Saturday, November 8, 2008

What's Good for GM's Pension Fund?


U.S. stocks rallied on Friday after two days of intense selling despite the fact that unemployment rate bolted to a 14-year high 6.5%:
The new snapshot, released Friday by the Labor Department, showed the crucial jobs market quickly eroding. The jobless rate zoomed to 6.5 percent in October from 6.1 percent in September, matching the rate in March 1994.

Unemployment has now surpassed the high seen after the last recession in 2001. The jobless rate peaked at 6.3 percent in June 2003.

October's decline marked the 10th straight month of payroll reductions, and government revisions showed that job losses in August and September turned out to be much deeper. Employers cut 127,000 positions in August, compared with 73,000 previously reported. A whopping 284,000 jobs were axed in September, compared with the 159,000 jobs first reported.

So far this year, a staggering 1.2 million jobs have disappeared. Over half of the decrease occurred in the past three months alone.

Although the unemployment report was worse than expected, and Ford Motor Co. reported dismal third-quarter results and announced plans to cut more than 2,000 additional white-collar jobs, Wall Street investors appeared to take it all in stride. The Dow Jones industrial average was up more than 190 points in morning trading.

Another company that reported a dismal third quarter was General Motors who warned it may be running out of operating cash this year:

General Motors Corp., seeking federal aid to avoid collapse, said it may not have enough cash to keep operating this year and will fall ``significantly short'' of the amount needed by the end of June unless the auto market improves or it raises more capital.

The largest U.S. automaker reported a $4.2 billion third- quarter operating loss today and said its available cash fell to $16.2 billion on Sept. 30 from $21 billion at the end of June. Merger talks with Chrysler LLC were suspended.

``GM is making a pretty direct plea for help,'' said Pete Hastings, a fixed-income analyst at Morgan Keegan Inc. in Memphis, Tennessee. ``The message is, `we've done all the things we can do, and we need help.' And if we don't get help, fill in the blank.''

The cash drain reflected the strain of a 21 percent slump in U.S. sales in the quarter as the credit freeze deepened. It also added urgency to U.S. automakers' request for government aid. The companies are asking for $50 billion in new loans, a person familiar with the proposal said.

Chief Executive Officer Rick Wagoner and the CEOs of Ford Motor Co. and Chrysler renewed the push for assistance yesterday in meetings with U.S. House and Senate leaders in Washington. Wagoner said GM also has been in contact with the staff of President-elect Barack Obama.

Poor President-elect Obama, he is just beginning to get a taste of the devastation that awaits him. Joe Stiglitz is right: it will take him at least 18 months to fix the U.S. economy.

In fact, a new report by a leading U.S. think-tank has drawn a doomsday picture for the North American auto industry that shows that if Detroit's automakers shrink further - even fail - the U.S. economy would suffer a crushing blow, losing at least 2.46 million jobs in the first year alone:

In a report released Wednesday, the Center for Automotive Research in Ann Arbor, Mich., outlined what would happen in two separate scenarios if General Motors Corp., Ford Motor Co. and Chrysler LLC were forced to scale back or shut entirely.

If all three Detroit manufacturers were to cease operations, the U.S. economy would lose 2.95 million direct and indirect jobs in the first year. Governments would lose at least US$156.4-billion in taxes over the first three years.

If Detroit cut output and employment by 50% to meet ever-shrinking market share, which would mean contraction by two of the automakers, 2.46 million jobs would be lost initially. Governments would lose US$108-billion in revenue over three years, according to the analysis.

"The circumstances are such that either of these scenarios is possible, and indeed one or the other is probable, within the next 12 months," the non-profit think-tank said.

The report discusses the ripple effects into Canada and Mexico:

It is reasonable to expect that a permanent contraction in the U.S. auto industry would negatively impact the auto industries of Canada and Mexico, since producers in these regions rely heavily upon U.S.-produced parts and components. This inter-dependency of the NAFTA automotive producers means that the total economic impacts presented here underestimate the full impact of the scenarios. The decline of Detroit Three production in Canada and Mexico would result in further U.S. losses in employment, income, and government revenues.

And it ends with this stark warning:

Finally, the bankruptcy of any of the Detroit automakers may have serious implications for their pension funds and the level of obligations of the Pension Benefit Guarantee Corporation, as well as funding of the nation’s health care system. The Detroit Three are directly and indirectly responsible for funding the health care of 2 million employees, retirees, and dependents of their own companies and their suppliers.

That is why the PBGC is keeping a tight watch on GM:

General Motors Corp. is being monitored by the Pension Benefit Guaranty Corp., “as financial reports come in,” said Jeffrey Speicher, PBGC public affairs specialist.

“We will be looking with great concern as financial reports come in,” he said. “We aren’t sending out any flares or raising any panic.”

GM’s pension plan was overfunded, based on its latest filings, he said. “From our point of view, it is difficult to say what the impact (of the market turmoil) is” on the plan, he said.

“I don’t know of any public contacts” the PBGC has had with GM executives, he said. “But there are no public steps we can talk about,” he added.

GM’s defined benefit plan was $9 billion overfunded, based on assets of $117 billion and accumulated benefit obligations of $108 billion as of Dec. 31, according to a Milliman report.

GM’s 10-K showed a funded status of $19 billion, based on assets of $104 billion and liabilities of $85 billion as of Dec. 31.

GM’s pension asset allocation was 48.9% fixed income, 30.1% equity and 21% other, according to the Milliam report. GM’s 10-K lists the allocation as 26% equity, 52% debt, 9% real estate and 13% other.

Because the GM plan is overfunded, it would not be affected by curtailments of pension benefits, including shutdown benefits in the event of layoffs, under the Pension Protection Act of 2006, according to an ERISA attorney who asked not to be named because of potential conflicts with corporate clients.

In 2006, GM froze its salaried defined benefit plan for all active participants, moving them into a new defined contribution plan. That reduced pension expense $383 million in 2006 and reduced the pension benefit obligations by $2.8 billion, according to its 2007 10-K.

Standard & Poor’s on Thursday put the bond ratings of GM and its finance unit, GMAC, on negative credit watch, triggering an S&P review of the financial situation over the next three months.

The negative watch “reflects the rapidly weakening state of most global automotive markets, along with capital market conditions that will remain a serious challenge for the foreseeable future,” the S&P report said. It did not address pension issues.

Why is PBGC worried about GM? To answer this, we have to go back three years when GM's pension fund was pouring billions into hedge funds and other alternative investments:

One of the first pensions to start working with hedge funds is also the nation's biggest corporate pension fund, the $90 billion General Motors fund. It started with a small test investment in 1999 and increased it to about $2 billion in 2003, said Jerry Dubrowski, a G.M. spokesman.

The company is using hedge funds, along with other unconventional investments, in hopes of getting something close to stock market returns without the market's volatility, Mr. Dubrowski said. To pay out the $6.5 billion G.M. owes to its retirees each year, the pension fund must produce annual returns of a little more than 7 percent. Otherwise, G.M. will have to dip into the fund's principal. At current interest rates, G.M. cannot get those returns with bond investments, and if it tries to juice returns by betting on the stock market, it will have to cope with market swings.

By 2007, GM's pension fund was getting rave reviews for being a "high-performance pension machine":

There hasn't been much good news out of General Motors in recent years, but you'll be glad to know that at least one part of GM's U.S. operation is finally fixed: its pension funds. GM may be having a hard time turning around its auto business and getting its financial statements straight, but it's kicked butt in pensionland. In fact, GM's funds have done so well that the company has switched about $20 billion in pension assets to lower-risk bonds from higher-risk stocks. It's the equivalent of taking chips off the table after you've gotten ahead of the game.

Here's the deal. For reasons we'll examine later, GM's pension surplus increased by $9.6 billion in 2006. That gain would have made GM spectacularly profitable if pension results were part of companies' income statements, as some folks propose. I think that's a bad idea because pension returns distort results, which in turn would discourage companies from offering them. Not that they need much discouragement these days.

GM shows just how volatile pensions can be. In a mere four years, its U.S. funds have swung $35 billion, going from $17.8 billion underfunded (according to generally accepted accounting principles) in 2002 to $17.1 billion overfunded last year.

To lock in those hard-earned gains, GM has switched investment targets in its $101 billion pension portfolio to just 29 percent stocks and 52 percent bonds from 49 and 32, respectively. (The other 19 percent is in real estate and "alternative investments" such as hedge funds.) Bonds are much less volatile than stocks, hence the change.

"It's all about maintaining the funded status of your pension funds," GM's chief financial officer, Fritz Henderson, told me. "We want to take pension risk off the table."

How did GM go from the most underfunded corporate plans in the country four years ago to the most overfunded? By putting a ton of money -- $18.5 billion -- into the funds in 2003, most of which it raised in a giant bond issue. It wanted to fix its pension problems once and for all, which it did by getting above-market returns on that new money in what turned out to be an excellent investment market. GM has a stellar investment staff, and I've joked for years that it should dump the car biz and become a money manager. But who listens to me?

While I applaud GM's foresight to move aggressively into bonds, I wonder how those alternative investments are doing following the latest hedge fund, private equity and real estate debacles.

Much has been written on what's good for GM or more specifically, "What is good for General Motors is good for America".

As I watch GM and other automakers beg for a $25 billion no-strings attached loan while they slash more jobs, I think about how they squandered the opportunity to introduce the electric car on the market or just put more fuel efficient cars in their brands.

I also wonder about the state of GM's pension fund. In particular, as I recall that arrogant and pompous statement uttered over 50 years ago, I wonder if what's good for GM's pension fund is good for American pension funds?

Unfortunately, I get this eerie feeling that GM's pension fund is not as solid as some make it out to be and that it too may be running on fumes.

No comments:

Post a Comment