again, I hope I'm wrong). And if we go into recession, then corporate earnings will drop and so too will stock prices.

Compounding the downward pressure on stocks will be the likely election of a democrat to the White House or a capitulating moderate republican, both of which will kowtow to the pressures to raise taxes and redistribute wealth. This will put further downward pressure on stock prices.

But more pressuring than that will be the retirement of the Baby Boomers which begins more or less now. The elder echelon of the Boomers are taking early retirement as we speak and as you enter retirement you switch your holdings from equity to fixed income. This outflow of cash from the equity markets into fixed income will put downward pressure on stock prices (but also push interest rates lower). Also, to make good on their social security and medicare promises, the government will have to increase taxes.

Thus the potential scenario I see is one where housing prices continue to drop, but the stock market continues to drop as well, and the ensuing decrease in consumer spending and confidence, compounded by likely tax increases in the future will throw and keep the economy in recession for a while.

And, in a viscous downward spiral sense, since pensions are primarily funded by investments in the stock market or securitized assets therein, this chart is bound to go down further as stock prices plummet.


Not to get negative on you.