Why Did GM and Chrysler Keep Their Pensions?

Unlike every other major company in history that has go bankrupt in recent history, General Motors and Chrysler kept their defined benefit pension plans in place.

Airlines and just about all other major companies that have gone bankrupt, terminated their pension plans, let the Pension Benefit Guarantee Corporation pick up unfunded liabilities, and started defined contribution plans.

This is because a defined benefit plan shifts a great deal of investment risk from the employee to the company. If a defined benefit plan is underfunded, which it typically will be during bear markets because its liabilities don't change in value much and its investments lose value, then the company has to put in more money at precisely the time when its bottom line is likely to be hurting. Absorbing investment risk from individuals is fine if you are a well capitalized insurance company selling straight annuity and life insurance products, and is not a very good idea when you are a manufacturing company with highly cyclic sales that is hanging on for dear life. A defined benefit plan is a significant contingent liability and form of leverage that isn't obvious on the face of the balance sheet.

Defined benefit plans also give workers an expectation of lifetime employment and an intense financial incentive to stay employed with the firm as long as possible, because this will not only allow the employee to continue to earn a wage, but will contribute an ever increasing amount (through a "normal" retirement age where the marginal benefits of additional work dramatically decline) to that employee's pension.

This makes voluntary early retirement incentives for employees, which are the main alternative to mandatory layoffs, very expensive, because early retirement is much more expensive for a worker who is close to retirement in a defined benefit plan than it is for a worker who is close to retirement in a defined contribution plan. This makes the job of scaling back operations for the two companies, which both have to do so and are likely to have to cut more in the future, more difficult.

Surprisingly, both companies actually had somewhat overfunded defined benefit plans at the time of their bankruptcies (assets which are not available to creditors), so it probably wouldn't have cost the federal government anything if the plans had simply been terminated at the time of the bankuptcy. Retirees did take a deep hit in the bankruptcies and were major creditors of both companies who have traded company debts to them for equity. But, the losses were from no PBGC guaranteed liabilities to retirees like retiree health insurance.

Now, the government faces the risk that there will be far bigger unfunded pension obligations in the future, and an increased risk that its investment in GM and Chrysler will be rendered worthless. The federal GM bailout investment looks likely to be repaid this year, and the federal government will still own valuable stock in the company, although this could change if a defined benefit plan liability that could have been eliminated in bankruptcy without undue controversy outstrips the ability of GM to meet its obligations.

But, the federal government has already lost its bailout investment to the tune of about $5 billion in the Chrysler bankruptcy, and the large stockholdings that the public has in Chrysler are more likely to become worthless as its sales have not turned around as GM sales have post-bankruptcy and it shows no signs of making a profit soon.

Essentially, labor, in insisting that the defined benefit plans stay in place in the bailouts and bankruptcies has made a big bet that the defined benefit plan liabilities won't pull GM and Chrysler under. This will mean a handsome reward for workers if the companies do survive, which is hedged by a federal PBGC guarantee. But, this has put the companies themselves at a far greater risk of future failure and has put the federal government at a far greater risk of having to make a big PBGC payout if one of these companies fails later.

Harsanyi Out Of Touch On Social Security

David Harsanyi, a libertarian opinion writer at the Denver Post today bemoans the lack of a "private option" for Social Security, and complains about the bite of payroll taxes. Could there be a worse time to make this point?

Wrong On Rates Of Return

Harsanyi decries Social Security as "a failing program and pay into a private one that offers more than a 1 percent return (like a savings account or a tooth fairy, for instance)." Sort of like the stock market.

Returns for the ten-year period ending June 30, 2009 were negative for the S&P 500. Social Security was invented, of course, to serve as a counterbalance to the hardships suffered by retirees in the wake of the stock market crash of 1929, troubles that we experiencing again now.

Stock markets abroad show this two time U.S. experience is not unique. The U.K. stock market "returned just 1.05% a year between 1998 and 2008 in nominal terms, according to Barclays Capital. . . . the decade ending in 1974 saw a weaker return at 1.02% a year. Returns look even worse after inflation: the UK stock market is down 1.4% a year in real terms over the past decade." The Japanese stock market hasn't been a sweet deal either: "In October 2008 the Nikkei 225 stock index reached a 26-year low of 6994.90."

Harsanyi is also simply wrong in the numbers he cites.

He understates the rate of return that the typical person receives from Social Security, which varies considerably depending upon marital status and the number of income earners in a married couple. About 95% of Americans marry, most of them have two incomes, and that about half of those who do not marry are women. Yet, single men make a 1% rate of return from Social Security, in excess of inflation, and single women and married couples do considerably better.

The returns of Social Security are considerably more than the 1% nominal rate of return cited by Harasanyi. The average annualized rates of return on contributions even after inflation, for people retiring in 2030 are as follows:

Single male 1.00%
Single female 1.90%
One-earner couple 3.37%
Two-earner couple 2.29%

No decade since the U.S. permanently departed from the gold standard in 1971 has seen inflation at an annualized rate of less than 2.78%. Thus, a real rate of return of 1.00% earned by a single male translates to a nominal rate of return of at least 3.78%, and the nominal rate of return earned by the median person, who is in a two-earner couple, is more than 5%. (Admittedly, predicting future inflation rates is not an exact science. The margin between the yield on Treasury bonds with fixed nominal rates of return, and Treasury bonds with inflation adjusted rates of return, suggest that the market expects inflation rates about 1.25% and 2%. This would implies returns of 2.25% to 3.00% for single males and 3.54% to 4.29% for two earner couples who are the median beneficiaries.)

The best interest rate available from any bank in Colorado on certificates of deposit, which typically offer the best returns available on bank deposits and are equally risk free, today, is 3.10%.

Moreover, unlike returns from a 401(k), traditional IRA, private defined benefit pension plan, or non-tax preferenced private account, a large share of Social Security benefits are tax free when paid to the beneficiary.

Corporate Aaa rated bonds currently earn about 5.6% nominal returns, which is not significantly better after tax than the median rate of return on Social Security contributions. Thirty year municipal bonds, which are tax free and low risk (but not zero risk), pay a 4.85% nominal rate on 30 year bonds, and considerably less on shorter term bonds.

The return numbers for private accounts are also before the considerable fees and commissions that apply in any form of private account, but are absent from Social Security. The payroll tax generates more dollars of revenue relative to the administrative costs of the tax, than any other tax used by the federal government. The administration of Social Security benefits, likewise, is exceedingly efficient relative to the volume of funds provided and the number of beneficiaries involved. Many private investment companies refuse to work at all with accounts as small as that of many people starting to participate in the Social Security system.

For the average family, the return they receive on their Social Security contributions is not significantly worse than what they could receive on an investment with low risk in a private account invested prudently. Of course, it is also true that not everyone would invest their private accounts prudently, creating a burden on society should their investments be unwise.

Risk in Private Accounts

Social security isn't perfectly in balance. But, it isn't in an immediate crisis, either, despite the fact that its benefits are inflation proof. "Even without any changes, current benefits are expected to be fully payable on a timely basis until 2037."

This level of security is something that is increasingly hard to find in private accounts.

Most Americans don't have access to private defined benefit pension plans at all (the private equivalent of Social Security), which are the real failing program. In a 2004 speech to the U.S. Chamber of Commerce, the Executive Director of the Pension Benefit Guarantee Corporation, the government version of the FDIC for private defined benefit pension plans explained:

The number of private sector defined benefit plans grew through the 1960s and '70s before reaching a peak of 112,000 in the mid-1980s. At that time, some 40 percent of Americans workers were covered by defined benefit plans.

Since then, there has been steady erosion. Over the past two decades, the number of defined benefit plans has fallen by 75 percent to just over 31,000 plans today. Moreover, just 1 in 5 workers—20 percent of the workforce—now participates in a private sector defined benefit plan.

People who don't have private defined benefit pension plans invest their funds directly in the securities market, which, as noted above, has a record a plummeting at some point during the relevant time period of a person's working career, with catastrophic effects if you are unlucky enough to need the money at the bottom of one of these crashes.

But, even those employees who, in theory, have a promised pension benefit that their employer is required by law to pre-fund at actuarial sound levels can't count of getting their promised benefits when they retire. The downside risk of private pension plans betting their beneficiary's retirement on the stock market has been realized:

In the 12-month period ending October 9, 2008, equities held by private defined benefit plans lost almost a trillion dollars ($.9 trillion).

For funding purposes, the aggregate funded status of defined benefit plans has fallen from 100% at the end of 2007 to 75% . . .

More than 50% of private defined benefit plans are less than 80% funded.

The aggregate contribution that employers will be required to make to such plans for 2009 could almost triple, from just over $50 billion to almost $150 billion.

The underfunding crisis matters because private pension plans, unlikely Social Security, are not fully backed by the full faith and credit of the United States government:

If a company fails while its pension plan is underfunded, the PBGC is obliged to pick up the plan and pay retired workers. But it may not pay the full pensions that workers thought they were going to get; in some cases, such as the steel companies and airlines that filed for bankruptcy in the 1990s and early 2000s, many workers who had retired early with their full promised pension saw their monthly checks cut by more than 25%. A 2008 PBGC study of 125 plans terminated between 1990 and 2005 found 16% of the 525,000 participants suffered an average benefit reduction of 28%. Of the 70,000 retirees of Bethlehem Steel, whose plan the PBGC took over on Apr. 30, 2003, about 11,000 lost benefits, typically $500 of their $2,050 average monthly check.

The PBGC itself is underfunded by $33.5 billion.

The Non-Problem Of Social Security Payroll Taxation

Harsanyi also proclaims:

How about those payroll taxes most of us pay to fund Medicare? Isn't it time that Washington instituted an opt-out clause so that future generations are able to select private options if they wish?

Yet, Americans are less concerned about taxes being too high than they have been at any time since 1956 (when the top marginal tax rate on incomes over $400,000 was 91%; the top marginal tax rate on incomes is now 35% and applies at a little more than $311,000 of income).

The Social Security tax base, in particular, has grown smaller:

[W]hen the maximum limitation was enacted, it caused 92 percent of earnings to be subject to social security tax on the employee. Over time, that percentage fell as real wages increased, and Congress amended the law and provided for cost-of-living increases to the specified maximum dollar amount. Yet, presently only 80 percent of wages are subject to social security taxation on the employee.

Of course, in any situation where there is a positive rate of return on your tax dollar to you personally, it is hard to call that a tax in the ordinary sense at all. Mandatory contributions to private accounts would take money out of your paycheck just as reliably as Social Security does, but without any reliable promise that there would be a positive rate of return.

The Poverty Issue

The other problem with a "private option" for Social Security is that Social Security does more than simply facilitating savings for retirement. It is also the most effective anti-poverty program every invented, which eliminates all sorts of other social problems that take government money to address, which poverty creates.

While people should set aside enough savings for their retirement and secure adequate permanent disability insurance without being required by tax law to do so, the reality is that many do not (and this was true before Social Security was adopted, indeed this was the main reason that Social Security was adopted in the first place):

Social Security provides more than half of the total income for almost 60 percent of beneficiaries. For almost 30 percent, it provides more than 90 percent of income. . . . The poverty rate among the elderly in 2000 was approximately 10 percent, down from a rate of 35.2 percent in 1959. Without Social Security, the poverty rate among the elderly would be 48 percent.

Low income workers do receive higher rates of return on their Social Security contributions, but we all get the payback of that higher rate of return because we don't have to spend money on more expensive to administered means tested programs to provide elderly workers who can't support themselves with the minimum level of support they need to survive.

Footnote On the Public Option

Of course, Harsanyi didn't write his column because the nation is in the midst of seriously considering private accounts in the Social Security system. He did so as an argument against a "public option" in health care reform, although it is not obvious why a libertarian should argue against more choices for consumers.

In that connection, it is worth noting that the population that the American health care system has the best record of providing health care to shown, the elderly, as illustrated for example, in its good outcomes from cancer treatment by international standards, does not just have a public option. For senior citizens, the American health care system is a single payer health care program. This program is essential, together with Social Security, in keeping America's senior citizens out of poverty, it has far lower administrative costs than private health insurance plans do, it is very nearly universal, and it has managed to operate without forcing health care providers to be government run and without significantly discouraging medical treatments for elderly patients.

About 78% of men, and 86% of women die at age sixty-six or later. This means that their health care in their final year of life, which makes up a large percentage of all health care costs, takes place while their primary health care provider is Medicare. A disproportionate share of the rest have Medicare or Medicaid as their primary health care provider, because parts of these programs provide health care to those who are disabled (who have shorter life expectancies than the general population).

The moral issues involved in balancing end of life care decisions against cost in the United States already arise overwhelmingly in the context of people who are in a single payer government health care program.

The British National Health Care system, for all the criticism it has received from American conservatives (often based on inaccurate claims such as the claim that physicist Stephen Hawking, who receives his care from the system, would have died sooner if he was cared for by the British National Health Care system), yesterday received resounding testimonials of support not only from the ruling Labor Party prime minister, but from the leader of the ranking leader of the opposition Conservative Party (sometimes called the Tories).

There is also no reason to believe that a non-profit health care plan would be more stingy about providing health care to those at the end of life than existing for profit health insurance companies, whose tendency to try to deprive sick beneficiaries of care is well documented.

The Trouble With Regulating Risk Concentration

In my view one of the main factors behind the severity of the financial crisis was the excessive concentration of aggregate risk in highly-leveraged financial institutions. Note that the emphasis is on the concentration of aggregate risk rather than on the much-hyped leverage. The problem in the current crisis was not leverage per se, but the fact that banks had held on to AAA tranches of structured asset-backed securities which were more exposed to aggregate surprise shocks than their rating would, when misinterpreted, suggest.

From here.

I've alluded to the issue a couple times when talking about FDIC regulation, which limits not only leverage per se, but also places some limits on types of investments permitted, which is a form of aggregate risk regulation.

The trouble is that this observation isn't too helpful from a regulatory perspective. Leverage is easy to monitor and regulate, even with rather complex risks. State insurance regulators and the Pension Benefit Guaranty Corporation both engage in this kind of reserve setting, and while it isn't perfect and can be stressed in extraordinary times, reserve regulation reduces systemic risk across whole industries, by imposing, if not more prudence than a typical industry executive would undertake, at least more prudence than a reckless industry executive would prefer, which in turn, discourages a race to the bottom scenario in terms of leverage (with part of the cost of any collapse paid by others).

No matter how much or little risk entities take on, when those risks go bad, entities with less leverage will be better equipped to absorb those risks than entities with more leverage. Even if leverage regulation doesn't prevent a bubble collapse or financial crisis, it will make it less severe.

Excessive concentration of aggregate risk, in contrast, is very hard to regulate directly.

Prudent investor rules, which require diversification of investments for fiduciary funds, help prevent concentrated risks in fiduciary investments, but it probably isn't reasonable to expect every player in an industry to be diversified the way that a fiduciary would be diversified. In the same vein, index funds work only because an important subset of the market doesn't index. The financial markets are all about taking risks on unbalance portfolios based upon relevant information that shows that current prices are wrong. Moreover, diversification often makes more sense at the investor level than at the investment vehicle level. Undiversified investment vehicles provide ways for ultimate investors to diversify. Nobody expects a mortgage backed security fund to diversify away from mortgage backed securities.

The AAA bond ratings assigned to bonds that, in fact, carried much more risk than a typical AAA bond illustrate how much skepticism and "read between the lines" effort is necessary for a regulator (who is probably very prone to regulatory capture) to distinguish between apparent risk and actual risk.

Transparency also has its limits. If AIG had disclosed all of its derivative positions, it would have done so in a couple of ways.

First, it might have disclosed the "worst case scenario" liability of its credit default swap obligations. But, given that these were credit default swaps on what were often investment grade bonds that the derivatives turned into AAA bonds, the numbers would have been simply a curiousity. Why use "worst case scenario" losses for a guarantee of a loss exceedingly unlikely to come due all at once? This would be like reporting the face value of all of a company's outstanding life insurance as a liability on the insurance company's books. Every once in a while, this number may even be meaningful, e.g., if you are Hiroshima Life and Casualty Co. when the Hiroshima bomb explodes, or write life insurance exclusively for gay men in California just before the AIDS epidemic sweeps in and dramatically increases mortality rates. But, investors and regulators are mostly going to right off this number as absurd. If they didn't, the industry couldn't exist at all.

Second, it might have disclosed anticipated risk. Somewhere out there, some CPA working for AIG prepared a document with an aggregate expected loss for its credit default swaps (probably based upon the bond rating assigned to the underlying investment whose default was covered) lined up against the price customers paid for those credit default swaps. This chart no doubt showed both a profit for AIG on each transaction and left AIG in the black on a balance sheet basis.

This is better than nothing. It isn't clear this kind of loss reserve disclosure, common at commercial banks and insurance companies, was on the books at all, and it would have at least provided a baseline from which to draw meaningful conclusions. But, this kind of analysis still doesn't solve the problem that sometimes the underlying assets that a credit default swap guarantees is riskier than it appears (indeed, adverse selection principles from insurance contexts makes it likely that the risks are higher than they appear), and it is quite unlikely that anyone would do the kind of counterparty default risk analysis needed, in part because the data was hard to secure and in part because counterparty risk normally seems remote.

Perhaps the best that one could do is to give someone smart with lots of easy access to good data, like a private mortgage insurance company, a very strong financial incentive to accurately assets the important components of downside risk, like poor underwriting and excessive housing prices in a market in the case of investments derived from mortgages.

Still, this was basically present in the mortgage backed security market. Typically, a mortgage backed security had standing behind its loans: (1) personal obligations to pay of the debtors, (2) brick and mortar collateral, (3) default rate triggered promises from the mortgage finance companies that supervised underwriting, (4) state law fraud liability for inaccurate applications and appraisals, (5) credit default swap guarantees from large financial companies that had been in existence for a long time, (6) reinsurance of credit default swap counterparty risks from large financial companies that had been in existence for a long time, and (7) the law of averages which made a simultaneous default at a level beyond that seen within the historic period within which good records were available extremely unlikely.

Defaults have cost debtors their homes and their credit. They have resulted in huge waves of foreclosures attempting to realize on the brick and mortar collateral. They mortgage finance companies turned everything they had over to their creditors in satsifaction of their contract obligations in the event of excessive defaults. Thousands of people who engaged in mortgage fraud or questionable disclosure practices have been prosecuted, faced suits for civil liability, or otherwise been financially ruined. The financial companies the issued the credit default swaps have taken massive losses, with many of them going out of business or getting federal bailouts that have decimated financial company equity.

While the housing bubble become obvious well before it collapsed, quantifying how much of the fallout from its inevitable collapse would be felt by investors in mortgage backed securities screened by layer affter layer of reassurances and risk mitigators was very difficult to do in advance. No regulatory agency can be trusts to catch this kind of Black Swam when it comes up through mere analysis and detective work.

Excessive concentration of aggregate risk is absolutely a key problem that goes to the heart of what caused this financial crisis and past financial panics. But, regulating it directly comes close to being a fool's errand. Pity the fellow assigned the job of systemic risk regulation at the Fed when the next crash strikes in some unexpected way.

This isn't to say that systemic risk can't be reduced. There are multiple sensible policy measures that can be taken. But, in order to work, systemic risk regulation must be indirect. Expecting regulators to identify problems waiting to happen before its too late is unrealistic. Instead, the regulation should give the smart people with inside information and insight who are in the game an incentive to avoid excessive risk, or, at least, to isolate the risk in the hands of ultimate investors who understand the risks they are taken and can afford to take them, so that losses don't spread and infect the entire financial system and economy.

In other words, the way to regulate excessive concentrations of aggregate risk is to implement measures that are broadly applicable across the economy, that encourages steps that make our economy more robust in hard times. This means removing artificial incentives to use leverage, and it means giving key economic actors, like financial firm managers, incentives that fairly weigh upside and downside risks. It also means identifying and discouraging arrangements and situations that turn independent random risks into synched correlated risks without intense and prudentially conservative regulation.

While preventing bubbles, or identifying the current existence and extent of specific economic risks, or promoting non-stop growth are goals that are nearly impossible to attain, using public policy to encourage actors in the economy to act in ways that make the economy generally more robust in bad economic times than it is now, does seem like an attainable goal.

GM Slips Further

General Motors is coming closer to the brink.

The Declining Price of General Motors Shares

GM led the Dow lower, falling 31 percent to 4.76. This is its lowest level since December 1950. A year ago, General Motors stock was selling at a peak price of $39.19 a share. The price of a share of General Motors stock has decline about 88% since then.

In recent years, General Motors operations outside North America and financing operations have helped mute less profitable operations in the United States, but the spread of the financial crisis worldwide and GMs sale of a majority interest in GMAC threaten to upset the balance.

The stock market, generally, had another very bad day. The Dow fell 678.91, or 7.3 percent, to 8,579.19. The close below the 9,000 level was the first since Aug. 6, 2003. The close is more than two thousand points below where it was when President Bush took office. All indications are that the bailout bill that Congress passed has not established confidence in the stock markets.

General Motors' Falling Bond Rating

General Motors has a bond rating that was recently downgraded to CCC, deep in junk territory.

What does a CCC bond rating mean?

Debt rated CCC has a currently identifiable vulnerability to default, and is dependent upon favorable business, financial, and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial, or economic conditions, it is not likely to have the capacity to pay interest and repay principal.

Only bond ratings of CC and C are worse.

But, it looks like a lower rating may be in the cards:

Standard & Poor's Ratings Services put GM and its finance affiliate GMAC LLC under review to see if its rating should be cut. GM has been struggling with weak car sales in North America.

The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months.

S&P also put Ford Motor Co. on credit watch negative. The ratings agency said that GM and Ford have adequate liquidity now, but that could change in 2009.

From a practical perspective, the low stock price and bad credit rating combined, make it very hard for General Motors to raise new capital from the public.

The Weak General Motors Balance Sheet

The market capitalization of General Motors is now $2.69 billion and a book value of negative $57 billion. Book value has been negative since sometime in 2006. The Company has lost $62 billion over the last twelve months on sales of $171 billion.

At the end of the second quarter of 2008, GM had about $20 billion in cash, $35 billion in current assets like inventory and accounts receivable, $11 billion in financing and insurance operations assets (like its interest in GMAC), and $62 billion in non-current assets like plant and equipment, and $18 billion in pre-payments to the pension plan. The value of plant and equipment would probably plummet if GM failed, as it has few good alternative uses and the overall market for the vehicles that GM makes in those plants is in decline -- that is why General Motors is in trouble.

On the liability side, General Motors had $75 billion in short term liabilities (like accounts payable, short term loans and current portions of long term debt), $4 billion in debt and liabilities in connection with finance and insurance operations, $32 billion of long term debt, $47 billion of post-retirement obligations other than pensions, $12 billion of pension liabilities, and $21 billion of other long term liabilities.

What Would Happen If General Motors Went Bankrupt?

General creditors, like General Motors bondholders, would probably be lucky to get more than 50 cents on the dollar in a liquidation of the Company, although a sale of the Company to another automobile company, or reorganization combined with a government bailout, would improve this return.

It would be possible to buy all outstanding General Motors bonds and all of its outstanding stock for less than the federal government has spent on its second tranch of the AIG bailout.

Another plausible suitor in a General Motors sale or reorganization would be the union. Pension and post-retirement liabilities to employees of General Motors are the biggest liabilities on the books of the company. Trading those obligations for stock in the Company would be worth about a 95% equity stake in the company, and would also greatly improve the bond rating of General Motors in the credit market. Also, the nation's biggest employee owned company would make a much more attractive bailout beneficiary, if further government lending of assistance was needed, than a shareholder owned company.

A Chapter 11 reorganization would, ironically, make General Motors more creditworthy, even without government lending, because it would effectively turn existing bondholders and creditors into subordinated debt, since operational loans during a reorganization are considered administrative expenses entitled to priority payment in a banruptcy, and would wipe out existing shareholders.

PBGC Exposure If GM Fails

If General Motors were to enter bankruptcy, it would trigger a huge obligation on the part of the Pension Benefit Guarantee Corporation to cover the obligations of its defined benefit pension plan for its employees. It would also likely trigger defaults on the Delphi corporation defined benefit plan, a spun off automobile supplier, whose pension is supported by General Motors despite Delphi's bankruptcy.

The most recent available information indicates that the recent market crash has probably left the domestic pension plan somewhat underfunded on paper, and the plan for foreign employees doing much worse. The shortfall would likely be on the order of the single digit billions of dollars, or perhaps the low double digit billions of dollars.

Historically more than half of the GM pension plan has been invested in stocks.

This would probably be the biggest pension bailout in U.S. history, because of the overall size of the plan, because most of it is for rank and file employees who are entitled to maximum or near maximum protection from the PBGC, and because the bear stock market has very likely left the plan underfunded.

An August 2008 analysis of the PBGC situation stated:

Pension Benefit Guarantee Corporation: This government agency insures $2.5 trillion in Defined Benefit obligations. The PBGC covers 30,000 business plans and 44 million workers. The PBGC charges an insurance fee and has $55 billion in assets. Unfortunately, the Bush Administration wanted to give the stock market a boost and forced the PBGC to move from mostly safe bonds into 45 percent equity holdings, a move that occurred just before the stock market really headed down. The PBGC is already $14 billion under-funded, and that's before the recession smashes the stock value of their portfolio.

Other Impacts of a General Motors Bankruptcy

An actual liquidation of General Motors operations would also send every state and local government in the Rust Belt into a financial crisis as a result of declining tax revenues, and would put about 236,000 people out of work all at once, again, with a highly concentrated geographic impact.

A General Motors liquidation would deal a serious blow to Delphi, possibly forcing it from a reorganization to a liquidation, and would be many thousands of car dealers all across the country out of business. GMAC would also probably fall too fast to survive on its own and would probably have to be purchased by some other financing company.

UPDATE: This source says that GM bonds were trading at an effective yield of 50% as of yesterday, which implies an exceedingly high risk of a default losing a large percentage of bond value.

In the comments, I suggest that early 2009 would be a likely collapse date, unless an inability to issue commercial paper pushed the company's collapse close to November, 2008. Stock and bond price collapses, however, suggest that the process could move more quickly. Also, earlier this year, GM was trying to mortgage its Detroit headquarters to obtain operating cash, another bad sign.

UPDATE 2 (10/10/08 5:40 p.m.): NPR notes that both GM and Ford are in trouble:

Standard & Poor's downgraded the credit of both GM and Ford on Thursday, placing each of them on "credit watch negative." The ratings agency also downgraded the companies' financing arms — GMAC Financial Services and Ford Motor Credit Co. — with the same designation.

GM has a 49 percent ownership stake in GMAC; the remainder is owned by a group led by private investment firm Cerberus, which also owns a majority stake in Chrysler. . . .

The peak of GM's stock this year came on Feb. 1, at $28.98 per share. At the market close on Thursday, when the stock closed at $4.76, it was down more than 83 percent . . . Ford's stock has also experienced a similar decline: On May 1, its share price was at $8.48. On Thursday, its stock closed at $2.08 — down more than 75 percent. . . .

David Zoia, editorial director for WardsAuto.com . . . [says that] Even before the financial crisis hit, the companies were "burning through close to $1 billion a month in cash." Now both companies are on a mission to build a "cash cushion" to allow them to survive.

There are also reports in the industry that GM may be exploring the idea of selling its world headquarters and leasing it back to generate more cash, something car companies have done in the past. . . .

Annette Sykora, chairwoman of the National Automobile Dealers Association, said in a speech in Detroit that "we're likely to lose up to 700 dealerships" in 2008. So far, 590 have closed this year. In 2007, there were 430 net closures, up from 295 in 2006. . . .

[M]ore than 90 percent of all vehicle purchases are financed through credit. The difficulty of securing loans has translated into "some of the lowest sales in 25 years for many of the manufacturers," . . .

Although GM still remains No. 1 in terms of sales of light vehicles (cars, pickups and SUVs), its market share has slipped 17.8 percent overall, to 22.5 percent, for the period from January through September, compared with 23.9 percent for the same months last year . . . Ford's market share also slipped 17.2 percent, to 14.5 percent of the total U.S. automobile market, from 15.3 percent.

Just when General Motors seems to be headlong on the death watch for dying car companies, Ford rushes to catch up with it. Also, a look at the Yahoo bond quote service did not corroborate my first update's source regarding GM bond prices. It indicates that they are trading at effective yields of just under ten percent. I don't know if this is accurate or not. Bond market public information sources are not as well developed as stock market public information sources.