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Why 95% of Traders Fail

Busted Governments, Pensions and Unions

Politics / US Politics Jun 16, 2010 - 02:05 AM GMT

By: Gary_North

Politics

Best Financial Markets Analysis ArticleWe are seeing the end of an era. The trade union movement in the United States has declined for the last 30 years. It is now in its final stages. The only area of the economy in which unions still have any degree of clout is in government. The union movement barely functions outside of government employment. Today, as states and municipalities face massive deficits, the union movement is threatened with destruction.


Last week, the governor of the State of New York began working out a deal to delay the imposition of drastic spending cuts in state and local governments. The problem facing all levels of government in New York is simple: the pension funds are not being funded adequately to enable retirees to receive what they have been promised. The retirees were overwhelmingly members of various trade unions. For decades, they successfully gained above-market wages and far above-market pension promises. Because unions have some political clout, state legislatures have cooperated. Union members have been able to benefit at the expense of taxpayers.

Now, however, the pension funds are under-funded. The decline of the stock market in 2008 and 2009 so eroded pension fund assets that municipalities and the State of New York have no likelihood of being able to recover from those losses in order to meet the obligations to retirees. There is no obvious solution to this problem. The governments over-promised to unions, and union executives over-promised to union members. Those promises cannot be met, according to specialists who have studied the pension programs.

The governor and the legislature have a problem. They need to fund the pensions adequately. But the politicians do not want to raise taxes in what is already one of the most heavily taxed states in the United States. The politicians also do not wish to cut spending.

Municipalities and the state government choose to maintain high wages for their employees, because their employees threaten to vote against anyone who attempts to reduce spending. So, there is only one alternative: the state and local municipalities must borrow the money in the capital markets.

The problem with this is that investors understand that state and local governments are unlikely to be able to pay off the bonds that are issued today in order to refinance the lagging pension systems. So, the state of New York and other municipalities will have to pay high interest rates in order to secure funding. They do not want to do that, either.

Where can they borrow the money? It should be obvious. The governor and the legislature intend to borrow the money from the state pension fund. State and local governments will borrow from the fund, issuing the fund IOUs.

These IOUs will be at a rate of interest significantly below the projected rate of return that the state pension fund's administrators have assumed would have to prevail in order to meet the obligations of the fund. State and local governments will pay about 5% to the pension fund, but pension fund executives and accountants have assumed that the pension fund would make 8% per year, long-term.

What will make up the shortfall between what pension fund administrators have assumed the fund would earn and the payments into the fund by the state and municipalities? Obviously, somebody has to make up the difference. The governor and the legislature say that the stock market will make up the difference. There will be a huge move in the stock market, and this will fill the coffers of the pension fund. Then, when it is time to pay retirees, the pension fund administrators will simply sell stocks to other investors, take the cash, and write checks to the retirees.

All of this assumes that the stock market will recover. Also, there will be willing buyers of stocks that will be sold by the pension funds at all levels. Of course, nobody can say how the stock market is going to go up by this remarkable percentage.

IN THE NAME OF THE PEOPLE

The governor and the legislature have the power to write IOUs to the state pension fund in the name of the people. The people are going to have to pay, whether they like it or not. The people are going to come through. The people are going to willingly accept the obligations that have been made in their name, and they will not revolt politically against pensioners who are being paid pensions higher than the income of the voters. We know the people will do this, because politicians have promised that they will do this.

If this sounds utterly crazy, consider the funding of the Social Security System. It also is running deficits. It also is statistically incapable of delivering on its promises. The Federal government continues to borrow money, and part of this money is used to pay off obligations to pensioners.

The Federal government assumes that there is no limit to its ability to borrow money at less than a percent per annum in short-term markets. The politicians also assume that the capital markets will enable the government to roll over this debt indefinitely. An increasing percentage of this debt will have to be paid to Medicare and Social Security beneficiaries.

No one calls the Federal government to account. Voters continue to re-elect politicians, and these politicians continually promise that all obligations to Social Security and Medicare beneficiaries will be kept, as promised. But the politicians do not raise taxes, and surely they will not balance the budget, let alone run a surplus, which is necessary if all of the government obligations are going to be met at low interest rates over the long run.

There is no tax revolt. There is no rising up of voters against obligations that have been made in the name of the voters. Voters assume that something will be worked out.

So, when the governor of the State of New York and the Legislature finally get together to arrange the transfer of IOUs from municipal governments and the state to the pension plan of the state government, there will be no massive protest.

There is no awareness on the part of voters of the impossibility of the situation that is facing them. Yet why should the voters be upset? Voters are poorly informed but not stupid. They know that some future group of voters will simply stop funding the pension program. They know that when things get tough, there will be a new Legislature, and there will be a new governor, and these faithful politicians will do whatever is necessary to get themselves re-elected.

TRUSTING THE PENSION FAIRY

We are seeing the destruction of the last remnants of the American trade union movement. Probably the best recent example of this war on trade unions was the decision of the Federal government to nationalize General Motors.

General Motors could not meet its pension obligations and its health-care obligations to unionized members and formerly unionized members who are now retired. It was impossible statistically for the company to survive, given its level of pension fund obligations. So, the government intervened. It put a cash infusion into the company and then restructured the debt of the company. It stiffed all of the pensioners, stiffed all of the bondholders, and transferred the stock to the pension fund of the United Auto Workers. "Let them eat profits." This got General Motors off the hook. The pensioners are now dependent upon the profitability of the company to maintain their income.

Any pensioner who thinks that General Motors is going to be profitable enough to secure payment of all the obligations to retirees is as naïve as investors were two years ago who did not sell their General Motors stock, because senior managers of the company said that the company was not considering bankruptcy as an option. The trusting investors refused to look at the statistical reality of the pension fund obligations. They believed in the pension fairy. Somehow, the pension fairy was going to raise enough money to enable the company to remain profitable and still meet the obligations to retirees.

Then there were the trusting souls who bought and held bonds issued by General Motors. They now have little to show for their trust.

Today, retirees believe in the profitability fairy, who is going to intervene to make it possible for General Motors to make enough money to pay off its pension obligations.

So, all along the line, everybody trusted in the pension fairy. Everybody believed that it was possible to kick the can out another month, another year, another 20 years. Investors believed that it was possible to profit by buying General Motors stock, General Motors bonds, and General Motors promises to pay.

Everybody was stupid. Everybody refused to look at the statistical reality. Smart people should have known that there was no possibility that the company would survive. The company did not survive under the old ownership conditions. The company went bankrupt.

What happened to General Motors is going to happen to most pension funds in most municipal governments and most state governments over the next 10 to 20 years. One by one, they are going to go belly up.

State and local governments have only one way out politically: stiff the retirees. They are going to do this. They are going to do this as surely as General Motors' management accepted the intervention of the Federal government to enable the company to shed its obligations to retirees in exchange for keeping the doors open. Those executives who had bought General Motors stock, or who had worked for the promise of stock options, lost the bet. But they still have jobs. They still have a source of income.

There is a law of politics here: decision-makers are willing to sacrifice past promises to others for the sake of their own present income.

The retirees now have promises from the pension fund of the UAW that somehow they're going to be paid off. Another round of promises has begun. There really is a sucker born every minute, and the suckers believe promises regarding their pensions.

THE BIGGEST LOSERS

The biggest losers over the next two decades will be pensioners. There is no group in the United States that is as vulnerable as pensioners, and there is no group that is less likely to be able to maintain its income.

Within the category of "pensioners," there is a subcategory: "government pensioners." These are people who spent their careers working for state and local governments. They received above-market wages, and they also received above-market promises regarding their pensions. They trusted the promises.

Now, however, it is clear what is going to happen to them. Anyway, it is clear to me what is going to happen to them, and it is clear to skeptics of government promises. But the market for government promises is still very strong. There are still people out there who believe that politicians' promises are as good as gold. In fact, they believe that they are better than gold. They do not own gold, but they are completely dependent on government promises to secure their financial futures.

The biggest liability that faces state and local governments across the country is the pension fund liability. Governments have not yet cut these liabilities by defaulting, because unions are in a position to strike against any government that was to do this. Furthermore, union members vote strongly, and they vote as a bloc.

Any politician who campaigns openly to stiff retired union members who worked for the government is not going to be elected. He probably isn't going to be elected over the next few years. But, at some point, he is going to be elected. When push comes to shove, and the voters see that it's either them or the retirees, they are going to vote for politicians who say that it is time to cut back on pension fund obligations.

The difficulty, however, is the court system. Judges are in a position to declare such a move illegal: violation of contract. Judges were in a position to make such a move illegal to General Motors.

But there is an option. That option is bankruptcy. Any state or local government, like any corporation, can eliminate its past obligations in one fell swoop. A company can declare bankruptcy, and thereby stiff the bondholders and the pension funds. This is perfectly legal, and we've already seen it at work. There was no hue and cry against General Motors or the Federal government when the Federal government stiffed bondholders. There will not be a hue and cry when state and local governments stiff the bondholders.

Voters have let politicians run up enormous debts on the assumption that these debts will never have to be paid. Voters allow this because they want to buy now and pay later. So, politicians follow their demands. Politicians spend now and promise to pay later. But, voters being what they are, they are not going to change their desire to buy now and pay later. When it comes to that point where the ability to buy now is being limited by previous promises to pay later, voters will ask politicians for another round of buying now and pain later. The best way for the politicians to do this is to declare bankruptcy, and start the whole process over again.

THE END OF THE ROAD FOR UNIONS

When this happens, the last bastion of political strength for the trade union movement will be visibly manifested as a myth. The trade unions today have almost disappeared from American life, except for government employment. The contraction of employment in manufacturing's sector of the economy has gone on for a generation.

Within manufacturing, trade unions for the most part have no clout. Union members know that it is possible to replace them at any time. They can be replaced by robots. They can be replaced by outsourcing. They know that they have no ability to strike, because their plants will be closed. So, the trade union movement is gutted.

The unions have been incapable of organizing the service industries. With only two major exceptions, the service sectors of the economy are not unionized. The two exceptions are entertainment, including professional team sports, and those services related to civil government – through direct hiring, funding, or regulation. This means that the union movement has not a great deal of clout politically.

Union members who are still in the labor force, and who still vote for union officers are going to see to it that their bread is buttered before the bread of retired members. They are going to see to it that they maintain their above-market wages, despite the fact that obligations to retirees must be contracted or eliminated in order for them to continue to be paid their salaries. There is no question in my mind that union members inside government departments will sacrifice the income of retired members if that is the only way to secure their own salaries. It will be.

As soon as politicians understand this, they are going to consider the possibility of declaring bankruptcy. We are not there yet. It may be another five years or even longer for some states to face the day of reckoning. But New York State and California are facing it today. They are playing games with the figures, in order to keep the political game operating without having judges decide who gets what.

The unions hold the hammer for as long as state and local governments stay out of the bankruptcy courts. But as soon as the state or local government goes into bankruptcy court, bankruptcy law takes over, and the promises made to bondholders and retirees go out the window. At that point, the lawyers will decide who is going to be paid.

BLAME THE GOVERNMENT

The trade union movement was created by the Federal government. Before the New Deal, and before the National Labor Relations Board, meaning before the Wagner Act, unions had very little clout. They could strike, but business owners could hire people who are willing to work at wages that were unacceptable to the union members. For as long as businesses could go into the labor markets and hire people who are willing to work at low rates of pay, the unions had no ability to extract above-market wages from corporations. Only when the New Deal intervened in the labor markets, forcing businessmen to negotiate with unions, and making it illegal for businesses to hire able-bodied workers at a wage that the workers were willing to accept, that the trade union movement gained control over about 40% of the American economy. Unions never gained as much as 50% nationwide. Unions were always in a minority. This is not true in Europe, but it was true in the United States.

The government has steadily allowed businesses to adopt practices which made it impossible for trade union members to strike. This was done very quietly, and was done by Democrats. Democrats voted to reduce tariffs, and in doing so, made it possible for businesses to move offshore. Democrats voted to create a tax structure that enables businesses to put capital offshore and earn money offshore without paying Federal taxes on any taxes collected by foreign governments. These policies enabled American large businesses to escape the clutches of American large trade unions.

The trade unions fought this, but they did not have sufficient votes to persuade members of the Democratic Party to vote against legislation that passed such authority on to American large businesses.

So, we now see the results. Consumers have the ability to buy at lower prices. No trade union can compel any large industry in the United States to deal with it exclusively. The above-market wages that were earned for decades by trade union members no longer exist, except for those who were grandfathered in. Unions have been willing to let new workers be paid under a different pay schedule. The most obvious example of this is the airline pilots' union. New members of the union are paid significantly less than the old-timers.

The government of the United States passed legislation in the 1930s that enabled trade unions to gain power over the labor markets. Step-by-step, the Federal government acquiesced to a series of changes which moved back union power. The only exceptions today are in those branches of government that have not successfully broken the unions. But the strategy used at General Motors is transferable. It can be used to reduce the liabilities of state and local governments to pension funds. If the courts force state and local governments to maintain the rules established by older agreements, the courts will probably allow the states to renegotiate the arrangement for present employees. If this proves to be politically impossible, then the states are going to go bankrupt. They're going to go bankrupt as surely as General Motors went bankrupt. They're going to go bankrupt for the same reason: pension fund obligations.

CONCLUSION

Anybody who is an employee of a state or local government who does not plan to have employment after his retirement is living in a fantasy world.

Anyone who believes that state and local governments will fulfill their promises to retirees is going to suffer enormous losses at a time in people's lives when they are unable to go back into the labor markets and reestablish their income.

Families of retirees who will be stiffed in a wave of state and local bankruptcies are going to have to pick up the tab for the parents. The parents believed the government promises, and the parents are going to find out how unreliable government promises are. Government promises are no more reliable than the latest public opinion polls. When the voters decided it's either them or the retirees, the retirees can kiss their income goodbye.

Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

http://www.lewrockwell.com

© 2010 Copyright Gary North / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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Comments

PJ
17 Jun 10, 07:13
sovereign debt will be toxic for a generation

Good article, I agree with you, with one exception: “When it comes to that point where the ability to buy now is being limited by previous promises to pay later, voters will ask politicians for another round of buying now and pain later”

There will be no round two, sovereign debt will be toxic for a generation if not a century. No thinking person will buy government bonds at any price after a global debt collapse. Government as we know it (since World War I) will be much smaller and dependent on current tax receipts, which may also be smaller.


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