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November 18, 2005

The next great financial accident, Fri., Nov. 18, 2005, 7:25 AM

Today I'd like to alert every Mom & Pop and every advisor to Mom & Pop, and every mutual fund/pension fund holding their assets, that the next great financial accident is going to be a series of big ones, each of which will be tied to the under-funding of public company pension plans.

At the end of the day, the directly affected owners of capital and workers, and all taxpayers, will be the losers. The extent of the problem may be a trillion dollars in North America.

What are the causes of under-funding?

As I see it, there are five major issues:

1. Corporate boards select the wrong capital manager of the pension fund assets. The manager might be a friend" of management/board, but in any case, the investment performance has been unsatisfactory
2. The capital manager may apply a discount factor that is too low; thereby not providing funding that adequately meets the real and future obligation. The obligation is a legal contract between the company and its present and past employees
3. Management, through control or domination of the board, have taken advantage of the company's shareholders by grossly inflating the pension obligations tied to their personal employment contracts
4. When a corporation that has a major under-funded pension liability terminates in a bankruptcy wind-up, there may be insurance. The government may in fact be the insuring party as well as guarantor
5. The guarantor of failed pension plans has been negligent.

Whenever there is insurance, there is an incentive by management to under-fund their contractual obligations. These fiduciaries, however, are incentivized to use corporate funds to buy back shares or pay out dividends, which is a plan to increase share price, which in turn creates immediate wealth for those on the management and board teams that made these self-serving decisions.

I think it is more than a figure of speech to say that such behavior on the part of management and the board is criminal.

This disconnect between self-serving management and boards and the employees, shareholders and bondholders of a corporation has probably never been more apparent than what we see today at General Motors and GM Canada, and at Stelco, which is Canada's major steel manufacturer.

Every school of law and every MBA School ought to be studying these cases. GM and Stelco represent merely the thin edge of the wedge to a problem that is threatening capital markets at the very core. By that I mean, there is a fundamental contract between the owners of capital and those who employ it, which is being destroyed today because management and the boards of directors are working in their self-interests. They have been doing this for too long, and now through a combination of circumstances, which include the weight of obligations to retired workers, the offshoring of current jobs, and the rise of interest rates, we have reached the end of the line.

In Canada, in recent years, this pension plan funding issue has destroyed Air Canada and Algoma Steel, and several other major corporations. What is worse, the same people who dismantled those great corporations, and put them back together for their friends, in effect stealing the assets from the shareholders, have honed their expertise, and are ready to strike again.

At the centre of the band of culprits in Canada are the bankruptcy judge James Farley and corporate restructuring officer Hap Stephen. Behind them are lawyers and CA's and consultants (lobbyists) to government who have created a team if you will, which is to say a club of experts, whose agenda is to earn professional fees and steal assets for friends in the so-called private equity business.

I believe these acts represent organized crime, and that the federal police should be investigating. I believe that with every fibre of my soul.

While maybe not as well organized by the same perpetrators, the same pension funding problem in the United States is much more serious. In fact the problem is serious enough to result in a major recession, and the demand on the federal government to pay out hundreds of billions of dollars for the miscreant actions of corporate management/board teams that are walking away from their contractual obligations to workers.

In the case of GM, the equity and fixed income of the shareholders and bondholders is now at the point of threat that could only be categorized as "red alert". There are and will be many others in the same boat.

I say that, more than the healthcare issue faced by Clinton, or the multitude of issues facing the Bush Administration today, the pension under-funding issue threatens the stability of democratic government in the United States.

The issue is trust.

If the owners of capital are going to risk investing capital in your corporation, is it going to be stolen by the officers and directors? If I work hard in meeting my employment obligations for a corporation, will their obligations to me be met?

I have written about this problem earlier in the year, well before it became the flavor of the day. But it seems almost nobody listens. Please re-read my article, then look at the date (March 2, 2005) and the price of Stelco at the time (over $4.00).

Today Stelco is trading at 19 cents, and Judge Farley, Hap Stephen and the Stelco Management/Board state unequivocally that the shares are worthless and will be struck from the share register.

This corporation has earned in operating profit more in the past seven quarters than at any time in its storied history. But in the few months since I published that article in March, the perpetrators have stolen $400 million from the shareholders. I told you they would. I also told you those assets are worth as much as $1 billion.

Yes, I warned everybody. Multi-millions of savings have been stolen in the interim by the very culprits I have pointed you to. And Big Media just stood by. And they still stand by. They must be dead from the ankles up.

Here are some other articles in the commercial media in Canada. I couldn't begin to attack the problem in the U.S., so I'll leave that to others.

http://www.caw2002tca.ca/e/pensions-news.htm

http://www.canadianbusiness.com/managing/article.jsp?content=20050815_69994_69994&page=2

www.theglobeandmail.com/servlet/
story/RTGAM.20051024.webrpension24/BNStory/SpecialEvents2/

http://www.dividend-growth.org/Pensions/Pensions.pdf

But I want to leave the reader with actionable advice: if you are an owner or manager of capital, look seriously within each stock or corporate bond in your portfolio, and in every case where there is an under-funded pension liability, eliminate all your positions as soon as possible.

In the near future, I'll start that process by listing the reprobate corporations of the Dow 30. That will be a start; but it represents the tip of the iceberg.

By continuing to invest in these corporations you are supporting the scoundrels and putting your capital at great risk they will steal it.

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Posted by Posted by Bill Cara on November 18, 2005 07:25:13 AM | Category: Cara Today in the Market

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