American Airlines Went Bankrupt in November; Are Taxpayers on the Hook for Pension Benefits? What is the Equitable Solution?

American Airlines filed for bankruptcy in November 2011. Here is the question at hand: Will Taxpayers Be On The Hook For American Airlines' Pensions?

American Airlines needs $18.5 billion to cover its pension promises to current and former employees, but it has only set aside $8.3 billion.

American Airlines is asking the bankruptcy court for permission to drop its pension plans. If the court allows that, the plans will be taken over by the Pension Benefit Guaranty Corp, a government agency that takes over pension plans for failed companies.

The PBGC works like an insurance company. Firms that are backed by the PBGC pay premiums to the agency. Those premiums are supposed to pay for the agency's costs, so taxpayers don't have to pay. But in recent years the premiums haven't been enough ? the agency's funding shortfall is currently $26 billion.

The PBGC, for its part, is pushing back against American's request. Here's a statement from PBGC Director Josh Gotbaum:

"Before American takes such a drastic action as killing the pension plans of 130,000 employees and retirees, it needs to show there is no better alternative. Thus far, they have failed to provide even the most basic information to decide that."

If the PBGC does wind up on the hook for American Airlines pensions, it would be the largest single claim on the agency since it took over United Airlines pensions plans in 2005.

Three Simple Questions

1. Why should taxpayers be on the hook for private pension plans?
2. Why are airlines bankrupt?
3. What is the equitable solution?

1A. Clearly taxpayers should not be on the hook.
2A. Airlines are bankrupt because of over-regulation and absurd contracts and benefits negotiated with unions
3A. The key to answering question 3 is contained in the answer to question 2. Unions negotiated pension befits that bankrupted the companies. Thus it is unions who are largely responsible and it is unions, not taxpayers nor other corporations who should pay the price.

Equitable Solution Details

With the above guiding principles, the equitable solution is straight-forward.

American Airlines needs $18.5 billion to cover its pension promises but it has only set aside $8.3 billion. That is a shortfall of $10.2 billion on $18.5 billion. In other words, a haircut of 55% on pension benefits will fix the problem.

Interestingly, that is nearly the same percentage haircut as just as happened in the Central Falls, Rhode Island Bankruptcy.

Some might protest that airlines should have been setting aside more money for their pensions all along. True enough. But the result would have been bankruptcy sooner, and it does not change who is to blame.

It's best to look on the bright side. A 55% haircut is far less than is going to happen to Greece.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

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