Premeditated Fraud

What other kind of fraud is there?

Picture this – millions of American retirees and those getting ready to retire in the next two decades marching on Washington, demanding a government handout.

It will happen.

American corporations have hundreds of billions of dollars in pension liability. This is money that has been put aside to pay for Joe six-pack’s retirement from General Motors, Ford, etc. It’s also for current retirees, who are enjoying the fruits of their labor and the fruits of union contracts negotiated when the U.S. Industrial machine was at its peak in the 50s, 60s and 70s. Back then, the American post-war generation had no competition for global trade. We made it, people bought it. End of story.

In the 70’s, the Japanese industrial giants were just entering the picture. China was still in industrial backwater, churning out five-year plans with the frequency of Mao’s affairs. The Soviets still could not make a car that could outrun the Pinto – even after producing the atom and hydrogen bombs. Western Europe offered some competition, but nothing compared to the mobilized, motivated, and money-hungry Americans.

Pension Plan Deficits: Losing Industrial Primacy

As the money came rolling in, U.S. pension plans became fatter. As long as locals were willing to pay the price for marginal goods and services, there was no end in sight. With no competition, there was nothing to stop profit margins from getting fatter ad-infinitum.

Of course, this type of short-sighted thinking always comes back to haunt you. As time wore on, the U.S. began to lose its industrial primacy. In the eighties, the U.S. teetered on the verge of exporting the majority of its manufacturing to third-world countries. Other countries quickly caught up: in the nineties, the Japanese could crank out a car in half the time of American companies, and the Chinese were finally getting the hang of capitalism.

Back home, things changed, too – for the worse. The giant corporate handouts in the form of lucrative retirement pensions persisted for many of the largest industrial companies. But the money stopped flowing in at the same rate and with the same margins.

The result? Deficits in the pension plans. Most people did not care, and still don’t…as long as the check arrives every month.

They cannot argue that they don’t ‘understand’; pension plans are really quite simple. In principle, money is set aside from the employer in a special fund. This fund is then invested in the markets to generate a return. This return, along with the principal, is paid out as an annuity after the employee retires. So, as long as the market is not crashing and there are enough investable funds to begin with, everybody is happy.

Pension Plan Deficits: The Obvious Chance for Chicanery

During the nineties, many large corporations were running pension surpluses because the stock market was doing gangbusters. Companies were obliged to put in money into these funds at a prescribed rate – which was directly related to the expected rate of return on the funds. Much as investors must do when determining how much to pay into private retirement funds, companies would try to estimate the return on the cash they put in and adjust their contributions accordingly.

The obvious chance for chicanery here is for companies to play with the expected rate of return. They can’t play with it too much, because there are limitations as to the rate they can use. For the most part, they are supposed to use the rate of return from the 30-year U.S. Treasury Bond.

Well, what if you could somehow tweak the rate higher? Either you could understate your liability, or you could effectively run a deficit. More on this in a moment.

Enter the Bear and lower interest rates. It is now 2003. The markets have fallen, and fallen hard for three years. Interest rates have plummeted. The effects are devastating.

Take GM, for example. At the turn of the century, GM’s pension fund was at a surplus. Today, it is running an $18 billion deficit. At this point, the question of insolvency sets in – unless, of course, GM is bailed out by either the government, investors or its own product line. Guess which two stepped up to the plate?

Pension Plan Deficits: The Government Steps In

First, investors stepped in by buying over $15 billion in low-interest, convertible debt. This money is not intended to better GM’s models or to improve efficiency or to make GM more competitive; no, every penny will go toward funding the underfunded pension plan. For their hard-earned money, the poor schmucks will get a paltry return from a company that is having quite a hard time making a profit after pension liabilities are considered. For GM, this is a sweet deal. They can stay in business and move the liability from one row of the balance sheet to another row.

Not to be left out of the fanfare, the government also stepped in. As I mentioned earlier, companies that still pay a pension are obligated to use a conservative rate of return – usually based on the 30-year U.S. Treasury bond – to calculate the future benefits from a plan. Well, as we all know, the 30-year Treasury Bond has seen its lowest rates ever in the past few months. This means that U.S. corporations have had to put even more money into these plans to make them compliant.

Well, what if you could raise the rate of return with the stroke of a pen? The answer: the amount of your liability would actually decrease…which means Corporate America would be perpetrating a massive fraud on retirees. After all, doesn’t the money have to be paid at some point?

The government has now decided to allow companies to use the rate of return from corporate bonds to calculate the needs and returns from pension plans. What’s a few hundred basis points’ difference? After all, shouldn’t the corporate bond be a standard of safety? Some may think so, but I am sure retirees from Enron, Worldcom, and Global Crossing would argue.

Pension Plan Deficits: Why We Should Care

Companies love this idea, since contributions to pension plans can decimate earnings reported to investors. The government loves it, since this means delaying the inevitable pension crisis in America, and it also means more contributions for their re-election efforts. Still, at the end of the day, only the retiree really cares…but as long as the checks come in every month, he’s willing to coast along.

And you and I – why should we care?

Here’s why. All of these pension plans are guaranteed to some degree by the PBGC, The Pension Benefit Guarantee Corporation. This is not some private insurance company, but one funded by you and me. It operates much like the FDIC – insuring the pensions based on the assumption that it can handle a crisis here or there if only one or two plans go belly-up – but heaven forbid that we have a massive failure.

So…what will happen if the Fed’s current effort at reflating does not result in higher rates? Once again, the American taxpayer will be called to step up to the plate, simply to guarantee higher paper profits for companies that need the numbers to send the market higher, so the taxpayer can feel better about the future.

The wheel of life continues.


Karim Rahemtulla,
for The Daily Reckoning
July 17, 2003


Alan Greenspan’s lips moved Tuesday. Speaking to Congress, he told the lawmakers that the danger of deflation was “remote.”

Was the Fed chairman lying? Or has he become so accustomed to telling people what they want to hear that he could no more spot a lie than a bubble?

Consumer price deflation may or may not come to the U.S., but it is hardly remote. The core rate of inflation – taking out food and energy – was zero last month, as it has been for 3 of the last four months. If there is a number closer to negative than zero, we have never heard of it. Far from being remote, deflation couldn’t be more proximate. Even adding back in energy and food, the inflation rate rose only by 0.2% – a rate so low it hasn’t been seen since the Beatles performed on the Ed Sullivan show. And if you step out to buy a manufactured item, you are likely to find the price actually lower than it was a year ago. Automobiles, for example, sell for about 1.4% less than they did last summer.

Nor are prices likely to rise soon. Factories are operating at only 75% of capacity, the lowest number in 20 years – giving them plenty of room to keep up with demand, if there were any demand. Consumer buying power, meanwhile, has been crimped by the highest unemployment levels in 9 years…and the highest debt levels ever. And “small companies [are] still cutting jobs,” says the Arizona Republic.

But Americans are still convinced that their brand of democratic, consumer capitalism is neither in an uptrend, nor a downtrend. To them, the boom is eternal. For they’ve become True Believers…and can imagine no improvement in the Dollar Standard system. America will always issue dollars, they think…and the world will always take them at par. And if the system seems to slow down or settle towards deflation, the Fed will issue more of them to perk things up.

How do you make money?

It’s a no-brainer, they think. You just invest in dynamic companies and hold for the long run. Little do they know that the whole idea of long-term stock-market profits is as big a humbug as Alan Greenspan.

“The simple truth is that stock-market prices do not rise all that much over the very long term,” explains David Schwartz in the English paper, the Guardian. “Periodic catastrophic declines that destroy years of accumulated profits are the norm, not the exception.

“When viewed from this perspective, it becomes clear that the 10 percent annual average gain of the 1990s (not counting dividends) was a temporary aberration. History teaches that virtually every major multi-year advance during the last two centuries ended with a lengthy period of under-performance.

“There were 25 occasions when shares rose steeply in a 15- year cycle. They did not rise in every one of those years, but their cumulative gain over the full 15-year period was well above average. In 24 of those 25 cycles, prices fell in the next 15 years.

“We had a very sharp gain in the 15-year run-up to the new century. The Footsie [the UK equivalent of the Dow] ended 1999 at 6930. If history repeats itself, the stock market will be lower at the end of 2014, after factoring out the effects of inflation.”

Something to look forward to…right, Eric?


Eric Fry, far from the nation’s capitol (thankfully)…

– Down on Capitol Hill yesterday, Alan Greenspan appeared before the Senate Banking Committee to drone on about monetary policy and the economy. The stock market yawned as the Dow dropped 34 points to 9,095 and the Nasdaq Composite nodded 5 points lower to 1,748. Meanwhile, the bond market celebrated the chairman’s remarks by staging a splendid little rally. Recovering from its shellacking on Tuesday, the 30-year Treasury bond surged 1 1/32 points, dropping its yield from 4.97% to 4.90%.

– Encouraging the bond buyers were assurances from Greenspan that he had not ditched his wacky idea about buying long-term Treasurys, if need be, to fight deflation. We would assume, therefore, that the investment logic inspiring yesterday’s bond rally must have been something like: “Gosh, if Alan Greenspan would buy 30-year bonds yielding less than 5%, shouldn’t we?”

– What are bond buyers thinking these days? Or maybe a better question would be, “What are they smoking?” Most bond buyers seem to think a little bit about maximizing yield, while never giving a thought to minimizing risk.

– How else could General Motors manage to sell more than $17 billion worth of bonds, the sole purpose of which was to pay down its pension liability? And how else could Calpine, a junk-rated Enron-wanna-be, sell a monstrous $3.3 billion bond deal to the public?

– “The $1.15 billion seven-year portion of the offering was priced at a yield of 8.50%,” Barron’s notes, “In late October, Calpine’s 8.5% notes due in 2011 hit a low of only 33.5 cents on the dollar. At that level, the market was assigning a relatively low probability that interest and principal would be paid fully and on time. Last week, the notes fetched over 80 cents on the dollar.”

– Have Calpine’s prospects improved as dramatically as the price of its bonds? Hardly. Moody’s Investors Service still rates Calpine’s senior unsecured debt at single-B1 – four notches below investment-grade. That’s the identical credit rating Calpine had before the Enron debacle. Like a hooker that marries a neurosurgeon, Calpine’s bonds have acquired a newfound semblance of respectability. But a hooker is still a hooker and a junk bond is still a junk bond, even if the junk bond acts for a while like an investment-grade issue.

– The bond bull market is shining a flattering light on all types of credits. But investors don’t seem to care. Bonds are hot, and investors want to own them, plain and simple…Hmmm…feels like a bubble to this market observer.

– In February of 2000, your New York editor convened in Miami with 25 of his friends and colleagues who practice the dark art of short-selling. At that time, everyone in our group adamantly asserted (through their tears) that the stock market was in a bubble of epic proportions. Meanwhile, Henry Blodget, Mary Meeker, Abby Joseph Cohen and all the other pied pipers of Wall Street, confidently heralded the rising stock market as a terrific bull market…and one with room to grow.

– The lumpeninvestoriat placed their trust in the misguided forecasts of these Wall Street seers…and then watched helplessly as $7 trillion of its hard-earned savings went up in flames. The short-sellers were right and Wall Street’s illustrious strategists, alas, were wrong.

– Fast-forward three years and the Wall Street crowd is back to its same old game, goading investors to throw their money into a bubble market. But this time, they are urging the lumpeninvestoriat to buy risky bonds rather than risky stocks. “Greenspan will keep rates low,” say the Wall Street experts, “and besides, everyone knows that stocks are risky. So buying bonds is the safe thing to do, especially high-yield corporate bonds.”

– The lumps are lapping up this drivel, and pouring billions into bond funds. In the 12 months ended April, a staggering $160 billion of new cash flowed into bond funds. Unfortunately, the bond market has become a treacherous place for capital over the last few weeks, as bond prices have dropped sharply. Is the bull market over, or just taking a breather?

– “The high tide for bond (and stock) investors has already taken place,” insists Bill Gross, the supremely successful bond fund manager. “Mid-year of 2000 is an obvious high- water mark for stocks and June of 2003 is a likely one for bonds. Both bond and equity strategies should begin with the assumption of low, single digit returns for the next decade…”


Bill Bonner, back in Paris…

*** “The party for bonds may be over,” says a Wall Street Journal headline. While the final fireworks were spectacular, few people realize what a huge, worldwide party it has been.

In 1970, the entire global bond market had a value of only $776 billion. Today, there are $40 trillion worth of bonds in vaults and mattresses around the globe. Readers will note that not only is there a debit for every credit…there is also a market price, which could change without notice. A man holding Japanese bonds over the last few weeks would be keenly aware of this phenomenon: much of his wealth has disappeared since the middle of June. Ten- year Japanese bond yields more than doubled in the last 30 days.

Bond prices – regardless of the face amount – collapsed. U.S. bond prices will collapse, too, but whether soon or late…we don’t know. (More on bonds and moribund pension obligations, from The Supper Club’s investment director Karim Rahemtulla, below…)

*** Daily Reckoning readers with a number of thoughts:

From Lake Forest, California, comes this note:

“Mr. Bonner, LOVE YOUR COMMENTARY, it is one of the few sanctuaries of reality I have to look forward to. Living in California, I am all too familiar with what you say, as being the truth, and yet you are not going far enough.

“In California, at the border check point in San Offre, as the border patrol is stopping ‘legal residents’ to verify your residency, you can actually see the illegal immigrants running along the sewer culverts…this you can witness from your car; without notice from the border patrol officers. On my last trip, as I was driving a new caddy, I was stopped and searched. When I enquired as to why I was detained, the officer stated it was merely a random inspection. In other words, they had no other reason, other than to show they are on the job, wasting my tax dollars.”

*** And from Colorado, on how the U.S. got to be like France:

“Your comments about the progressive socialization of America remind me of the story about the lobster. If you dunk him in boiling water, he objects strenuously. But if you put him in cold water and turn up the heat, he gradually becomes accustomed to the heat and doesn’t notice that he is being boiled alive.

“That is precisely what is happening to the U.S. economy. Gradually we are being weaned from our freedom and self- reliance and made more dependent on the central government for everything from cradle to grave. You name the acronym and we have become dependant on it!”

*** And from Puerto Rico, botanical clarification:

“On 11 JUL 2003, Bill Bonner wrote: ‘Down by the river, crews of workers are turning the banks of the Seine into a beach. They put up palm trees….’


“A tree is, by definition, a critter that’s got bark and an extended root system and leaves. Palms possess none of the preceding. They are plants, but they ain’t trees. As a resident of palm-invested San Juan, Puerto Rico, USA, I know whereof I speak.

“You guys are, however, dead RIGHT about GOLD.”

[See:The Case for Gold]

*** And, finally, a reader sends this article from the Christian Science Monitor, describing the difference between French and American attitudes towards vacations:

“In their daily life, the French constantly ask one another about their plans for holidays – with good reason. With the introduction of the 35-hour workweek in 2000, five weeks of mandatory holiday turned into seven. Holidays aren’t just a relaxation in France, they’re a way of life.

“When North Americans see how much time the French spend on holidays, they can’t help wondering how the French get any work done. And how does their economy survive?

“We lived in Paris from 1999 to 2001 to study the French for an American institute. Many of our assumptions were turned upside down – including our prejudices about the French taking too many holidays. The main reason they ‘manage’ to afford their holidays is that they work hard the rest of the year. They’ve also found ways of making holidays economically productive.

“Contrary to many North American assumptions, France – according to wealth produced per hour worked – is one of the most productive countries in Europe. Labor is expensive in France, so industries are extremely mechanized. The French would be even richer if they limited their paid holidays to two weeks, but they look at the problem differently. If fewer people are necessary to produce the same wealth, they reason, then why not translate that wealth into more holidays? As many of our French friends remarked, whether holidays are good or bad for the economy is beside the point: ‘The economy is supposed to work for us, not the other way around!’

“Although the French project a hedonistic image, they work long, hard days – when they work. French workdays don’t start later than in North America, but they do end later. We lived in a popular Paris neighborhood, and the Metro rush hour there lasted until 8 p.m.

“‘The French also have a very distinct work ethic. They pretend they’re not busy even when they’re working like crazy. To us, looking relaxed shows you’re in control,’ a friend explained. Hence, long leisurely lunches at cafes. Make no mistake: They’re working hard, they just don’t have stigmas about taking their time and looking relaxed in public.

“As to the social costs of holidays, the French argue that their economy has faced far greater challenges than generous holidays for workers. The way they look at it, if their economy absorbed women entering the workforce and the introduction of weekends and statutory holidays – impossible dreams a century ago – it can certainly survive the 35-hour week. And, for that matter, a lot of the wealth produced in France during the last six centuries was spent on war. Europe has been at peace since 1945, and the fantastic wealth that was once devoted to destruction and reconstruction is now spent on leisure. And who but the French understand best how productive holidays can be? A leisure society is good business. France welcomes 75 million foreigners a year, making it the most visited country in the world. (A mere 51 million visit the United States.)

“If you pay attention at the cafe, the restaurant, or the hotel, you’ll notice that most of them show a blue crest that reads: chèques-vacances (holiday vouchers). Many French companies give a holiday bonus to their employees in the form of $1,000 in holiday vouchers valid in 130,000 French travel agencies, hotels, restaurants, resorts, and more. Employees have two years to spend the money. Other companies simply build resorts for employees: Some 2,000 companies make 240,000 beds available for their employees in 8,000 resorts. The result? The money stays in France.”

The Daily Reckoning