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A Solution to the Pension Crisis?


Will public-sector pensions follow their private-sector counterparts into relative obscurity? Robert Lowenstein raises this question in a new piece at the Wall Street Journal, drawing parallels between the growth and decline of pensions in private companies in the mid-20th century with the pension crisis currently afflicting cities like Detroit and Stockton. The problems are best illustrated through the story of the now-defunct auto manufacturer Studebaker, which promised restive workers pensions in lieu of salary increases to hide the fact that the company was struggling—until the whole thing blew up in their faces:

While Studebaker was nominally increasing benefits, it hadn’t the slightest hope of making the requisite contributions. The “increases” were a fiction, but when you have no cash, promising future benefits is the best you can do, whereas raising salaries is out of the question. The United Auto Workers was complicit in this fiction. Union officials reckoned that it was better to tell the members they had won an “increase” rather than to admit that their employer was going bust.

Studebaker halted U.S. operations at the end of ’63, and the company terminated its pension plan. Workers saw the bulk of their pensions go up in smoke. The loss was devastating—$15 million—and Washington didn’t offer a bailout. People were shocked, though it isn’t clear why. In 1950, when General Motors agreed to a pension plan, a young consultant named Peter Drucker had termed the landmark agreement a “mirage,” doubting whether any company could anticipate its finances and the actuarial evolution of its workforce decades hence.

This story should sound eerily familiar to anyone following the current public pension crisis, but as Lowenstein notes, there is one big difference: Studebaker ceased to exist once it ran out of money; broke cities do not. And even a broke city needs workers to keep the streets safe and the lights running. As we’ve seen in Detroit, this can lead to a major debacle when a city finally funs out of money. It’s one big reason why it’s so dangerous to believe politicians who make pension promises they can’t or won’t keep.

At this point, there’s not much that can be done about the worthless promises already made; either taxpayers or pensioners (likely both) will have to take a loss. But we can do something to keep politicians from making bad promises in the future. Lowenstein proposes that the government do for public-sector pensions what it does for private-sector plans: ensure that municipal governments keep their plans funded at an adequate level, and punish them when they don’t:

If you want governments to come clean, go after their drug of choice—credit. Detroit’s bankruptcy has had a salutatory effect, pushing up interest rates for other cities with pension problems. If bond markets punish localities for not funding their pension plans, politicians will not be able to look the other way.

The trouble is, the bond market’s memory is short. Before we get more Detroits, or more Studebakers, the federal government should enact an Erisa (with teeth) for public employers. More simply, it could announce that local governments that fail to make timely and adequate contributions to their pension plans would lose the right to sell bonds on a tax-free basis. That would get their attention.

This isn’t a foolproof plan. We’ve already seen how municipalities use accounting tricks and rosy investment forecasts to make their pensions appear better funded than they are. But it’s at least a step in the right direction. Common sense dictates that cities keep their plans funded adequately. A reform like this could at least cause municipal leaders to think twice about making promises they can’t keep.

[Studebaker image courtesy of Shutterstock]

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  • Kavanna

    And keeping the promises they do make.

    As they say, if private individuals or companies did some of the things governments do, they’d all be in jail.

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