UAW, Pensions & Retirement: The Black Swan Trumps the Sacred Cow

Here's the scenario: The roof of your house is on fire.   At the same time a tree falls in your yard, smashing your neighbors fence.   The neighbor comes out and you begin discussing the broken fence, how to fix it and who should cover the cost.   You spend lots of time talking about this, reach a deal and feel good about it.    All while your roof keeps burning and eventually the entire home burns down.   The fence deal doesn't look so good after that.  Neither does the recently-approved auto loan package in that it does not address the "fire" of the massive UAW pension obligations.

The Wall Street Journal describes the primary terms around the $17.4 billion dollar loan as:

The deal's ambitious targets for the companies include replacing two-thirds of their debt with stock; using more stock instead of cash to fund retiree health-care obligations; eliminating much-criticized union "jobs banks" that pay laid-off auto workers; and establishing wage structures and workplace rules that are more competitive with foreign rivals.

Notice the pension costs faced by GM and Chrysler are not even discussed.   They are obvious in their absence.   It is clear that the pensions are sacrosanct, the cow so sacred that it dare not even be discussed.   Sadly, that cow is also the one kicking the lamp over in the barn and setting off the inferno.

Reference again the New York Times story a week ago laying out the cost differences between the domestic and foreign auto companies.   According to the article, on average GM, Ford and Chrysler pay $3 per hour more in actual wages, $5 per hour more in vacation and overtime, just $1 per more in current benefits, but a whopping $13 per hour more in legacy costs such as pensions.  Put another way, the legacy costs per worker per hour are more than all the other higher costs combined.   Yet the UAW, automakers and the government only continue to discuss the wages and health care issues and leave the real problem of pension reform presumably to the imagination.

The problem is growing worse by the year, as the UAW workforce continues to age and place an increased burden on the companies.  Check out this page from the UAW's own website, written back in 2003.   It notes that the average age of a GM/Delphi worker was 48.9 that year with the average length of service at 23.3.   30 years of service is the primary retirement figure.   This means that in less than 7 years (2010, as this article was written in 2003) most GM/Delphi workers would be eligible to retire with full benefits.   All the the ripe old age of 56.

56 years old.  Today, that is basically middle age.  The average lifespan of an American is now nearly 80 years.     It is very likely that many workers will be getting benefits for longer than they actually worked at a given company.

If the domestics were more profitable than their foreign counterparts the problem may not be so severe.    Yet they are less profitable, indeed not profitable at all.   The Times article also notes that the Detroit 3 sell their cars for an average of $2,500 less than Toyota, Honda and others.  Higher costs, lower margins and selling prices.   It doesn't a PhD in economics to understand the problem.

The reality is simple: until the domestic auto companies can figure out a way to deal with their crippling legacy and pension costs, they will continue to be at a significant cost disadvantage to their non-union competitors.   The union and its members no doubt consider the pension untouchable.   Understandable, given that more than a million retirees count on it.    Yet the pension is also the problem, and the thing that will likely permanently prevent them from ever being truly cost competitive.

Which brings us to the decision no one wants to address: find a way to wind down the pensions or find a way to wind down GM, Ford and Chrysler.    Years of fiddling with other aspects of the problem have delayed the need to get to this hard conclusion, but nearly everyone knew it was coming.    The downturn in the economy and credit markets is a problem, but not the problem.   It is merely the "black swan" event that exposed the structural flaw.   It's like having $10,000 in credit card debt on a $100,000 per year salary, having your salary cut to $50,000 and then blaming your bankruptcy on the pay cut.   Yes, the pay cut hurt, but the real problem was the initial debt load.

If the pension plan is not addressed and altered in a serious manner soon, the only option will be bankruptcy and a breaking of the plan regardless.   The cow may be sacred, but it's not immortal.