Corporate bankruptcy

Bill Fleckenstein has a gem on the bankruptcy system buried in his most recent column:
The flawed bankruptcy "system" is also part of the reason why many of these troubled industries continue to get more troubled, rather than healthier. The first one into bankruptcy gets a lower cost structure and ultimately starts a price war -- eventually dragging its competitors into bankruptcy as well. Given that all of this is occurring when times have been relatively good, one can only imagine the types of problems that will emerge when times get tough in the not-so-distant future.

United's pension default is a shocking reminder that in Corporate America, nobody's word is worth very much. A person can slave away his whole life for the company and then be informed: "We're not going to give you what we told you we

We saw it happen first with WorldCom/MCI in the telecom business, and now we're seeing it in the airline business. Irresponsible companies commit fraud or default on their pension or other obligations, then simply file for bankruptcy and emerge leaner and meaner. Companies that played by the rules and/or negotiated sensible pension arrangements are then put at a competitive disadvantage.

It's certainly a contributor to disinflation, which is what the Fed wants, but it's not good for economic growth or the stock market, to say nothing of the shafted retirees.

UPDATE: George Will goes into more detail about the PBGC in the column referred to in the Comments below by IPFreely and Slate's Daniel Gross has a column loaded with facts and figures that illustrate the magnitude of the problem.

Most of these commentaries, though, avoid getting at the root cause of the problem: unrealistic pension assumptions. Extremely loose accounting standards basically allow companies to make up whatever numbers they want when forecasting investment returns. So if a company wants to stop putting money into its pension plan, it just says, "No worries! We believe our pension investments will grow 10% per year forever. So we don't have to fund the pension plan any more!"

To see how unrealistic these return assumptions are, do the math. Assume a typical 60% stock / 40% bond pension plan. If the fund is earning 5.1% on its bonds, a full percentage point over the 10-year Treasury yield, it has to earn more than 13% annually on its stocks to make the total fund return 10%. With dividend yields at a sickly 2%, that means we'd need earnings growth of 11% annually for the long term. How the entire stock market grows earnings 11% annually in an era of 3-4% GDP growth is beyond me.

If you are an employee of a company with a traditional pension plan, or if you are a shareholder, find out what your company's pension return assumptions are. They are in the annual report. If it's anywhere near 10%, you're not dealing with an honest company.

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