From the wonder of the Olympics to the horror of Libor, there’s been plenty of news this summer. So maybe it’s not surprising that a 1,676-page bill called Moving Ahead for Progress in the 21st Century, which President Obama signed into law on July 6, has escaped attention. (Really? You’d rather watch Gabby Douglas win the all-around gold than read this bill? Shocking.) But buried within the bill, which is also known as the Highway Act, is a provision that matters to many Americans, a provision that sums up a lot of what’s wrong with Washington today, a provision that is not just bad finance but also reeks of the cronyism we should all fear.
The provision is called the Pension Stabilization Act, and really, it should be renamed the Pension Destabilization Act. Pensions are fairly unstable already, relying on markets of the future that smart prognosticators doubt are going to be as generous as the markets of the past. And yet, many pension plans are counting on similar rates of return anyway. In his August letter, Pimco’s Bill Gross pointed out that one of the country’s largest state pension funds says it will earn what sounds like a modest real rate of 4.75 percent. But as Gross notes, assuming a portion of that is in bonds yielding 1 to 2 percent, the pension would need stocks to return 7 to 8 percent after adjusting for inflation to hit its target. That is, as Gross writes, “very heavy lifting.” Nor are we heading into tough times with a cushion. Different sources put the funding deficit for large corporate pension plans at somewhere between $475 billion and $500 billion as of the end of 2011.
Given that, and given that corporate profit margins and cash balances are near all-time highs, you might think, or hope, that Congress would be cracking the whip. And it did, sort of, by passing the Pension Protection Act in 2006, which among other things generally required companies to fund their pension shortfalls over seven years. But then the financial crisis hit, and companies begged for relief, and now, in 2012, we have the Pension Stabilization Act. While the math is complicated – Jim Moore, a managing director at Pimco, calls it a “Rube Goldberg contraption”– most people who have looked at it say that the overall effect is going to be, as JPMorgan put it in a recent piece, to “significantly reduce” the cash that companies are required to contribute to their pension plans in the next few years. It does so, in essence, by increasing the discount rate that companies use to calculate their pension liabilities when they’re determining how much money they need to put in. Using a higher discount rate makes the liability look smaller, thereby decreasing the funding requirement.
Right after the bill was signed into law, Sears, which is controlled by multibillionaire Eddie Lampert and has a pension plan that, according to JPMorgan, is underfunded by some $2.3 billion, announced that it would contribute from $380 million to $430 million to its pension plan in its fiscal 2013, down from its previous estimate of $740 million. Alcoa is reducing its contribution by $100 million to $130 million. And so it goes. Overall, the Society of Actuaries predicts that the required 2012 pension contributions will be 43 percent less under the new law than they would have been under the previous law – $45 billion instead of $80 billion.
The idea is that in the future, when everything is coming up roses, companies will make the shortfalls. Or as Society of Actuaries puts it drily: “The solvency of plans would decline in the short term due to lower contributions, and would eventually return to the levels expected under current law as contributions increase.” That sounds good, and it’s true that providing troubled companies with some relief may give them flexibility to figure things out. But what happens if they don’t, and what if, when the time comes to pony up the cash, there is none? Given the troubled status of many pension plans, there’s a cliché that describes this situation perfectly: kicking the can down the road.