Friday, November 20, 2009

Induced Bankruptcies Costing Taxpayers Billions?

Independent financial analyst Diane Urquhart sent me her latest research report, Induced Bankruptcies Cost Canadian Taxpayers Billions of Dollars Federal Government Not Stopping the Abuses.

Here are the key conclusions:

The credit default swap (CDS) invention of 1997 and the trend of private equity funds making leveraged acquisitions of large public corporations over the past decade are causing a proliferation of bankruptcies today in both the U.S. and Canada. The damages to the Canadian taxpayers and the economy from these induced corporate bankruptcies will be in the billions of dollars.

Canadian Federal bankruptcy laws are allowing corporations to walk away from their employee benefit obligations and to download onto Canadian taxpayers the additional costs for public social security programs and lost income taxes from the former employees whose employee benefits are being severely cut.

For example, I estimate that the Nortel liquidation will cost Federal and Provincial Governments at least $355 million in additional social security program expenditures and reduced income tax revenues, even though Nortel will have an estimated $6 billion plus of cash in its global bankruptcy estate.

The Canadian economy will experience the multiplier impact of an estimated $1,593 million of after-tax income and health care benefits lost by Nortel's close to 25,000 affected Canadian pensioners, survivor pensioners, active and deferred beneficiaries of pension plans, long term disabled and terminated employees.

The impacts are based on the present value of lost Nortel-provided annual income and health benefits, which have the following impacts on government: lost income taxes from all four Nortel former employee groups; additional Age Allowance and Medical Expense Tax Credits for pensioners, increased use of the Guaranteed Income Supplement and the Medical Expense Tax Credit for survivor pensioners, new use of Provincial means tested drug assistance programs for the long term disabled, and additional Federal Employment Insurance and Medical Expenses Tax Credit for the severed employees.

The recommended Bankruptcy and Insolvency Act (BIA) Amendment is to give preferred status for employee benefit claims over unsecured creditors. This is the best short-term and long-term solution to prevent corporations from walking away from their pension and long term disability plan deficits and unpaid severance, when there is money in the bankruptcy estate. This BIA Amendment ensures that Canadian taxpayers' interests are protected from the increased social security program costs and lost tax base that induced bankruptcies cause.

Key New Information in This Research Report

(1) Added estimates on the impact of Nortel's liquidation on the Survivor Pensioners and the Severed Employees.

(2) Added health benefit losses to the total loss of Nortel employee benefits and determined that the % loss in Nortel employee health and income benefits range from -35% to -55% in the best case of the estimated cash settlement ratio being $0.45 per $1.00 creditor claim; and, from -40% to -85% in the worst and likely case of the estimated cash settlement ratio being $0.15 per $1.00 creditor claim. The worse case assumes that the U.S. and U.K. government and U.S. junk bond creditors have improved their relative position by their hoarding of cash outside of Canada and by collecting their non-arms' length Debtor-in-Possession prior charge and other inter-company loans made to the Canada Estate.

(3) Added analysis on the % impact on the combined Nortel health and income benefits and the government social security programs as noted in Figure 2 above (click to enlarge image). The % loss on total income and health benefits from both Nortel and Government is in the range of -20% to -55% in the best case and -20% to 60% in the worst and likely case.

(4) Determined that Nortel's long term disabled employees have the severest damages amongst the four employee groups because: their future disability income has been deeply underfunded in a self-insured plan, Nortel has stopped making new cash contributions into the Health & Welfare Trust (H & WT) to pay for the current LTD income and so the capital in the H & WT is being depleted by current long term disability income being paid during the restructuring period; the long term disabled employees have heavy health care costs estimated at $12,000 annually whose reimbursement will be cut off at the time of Nortel's liquidation; the long term disabled are being threatened to lose their health benefits sooner if they attempted to shut down the H & WT to get their capital out now before it is depleted during the remainder of the restructuring period; the CPP Disability Income is a low $13,272 annually and the long term disabled cannot go back to work.

Diane's research has wider implications for employees and pensioners of other companies teetering on bankruptcy. If the explosion of CDS and leveraged buyouts is inducing a wave of bankruptcies, then why should taxpayers borne the cost? I say we tax the funds that are wreaking havoc on the real economy with their sophisticated financial "leveraging and hedging".

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