The Cram-Down Decade

You met your obligations; your employer didn’t. Result: You’re screwed.

It may seem awfully premature to start thinking about defining the decade in finance. But if you start counting from Jan. 1, 2000, it’s more than half over. And in this age of the Feiler Faster thesis, it’s never too early.

And so Moneybox hereby declares the zeros (the oughts?) the Decade of the Cram Down.

In corporate finance, a “cram-down deal” is defined as a transaction “in which stockholders are forced to accept undesirable terms, such as junk bonds instead of cash or equity, due to the absence of any better alternatives.” More broadly, it’s what happens when stakeholders who have met their obligations are nonetheless forced to accept returns or compensation that are far less than they were promised. Frequently, cram downs occur because the entity charged with managing the investment has screwed up—it frittered away cash or went bankrupt. And this is the theme that is defining personal, corporate, and government finances this decade.

The cram-down trend started with defined-benefit pension plans, the kind that are prevalent in unionized, old-economy industries. When the 1990s boom ended, many companies with large pension plans began to fail, especially in the steel and airline industries. Not surprisingly, many of these failed companies didn’t bother to fully fund their pension plans.

In many instances, bankrupt companies turn over their plans to the Pension Benefit Guaranty Corp. But if you’re entitled to more than the maximum that the PBGC insures, tough. For example, the PBGC recently took over the pension plan of bankrupt United Airlines, which was underfunded by $9.8 billion. Since the PBGC would guarantee only $6.6 billion of those benefits, the workers—who had met all their obligations to United—took a $3.2 billion cram down.

Meanwhile, the PBGC itself is in deficit. As of last September, it had only $39 billion in assets to cover the $62.3 billion in guaranteed pension benefits it owes to more than 1 million workers. In other words, it doesn’t have the resources to meet even the crammed-down plans. Oh, and the PBGC, which insures pensions for 44 million workers in 31,000 plans, is bracing for more pension failures.

At the same time, corporate America has been systematically setting up its employees for United Airlines-like cram downs. Nearly a year ago, the PBGC reported that there were 1,050 companies that had an unfunded pension liability of $50 million or more. (Collectively, their plans were underfunded by $278.6 billion.) That’s up 15 times from the $18.4 billion total in 1999. The PBGC estimates that the total shortfall among all the 31,000 plans it insures is significantly higher.

Around the country, state and local governments are similarly waking up to the realization that they can’t afford the pensions and benefits they promised to workers. At the end of 2003, according to Wilshire Associates, state pension funds were underfunded by $375 billion. Unless governors and state legislatures around the country decide to enact tax increases to fund the promises they made to employees, it looks like teachers and civil servants are going to be crammed down en masse.

So far, pension failures—and the ensuing cram downs—have been largely concentrated in the airline and steel sectors. But large industries such as coal, textiles, and auto manufacturing are facing similar structural problems. And even when they’re flush, many healthy companies simply fail to take the steps necessary to fund the benefits. According to another study by Wilshire Associates, 81 percent of corporate pensions are underfunded. American corporate managers have collectively decided not to adequately fund the pensions and post-retirement health benefits that they promised to employees or negotiated with unions.

There’s another troubled old institution where loyal workers are getting crammed down, thanks to mismanagement. On May 12, the New York Times reported that “the Roman Catholic Archdiocese of Boston is proposing cuts in its pension benefits for priests.” Why? The pension fund has notched poor returns, and it’s had to spend money settling sexual-abuse litigation. The archdiocese wants to freeze pension benefits at the current level ad infinitum and slash medical benefits and other measures. Here’s the kicker: The archdiocese apparently failed to make any contributions to the pension plan between 1986 and 2002, even though it held fund-raising drives to fund priests’ retirements twice annually. As the Times notes, “[F]or many years the archdiocese has used that money to fill other needs.”

Using money dedicated for retirement savings for other needs? What does the Boston archdiocese think it is, Congress?

Indeed, the mother of all cram downs is shaping up this decade in Washington. For the past four years, as Americans have gone to work, played by the rules, and paid their taxes, Republicans in the White House and Congress have engineered a fiscal disaster. Every year, they take money that was supposed to be used for planning for retirement and spend it on other things. That’s one of the reasons we have a crisis in Social Security. But like some of the private-sector corporate pension crises, this crisis is entirely discretionary. It’s not that Congress and President Bush can’t adequately fund Social Security. It’s that they just don’t want to. Instead, they want to cram us down.

Because the national pension system—like many of its private-sector counterparts—is woefully underfunded, we are told, stakeholders must be willing to accept benefits that are lower than were promised and less than were anticipated. Robert Pozen’s progressive-indexing plan, which President Bush endorsed at his press conference in late April, would cram down 70 percent of Social Security beneficiaries to different degrees. But that’s just the first act. As economist Jason Furman notes, progressive cramming down—I mean, indexing—would close only about 70 percent of the projected shortfall in Social Security. The rest of the funds needed to restore Social Security to long-term solvency would have to come from benefit cuts or tax increases. Which solution do you think this crowd prefers?

Given the strength and importance of the housing market over the past several years, branding the ‘00s as the decade of the cram down might seem odd. And it may likewise seem dubious to define a decade with a phenomenon that has thus far touched only a small minority of Americans. But the housing bubble could be popping soon. And I’m confident that by Dec. 31, 2009, a large number of us will have been crammed down.