Thursday, July 10, 2008

Setting GM and corporate pensions straight

So apparently GM is back in the news. Mark Thoma does his usual thing of posting a lengthy quote without his own analysis, of a New York Times piece in which Roger Lowenstein discusses the history of GM and the legacy costs that are currently bringing it down.

Many, many people think it is legacy costs or bad management or fuel costs that is causing GM to falter. While I've said this in many posts across the internet, it's time to set things straight on this blog: only the legacy obligations can account for GM's poor health.

Why? It's simple. Even if you were to go in and replace whoever you think is a fool at GM, with whoever you think is capable of doing a superior job, that still wouldn't save them. Because those very same supergeniuses would just get bid away buy someone that doesn't have to dock off the legacy costs from the supergeniuses' pay!

Failure to recognize this insight has led to some monumentally stupid analyses of the issue. For example, the perpetually hate-able Malcom Gladwell blames GM's problems on the magical dependency ratio, ultimately claiming that when a company can do the same tasks with fewer workers, that makes it harder to pay retirees!

What happened in GM's history was this: management convinced the unions to accept lower wages in the present, in return for guaranteed pensions later -- that is, deferred compensation. And where would the money for those pensions come from? "Durr, well GM's always going to be superprofitable, no matter how many people they have to support, right?" Well, that's what the unions had to be thinking in order to accept such a deal, in which they didn't have oversight in the (non-existent) pension fund. (It would have made much more sense just to take the higher wages and divert them to a union-controlled pension fund, but I guess if you think GM can't fail ...)

Today, such practice of having an unfunded pension -- or, in effect, stuffing the pension fund with low-grade GM bonds -- would get management thrown in jail, and only recently are they making them actually, heaven forbid, fund the pension.

The upshot is, GM should have taken the wage savings and invested them in a diversified portfolio. But instead, they saw the cheaper labor as free money and threw it off as dividends. And that, my friends, is what enrages me about the whole thing. As deferred compensation, the pension is effectively a wage and thus should have priority over debt. Yet even up to today with an underfunded pension, GM is (and has long been) throwing off dividends. No dividend should be paid until GM has bought a third-party annuity and health insurance plan for everyone they've promised those things to.

The surest sign GM's going to face bankruptcy? Check out this AP article:

The chief executive of General Motors Corp. dismissed speculation that the largest U.S. automaker might soon seek bankruptcy protection ... Comments in the past week about a potential bankruptcy are "not at all constructive or accurate," Rick Wagoner said Thursday.
That certainly sounds like a weasel! "Not constructive"? Right, because it's our job to help you rook people into trusting that you'll be around for a while. And people thought I was crazy for avoiding GM in fears that the warranty promises are a joke...


gcallah said...

"Because those very same supergeniuses would just get bid away buy someone that doesn't have to dock off the legacy costs from the supergeniuses' pay!"

Silas, where they will get paid more depends on where their expected future returns are higher, and not on legacy costs.

Silas Barta said...

Except that legacy costs limit what they can bid for the labor.

gcallah said...

No, because if the expected future return is high, they can borrow money to pay whatever wage is justified. (Of course they would have to convince investors of that high return, and their bad track record from the past might be taken as a negative sign of future performance, but it is only future returns that are relevant.)

Silas Barta said...

Yes, I know. But so long as GM has to pay pensioners before investors, other companies can make a more attractive offer to those investors than GM.

Toyota: Lend to us. We'll give you almost all of the returns this superstar generates.

GM: Lend to us. We'll give you almost all of the returns this superstar generates ... um, net of $40 billion in liabilities we have to pay off first.

Investors: Hm, for GM's offer, I'd lend $20 billion, but for Toyota's offer, I'd lend $60 billion.

Toyota: Hey Superstar, we'll pay you $60 billion - $1 to work for us.

GM: Hey Superstar, how do you like your $20 billion - $1 salary?

Superstar: I don't, I'm leaving to work for Toyota.