Coyote Blog

As the Enron trial lumbers towards the end of its second week, Tom Kirkendall continues to have good analysis (keep scrolling).  While the Enron bankruptcy has spawned a number of books, it is likely that the Enron prosecution may spawn a few of its own.  Already, the prosecution has botched trials thought to be lay-ups and has demonstrated a new level of presecutorial abuse.  I know that most people have little sympathy for the defendants, but one has to be concerned with the tactics being used in these cases.  From reading his posts, while its early in the game, the defense may be ahead on points, as the prosecution made another tactical error in leading with and spending far too long with a weak witness, indicating that they are ready to commit on the same mistakes they made in the failed broadband trial.

By the way, this snippet is very funny - the indictment against Skilling and Lay is apparently so unclear and confusing and poorly written that the prosecution, who wrote it, is asking that the judge not allow it to be mentioned or quoted in the trial.  LOL - they are asking that no one mention the charges against the defendants in front of the jury.  Which is actually pretty appropriate, since in effect the prosecution is going to try to get Skilling and Lay convicted of being rich and unlikable rather than convicted of any specific charges.

By the way, we in Phoenix have been watching the revelations about gambling surrounding our Coyotes coaching staff.  The leaks by the police of as-yet unproven charges against prominent people is yet another abuse that happens all-too-often.  Beyond my own questions as to why gambling of this sort is even illegal in this day and age, it is crystal clear to me that the NJ police are going out of their way to leak insinuations of Gretsky involvement, which I don't think they can prove, merely to get press and attention for themselves.

The NY Times has a fairly scary (though not particularly surprising) article about unfunded retirement obligations of government bodies.

Thousands of government bodies, including states, cities, towns, school
districts and water authorities, are in for the same kind of shock in the next
year or so. For years, governments have been promising generous medical benefits
to millions of schoolteachers, firefighters and other employees when they
retire, yet experts say that virtually none of these governments have kept track
of the mounting price tag. The usual practice is to budget for health care a
year at a time, and to leave the rest for the future.

Off the government balance sheets - out of sight and out of mind - those
obligations have been ballooning as health care costs have spiraled and as the
baby-boom generation has approached retirement. And now the accounting rulemaker
for the public sector, the Governmental Accounting Standards Board, says it is
time for every government to do what Duluth has done: to come to grips with the
total value of its promises, and to report it to their taxpayers and
bondholders.

Its not too surprising to most of us that the government, which is actively putting Enron managers in jail for hiding liabilities off-balance-sheet, turns out to be a far worse offender at the same practice.  The few agencies that have performed the actuarial calculation are coming up with staggering numbers:

Stephen T. McElhaney, an actuary and principal at Mercer Human Resources, a
benefits consulting firm that advises states and local governments, estimated
that the national total could be $1 trillion. "This is a huge liability," said
Jan Lazar, an independent benefits consultant in Lansing, Mich. "If anybody
understands it, they'll freak out."...

Maryland, for example, now spends about $311 million annually on retiree health
premiums. But when that state calculated the value of the retirement benefits it
has promised to current employees, the total was $20.4 billion. And the yearly
cost will jump to $1.9 billion under the new rule, according to an analysis for
the state by actuaries at Aon
Consulting, which advises companies on benefits.

I usually severely discount consultant scare numbers like "$1 trillion", particularly after the year 2000 bug orgy of doomsaying, but if Maryland, an average size state, is facing $20 billion, then a trillion may only account for state governments.  The number may well be higher when you include cities, counties, school districts, etc. 

While this is clearly bad news, there is also a silver lining.  Politicians for years have given away richer and richer public employee retirement benefits because they appeared "free"  (free to a politician being anything that doesn't have to be paid for when he/she is in office).  By changing accounting standards to force acknowledgment of this liability, politicos will at least have to address true costs of any future giveaways.

As a minimum, most public authorities are looking to change benefits for new employees, which is an entirely reasonable response that should have been taken years ago.  Just as past changes in public accounting for pensions caused agencies to shift benefits to 401K's from defined benefit pensions, so this rule-changes in retiree medical care will certainly change benefits packages.

However, that being said, I have a much bigger problem with several state's proposals to retroactively reduce benefits for existing retirees and employees.  These retirement benefits are a contract, and should not be allowed to be changed casually, any more than could an agency just choose to renege on a municipal bond payment.  Sure, the commitments may have been irresponsible, but that does not make them automatically void.  Private companies from time to time get themselves in a similar mess, and the only way for them to relieve themselves of some of this liability is through the bankruptcy process.  Public agencies should be forced to do the same.  They should not be able to use their coercive legislative power to just make these obligations disappear at the stroke of a pen -- they need to go through the pain of a bankruptcy, where all creditors, not just pensioners selectively, will need to share in the haircut.

I wrote about the Vioxx decision here as another defeat for personal choice. Marginal Revolution has a good post on gaps in the anti-Vioxx science.  Here is a taste:

...[E]ven if there actually is an elevated risk of the magnitude the studies
suggest but can't prove, the question is whether I might want to accept a 1 in 4,000 risk of dying
from a heart attack in order to get the only medication timt
makes my pain bearable and a mobile life livable.  And if I say no to the
Vioxx, I may end up taking something that is less effective for my pain but has
risks of its own.

.... How did we arrive at a system in which 12 random Texans are assigned
responsibility for evaluating the scientific merits of statistical evidence of
this type, weighing the costs and benefits, and potentially
sending a productive blue-chip American company into bankruptcy protection?

I missed it last week, but apparently the CEO's of a number of major US airlines took the PR offensive last week to beg for more government subsidies and pension bailouts.  Reason's Hit and Run has the roundup.  They observe that the Senate was open to their pleas:

But luckily for the money-squandering dullards, there are enough members of
the Senate Commerce Committee who apparently believe certain businesses are too
colossally incompetent to fail:

The Commerce Committee's ranking Democrat, Sen. Daniel Inouye of
Hawaii, agreed: "If we do not begin to solve the problems plaguing the air
carriers, we will see more failures in coming months and certainly more jobs
cut."

Because what is the federal government if not a
guarantor of full employment at lousy companies?... If Inouye and his fellow
hacks were serious, they could start by privatizing airports, allowing vigorous foreign
competitors to own more than 50 percent of U.S.-based airlines, and letting
the failures actually fail, for starters. But that would take a belief in free
airline markets we haven't really seen since the Carter Administration.

It has always been hard to get airlines to just go away.  Pan Am hung around forever, as did TWA, through bankruptcy after bankruptcy.  My guess is that politician's unwillingness to let airlines fail has only increased with the advent of frequent flyer miles - no congressman wants all of his well-healed constituents calling the office and complaining about the 300,000 United miles they just lost.  By the way, have you ever noticed that frequent flyer mile holders are the only creditor of airlines who consistently come out of bankruptcies whole?  Even the worker's defined benefit pension plans get a haircut before frequent flyer mile holders.

Legacy airlines are really backwards in their practices - for example, many of their supply chain processes are reminiscent of the auto industry in the 60's and 70's, in part because airlines are sheltered from foreign competition while auto makers for the most part aren't.  I used to work in the aviation industry, and the opportunities there are tremendous, but no one in the industry will even listen.  The "not invented here" attitude was invented in the airline industry.

And while the management of these firms is backwards, you also have to deal unions a share of the blame.  Union supporters often accuse companies of "union-busting".  I have never heard the term, but in the case of airlines, one might be able to accuse the unions of "company-busting".  Unions hold out and strike for outrageous salaries and benefits and work rules that far outstrip what similarly skilled people make in other industries.  By the way, unlike conservatives, I don't have some deep seated hatred of unions.  In a free society, workers can try to organize to increase their bargaining power.  I do have problems with the way the US government, through legislation, tilted the bargaining table in the unions' favor, but that is a different story. 

For some of these reasons, and others, I was flabbergasted that local company America West would purchase USAir.  When there are so many planes and gates for sale on the market, and cities are begging for new competitors to enter their airline market, why would you buy yourself a load of trouble in the form of legacy union contracts and frequent flyer obligations?  It is noteworthy that Southwest has never bought another airline, and prefers instead just to buy assets out of bankruptcy.

According to the WSJ($), you and I are going to take on the pension obligations of UAL:

A bankruptcy judge approved a
proposal from United Airlines parent UAL Corp. to transfer four
underfunded employee pension plans to the federal government, paving
the way for the largest pension default in U.S. corporate history.

The plans, which have a shortfall of $9.8 billion,
cover more than 120,000 United workers and retirees. United, the
nation's second-largest carrier in terms of traffic, wants to transfer
them to the federal Pension Benefit Guaranty Corp., or PBGC, which
would add to the already heavy strain on the agency from a spate of
pension defaults in recent years. Since accounting for United's
obligations last year, in anticipation it would assume them, the agency
has taken on obligations exceeding its assets by $23.3 billion  [ed note- the agency takes in only about $1 billion a year in premiums, so $23.3 billion in the hole is a very big number]....

The court's decision could have wide
repercussions in the airline industry, which is struggling with high
fuel costs, intense fare competition and overcapacity. Sidestepping its
pension liabilities will help UAL attract additional funding, while
giving it a huge cost advantage over many of its rivals, which are
saddled with underfunded defined-benefit retirement plans of their own.
That will put further pressure on those airlines to slash their costs
or in some cases seek bankruptcy protection in hopes of terminating
their own pension plans.

It is difficult for me to even start on how much this pisses me off.  These pensions are real obligations that UAL took on, and represent value provided in exchange for work that has already been done.  As outlined below, I am not big on the defined benefit pension model, but that does not change the fact that these companies are defaulting on a solemn obligation.  The temptation I guess is always great when finances get tight to defer obligations that are the farthest in the future, and so pension underfunding is one of the first things to occur.  There is no way management should get a pass for this, and I am flabbergasted that equity holders expect to retain anything out of the bankruptcy when employees have not been fully paid.

This being said, there is plenty of blame to go around, including for the union and the government.  The UAL unions should have been dropping the hammer on the company in the form of strikes or whatever at the first sign of under-funding.  Instead, they were more concerned about jacking up their salaries to the highest levels in the industry, ignoring the reality that airline finances by the late 90's were basically a balloon that if you pushed on it in one place, it popped out in another.  Unions allowed the underfunding to continue in large part lulled by the promise of the PBGC and taxpayers to make the pension funds whole if they continued to be underfunded.  This is the moral hazard that occurs in any kind of financial insurance like this, and the unions apparently were both right and wrong - we taxpayers will take on the obligations but their benefits will also get a haircut.

One of the lessons I thought was learned from the S&L bailouts of the 90's was that you can't provide such financial insurance without a parallel regulatory structure to make sure some kind of minimum fiduciary responsibility exists.  But, not learning a thing, the government has this pension guarantee program in place and exercises virtually no oversight over the funding or management of the insured pensions.

It is astounding to me that a large number of people still support defined benefit plans over defined contribution plans. What I don't honestly understand is why the rank and file still buy into this.  Defined contribution plans are much easier to monitor and audit and keep companies honest.  Once the money is in a vehicle such as a 401K, the money can't be taken away by the company or lost in a bankruptcy (unless the 401K is invested in the company's stock, which any adviser will tell you to never, ever do (see "Enron").  Now, I understand that there can be some tricky migration issues from one system to another, and companies use the transition as an excuse to cut back on their net contributions, but these are workable and negotiable issues .  My guess is that the support for defined benefit plans comes mainly from union leadership, since these plans give
them control of huge amounts of funds and thereby gives them extra
power (see Teamsters for the classic example, or more recently, the situation at Calpers).  I wrote more on this topic here.

The issues here are surprisingly similar to the Social Security debate, as discussed here.  Would you rather have the money in your own account, despite the fact you will then have to bear market risks, or would you rather the money remain in the hands of your company or your Congress.  In entirely parallel situations, money entrusted to UAL management and to Social Security has all been spent, with nothing now left to pay retirees. 

Update:  It just occured to me to ask - why don't frequent flyer mile holders ever have to take a haircut in an airline bankruptcy?  We frequent flyers are creditors too, holding a claim on the company in the form of our miles.  In fact, I would think my claim as a holder of miles is much much worse than other creditors.  For example, why should employees have their pensions cut before I get my miles account cut?  Heck, employees seem to have a much better claim than I do, especially since many of my miles were earned, like everyone else's, as marginally ethical kickbacks directly to me for influencing my employer's spending on air travel.  Despite this, it appears that pensions will be cut, and salaries will be cut, and bondholders will lose value, and stockholders will be diluted, but my miles will all still be good.

Update #2: Assymetrical information has a nice post along the same lines, pointing out an issue with corporate defined benefit pensions that I forgot to mention:  If you are 20 years old with a company, are you really willing to make a bet that your company will even exist in 60 years to pay off your pension?  Not to mention the portability issues, since few people remain with the same company to retirement.  I think I actually have a couple of defined benefit pension plans I am vested in from early in my career - one from Exxon, when I was about to quit to go back to school and was offered, due to poorly structured plan rules, the chance at early retirement instead.  I think I qualify for like $1.23 a month for life from that plan.

More also from Will Collier:

I don't mean to tread on Martini Boy's turf here, but the pensions
crisis among all of these old-line companies illustrates a great no-no
of long-term investing: lack of diversification. In the end, even
though they presumably didn't have much choice in the matter, all those
UAL employees who've been promised a defined-benefit pension are in the
same boat as the Enron and WorldCom employees who voluntarily put all
of their 401(k) money in their own company's stock. They bet the house
on one horse, and by they time old age caught up with the grizzled nag,
there was barely enough left of it to cart off to the glue factory

Kevin Drum also points out that these defined-benefit funds are easy to manipulate, since managers can play with the "expected returns" variable to change the necesary annual contribution. 

Frequent readers will know that I have little patience with the argument against private Social Security accounts that goes something like "Americans are too dumb to be trusted with their own retirement funds".  Today, however, I am going to put that aside for perhaps a better question:

Can the government be trusted with our retirement funds?

This is the argument made by Brad DeLong and quoted in Marginal Revolution:

We need to raise our national savings rate. But if we just raise Social Security
taxes, Congress will treat these taxes as general revenue and spend them. Only
by funneling Social Security contributions into some vehicle that Congressional
representatives cannot interpret as a resource available to fund current
spending can we raise the national savings rate. And private accounts are the
best vehicle we can find to (a) accumulate contributions without (b) allowing
Congressional representatives to seize them as resources available to fund
current federal spending.

Congress has taken all the savings surpluses built up by Social Security over the past decades and it has spent them.  Republicans have spent the money.  Democrats have spent the money.  It is gone, spent on cruise missiles and welfare moms and ethanol subsidies and PBS broadcasts and snail darter studies.  No matter what verbal acrobatics people try to engage in to argue that there is a real "trust fund", the fact of the matter is that all that is in the Social Security till are IOU's that can only be redeemed by raising taxes. 

The situation with Social Security is entirely equivalent to having invested your money in a mutual fund and only later finding the directors of the fund spent your money on themeselves rather than investing it in redeemable securities.  The only differences are that:

• The proprietors of that bogus mutual fund may go to jail, but Congress won't
• Congress can raise taxes to get the money to bail themselves out of their malfeasance

Think of it this way: 

• There were more real assets of value remaining in Enron in its bankruptcy to divide up among investors and creditors than remain in the Social Security "trust fund" to divide up among program contributors.
• There were more real assets of value remaining in the Teamsters retirement fund after years of being raped by organized crime than remain in the Social Security "trust fund"

Stop handing over our savings to such unsavory racketeers (ie. Congress).  We certainly can't do a worse job for ourselves.

I have tried to resist the temptation to blog much on the whole Ward Churchill situation.  In part this is because it has been kicked around so thoroughly in other venues, and in part because I just knew I would get emails purposefully misunderstanding my point.  I have instead tried to focus some positive attention on emerging examples of scholarship where none existed before.  That said, I would like to try to add my own postscript on the whole Churchill fiasco.

First, while he has made some truly egregious statements that point to his moral bankruptcy,such as those he made about the 9/11 attacks and victims, I don't think that UC has grounds to fire him for these comments, at least based on the accepted rules and purpose of tenure.  One of the reasons for tenure is to give academics the freedom to pursue scholarship in any direction, without threat of political retribution.

However, Churchill should be fired for his complete lack of quality scholarship or principled academic research.  Churchill, through his poor scholarship, plagiarism, and outright fabrications have helped to set back historic studies about Native Americans and their tragic interaction with Western Civilization.  Churchill has become the poster boy for one of the leading problems in academia today, that is the ability of certain individuals to substitute vocal leftist politics and minority status for intellectual rigor and true scholarship in getting tenure at major universities.   A non-protected group white male of moderate politics with the same body of academic work as Churchill couldn't get a job teaching at any self-respecting university, but put the same work under the banner of radical leftist native American, and suddenly he has tenure at the University of Colorado.

Anyway, Victor David Hanson has a great piece in NRO summarizing why Ward Churchill represents what is wrong in academia today.

Today, we had another $300 workers compensation claim.

First, I will begin by saying "Thank God for the workers comp system in this country". Basically the philosophy of the system is this: Workers give up their right to sue their employer over workplace injuries in return for a guarantee of medical care and a defined benefit compensation system. Yeah, some states (like Florida, in particular) have some real fraud and management problems. In California last year, before reform, I was paying $20 in workers comp premiums for every $100 in wages -- and this despite having no claims the last few years. But, given the state of the lawsuit industry in this country, imagine the effect if workers could sue over every injury, large or small. Shudder.

As an aside, this issue has greatly affected the whole asbestos litigation situation, as detailed here. It can be argued that most workers' asbestos injuries are more likely due to poor protections on the job site, rather than any product problems from the asbestos makers. Asbestos using companies, after all, have known asbestos is dangerous since before WWII. In fact, navy shipyards in WWII were some of the worst offenders in terms of not using masks, poor ventilation, etc. But, since employers generally can't get sued over injuries (and its hard to sue the feds), lawyers concentrate on the "product labeling" argument and sue the asbestos makers into bankruptcy, which explains why litigation attorney's coach their clients like this.

Anyway, in many states, workers comp needs reform. Ahnold, for example, did a nice job of attacking this issue in California, and our company got an immediate 10% discount on our rates once the legislation passed. One thing that is never discussed and frustrates the heck out of me is the issue of deductibles. We get a lot of small claims (e.g. went to emergency room, got checked out, all was OK, went home). As with any kind of insurance policy, filing a lot of small claims this year is death on premiums next year. Workers comp is worse than most, as it has an experience mod system that guarantees that for every dollar in claims that goes out this year you pay an extra $1+ next year in premiums (in the next few days Coyote Blog will be starting a new series called "things they didn't teach me in business school" and the mechanics of workers comp will be one of the first posts).

Unfortunately, many states, such as Arizona, do not allow you to have a deductible on your workers comp policy. This is not an insurance company practice that might change with new competitors, but the law. So, we keep paying out small claims that probably drive up our premiums $2 for every dollar in claims.