Not Out of The Woods Yet

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Monday afternoon, Vice-President Joe Biden spoke in Toledo, Ohio at a Chrysler plant. The speech was designed to promote the successes of last year’s auto industry bailout, where $50 billion was given to GM and Chrysler to avoid the collapse of each firm. It also follows closely on the heels of President Obama’s own auto plant tour made earlier this month.

GM is currently trumpeting a stock IPO as a sign that their business is back to normal, and the Vice President was singing from the same song sheet today: “It’s a huge reversal and one we’d never have seen had we listened to those who told us to walk away.”

But these rosy predictions belie serious challenges ahead. GM is still in serious trouble, and has yet to develop a strategy to fix its severe pension problems. In fact, according to the Financial Times, “closer inspection of its gigantic pension fund suggests that in the long run, the business may be worth nothing at all.”

As many have pointed out since the auto bailouts took place, a fatal flaw in the GM restructuring was that the deal failed to address the crippling weight of pension obligations GM was subject to. Without massive reform of the largest private pension plan in the world, many worried that the restructuring would do little toward the long-term health of the company.

How bad are the pension shortfalls at GM? Here are a few frightening statistics:

• GM has $100 billion in unfunded, long-term liabilities in its pension fund.
• Currently there are six retirees poised to draw pensions for every current worker at GM. Roughly speaking, this means that 87,500 workers must support 531,500 pensioners.
• The amount of the unfunded pension liability is calculated assuming a long-term rate of return of 8.5%, an extremely optimistic number bordering on the absurd.. In contrast, most analysts would assume a rate equal to Treasury bonds for such assets, closer to 2.6%.

Despite being a car company, most of GM’s real problems are related to financing retiree costs not to selling cars. According to a piece by Financial Times columnist Tony Jackson, in which he referred to GM as “A Hedge Fund in Disguise”, GM will sink or swim as a company based on the rate of return on their pension fund, not on the quality of their products. Jackson likens the auto giant more to a hedge fund than to a car company, with its auto operations merely a sideline to investments designed to support the pension portfolio:

And as a hedge fund, it is fairly racy. Mr. Ralfe calculates that only 35 per cent of its assets are in investment-grade bonds, either Treasury or corporate. The rest is spread across real estate, equities, hedge funds, private equity and so forth. This poses an interesting question. Why would investors put their money into GM, rather than into regular hedge funds that are not distracted by the vexing business of selling cars in competition with the giants of Asia?

GM is thus facing the enormous burden of paying for the retirement of over half of a million retirees—and counting—through their underfunded pension fund which has little chance of performing as an investment as well as would be necessary. Unfortunately, this is the same crisis which faced GM before the bailout, and none of the fundamentals have improved, which makes any talk of a turnaround seem very premature.

For more information on GM, check out the piece "GM Joins Fannie and Freddie" that was published recently at the Weekly Standard.