A Stitch in Haste

While looking up a link for an entry in yesterday’s “Sunday Updates,” I stumbled upon an old post that takes on a new relevance in light of the (apparently near completion) mortgage-based securities bailout and the increasing concern over the financial health of the Federal Deposit Insurance Corporation. This piece was originally published on November 3, 2005.

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One little-noticed consequence of the growing crisis at the Pension Benefit Guaranty Corporation is that the federal government is becoming an increasingly important stockholder in companies that turn their pensions over to the PBGC (WSJ – $):

The Pension Benefit Guarantee Corp. … recently was awarded 7% of US Airways Group Inc. by a federal bankruptcy court handling the company’s Chapter 11 reorganization… The agency is likely to get an even larger stake — between 15% and 35% of new shares — of UAL Corp.’s United Airlines when it emerges from Chapter 11 in February…
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Bankruptcy courts have awarded company stock to the PBGC in the past, but the practice has been relatively rare, given that most companies that terminated their plans then went on to liquidate their assets. Now, companies are using bankruptcy in part as a strategy to shed billions of dollars in unfunded pension liabilities to clean up their balance sheets. That means that the size and number of PBGC’s holdings are likely to reach an unprecedented scale, creating a delicate situation for the federal agency

This is, to be succinct, a terrible idea.

What an enormous can of worms government ownership of stocks opens up. How should a “federal portfolio” be managed — for income, total return or preservation of capital? Who gets to decide? Should the government use its proxy voting power or stay on the sidelines? Should the government be limited to the (very undiversified) portfolio of stocks it acquires from PBGC-related bankruptcies or should it be allowed to buy equities on the open market to balance out its holdings? Should it be allowed to hedge positions via options or other derivative contracts? Is the PBGC strictly autonomous, or can Congress micro-manage the portfolio? What about “socially responsible investing” — many activist fund managers of state and local government pension funds have shown an eagerness to subordinate the financial interests of government employees for the sake of “making a statement.”

In short, the potential abuses of “government as stockholder” run the entire spectrum: the Politics of Pull, the Politics of the Warm Fuzzy Feeling, the Politics of Pork, “Red State v. Blue State” politicking, violations of fiscal federalism, and so on.

Like I said, a terrible idea.

The solution is quite simple: Require the PBGC to immediately commence a structured liquidation program of any equity securities it receives from bankrupt pension plans (e.g., selling 4% of its stock in a company every month for 25 months, regardless of price). This is the same conflict-free arrangement that corporate insiders utilize to sell their stock and would minimize any shock to the market or liquidity strain in the particular security.

The PBGC crisis, and the defined-benefit pension crisis generally, are already bad enough (and growing worse every day) without overlaying a whole new web of conflicts on top of them. Federal ownership of private equities must be kept to an absolute minimum.

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There is, meanwhile, a fundamental difference between the PBGC situation and the subprime bailout, which I touched upon in this post: The securities the Treasury will be buying up are debt instruments, not equity. The intention underlying the bailout is, as I understand it, to hold these debt securities to maturity and hope that they will, in the end, provide at least some return over time. That’s much different from the notion of the government holding and trading huge equity positions in distressed companies, as will be the case with the bailout of AIG (the government will however receive warrants — a no-risk equity equivalent — in companies that participate in the bailout).

The more proximate problem with the subprime bailout is, as I noted, the preposterous notion peddled by the politicians and bureaucrats that “the market is wrong” and that these securities are actually “worth” more than the collective opinion of the entire financial sector says they’re worth (and that the bailout will therefore end up costing significantly less than the initial outlay — whether $700 billion or some other amount). Paulson’s résumé notwithstanding, that is bureaucratic hubris on a massive and possibly calamitous scale.

Filed under: Activist Legislators & Nanny Statists, Economics & Finance, Freedom of Contract, Taxation & Fiscal Policy