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By: The Issue Wonk

Originally Published: 7/31/2013




  The Issue Wonk

Business Models:  According to Wikipedia, “A business model describes the rationale of how an organization creates, delivers, and captures value. . . The essence of a business model is that it defines the manner by which the business enterprise delivers value to customers, entices customers to pay for value, and converts those payments to profit: it thus reflects management’s hypothesis about what customers want, how they want it, and how an enterprise can organize to best meet those needs, get paid for doing so, and make a profit.”

I would like to posit that it may be that bankruptcy is being used as the new business model.

Corporate Bankruptcies:  Corporate bankruptcies have abounded in the past few decades. In just the last 25 years there were over $2.22 trillion in corporate bankruptcies in the U.S. for corporations with assets of $10 billion or more. (BankruptcyData) I didn’t have the wherewithal to try to find out how many of the lesser corporations have filed for bankruptcy. CEOs, directors, and shareholders aren’t held liable for any mismanagement that led to the bankruptcy. Yet, with the passage of Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, individuals filing for bankruptcy are subjected to a “means test” to determine whether they are eligible to file, consumer debt is only dischargeable under limited circumstances, and student loan debt can never be discharged. So, no matter what the reason for filing bankruptcy - your fault, someone else’s fault, the fault of the economy - many people are still required to pay off debts. (U.S. Department of Justice) Not so for corporations.

There are 2 types of bankruptcies that are of interest to us here. In a Chapter 11 bankruptcy the corporation can reorganize the company’s assets. In most cases the corporation continues to operate. In these cases workers may be able to keep their jobs although they may be forced to re-negotiate for lower wages just in order to keep their jobs. With a Chapter 7 bankruptcy, the company has to sell, or liquidate, all its assets, and the company no longer exists.


CEOs and directors can mismanage a company, suck it dry for their own income and dividends for shareholders and then file bankruptcy, stiffing their creditors - other businesses that may themselves have to file bankruptcy for lack of payment of what’s owed them. But what of the workers and their retirement benefits?


When a corporation files for either type of bankruptcy, health insurance for retirees will probably be eradicated. Gone. Or maybe it will be replaced with a less comprehensive plan, costing workers and/or retirees more money.


As to pension plans, I’m discussing here the defined benefit pension plans. These are retirement plans in which an employee knows the terms of the benefit that will be received upon retirement. (Investopedia) (For an in-depth description, see Defined Benefit Pension Plans in Bankruptcy.) Remember, workers negotiate for a salary and benefits - with or without the help of a union. And also remember, a company pays into the pension plan, but so do the workers. They’ve paid in and what has been paid in by the company on their behalf is money they gave up as salary in order to increase their retirement pension. It's deferred wages.


The Employee Retirement Income Security Act (ERISA) governs pension plans. It requires employers to meet certain requirements designed to protect their workers’ pension plan. It requires employers to keep pension funds separate from other assets and regulates how plans are administered. It also requires minimum funding into the plan based on actuarial calculations. ERISA also establishes the Pension Benefit Guaranty Corporation (PBGC), a federal program that guarantees benefits in a traditional, defined benefits plan, even if the plan is terminated because of bankruptcy or other reasons. Employers are required to pay for PBCG insurance with annual premiums. If a plan is terminated, PBGC assumes responsibility for the plan and pays benefits up to a certain maximum amount. In other words, what you get at retirement may be considerably less than what you expected based on your negotiations with your employer. (See PBGC Maximum Monthly Guarantee Tables) Defined contribution plans, like 401(k)s, aren’t covered under ERISA.


We already know that corporations may pay their CEOs, managers, and directors excessive salaries and pay hefty dividends to their shareholders. ERISA states clearly that companies cannot “use” the pension funds for operations. But there are loopholes that allow companies to skim off “excess” pension funds for other purposes. (See Winston & Strawn, Excess Pension Plan Assets Can Be Put to Various Uses.) How do you get “excess” pension plan funds? By manipulating the actuarial calculations, of course. In fact, the Financial Accounting Standards Board (FASB) sets out the steps in calculating post-retirement benefit obligations (PBOs). It’s easy to see how this can be manipulated.


I’m not going into the details of making actuarial calculations for pension plans. If you’re interested you can read this paper by the American Academy of Actuaries. My point here is that this is not a science; it’s an art. Different assumptions will produce different outcomes. For less-than-ethical actuaries, it’s easy to come up with the result desired.


So, if a corporation is having financial difficulty but wants to hide it and keep the lucrative salaries and dividends flowing, it has to look somewhere for the money and pension plans may be a pocket to dig into. By over-estimating the value of the benefits and under-estimating the long-term liability, the corporation can show that the plan is over-funded. (See McGraw-Hill on Projected Benefit Obligations.) And, as stated above, “excess pension plan assets can be put to various uses.”


So, the corporation has sucked itself dry - paying exorbitant salaries and dividends - and using every available asset, including some of the pension funds. Filing for bankruptcy allows them to stiff the creditors out of what’s owed to them and the workers out of their retirement benefits. If the corporation is liquidated, everyone is just out of luck. If there’s a re-organization, they’ve just gotten rid of their debts and can keep on trucking.



I’m not asserting that all the corporations that have filed for bankruptcy have used this model. I’m not even asserting that most have used it. I’m just hypothesizing that, given what we know about corporate greed, it’s a model that may be occurring. Many corporations, we know, pay excessive salaries and dividends all the while keeping workers’ wages at roughly the same rate as they were 30 years ago. We know that this is the model used by many equity firms, such as Bain Capital. (Wikipedia) And, if the model wasn’t successful, why would it be spreading to the public sector?


Public Sector Bankruptcies:  Many cities and other public entities have been filing for bankruptcy. Detroit is the latest in the trend and the largest city in history to do so. Chapter 9 bankruptcies are available exclusively to municipalities. According to definition, “municipalities” refers to many types of governmental units, not just cities. (Wikipedia) It allows them to reorganize, just like a Chapter 11.

In the case of cities, however, it is not that mayors have absconded with the money. Yes, there may be mismanagement and in some cases - like Orange County and Detroit - there may be felonious behavior, something we never hear about with corporations. But usually it’s that the economic base has fallen out and the city has insufficient revenues to run itself. In Detroit there’s also the fact that the State of Michigan reneged on a deal with Detroit which resulted in a loss of about $700 million. (BridgeMI)

There are laws governing Chapter 9 filings. Municipalities have the ability to re-write collective bargaining agreements and this can trump state labor protections, “allowing cities to renegotiate unsustainable pension or other benefits packages negotiated in flush times.” (Wikipedia) Check out what happened to Central Falls, RI when it filed bankruptcy. (NBC News) There have been at least 18 Chapter 9 filings since 1989, 14 of those since the year 2000.


Summary:  It seems likely that bankruptcy has become the new business model and that model is being extended to political entities. For cities, revenues are dropping because manufacturing in the U.S. has been decimated. Corporate taxes are no longer being paid into city coffers. Also, the people that were employed by those corporations no longer have jobs and, thus, are no longer paying into the city coffers. For private corporations workers are making less and less money, meaning also that they are (a) spending less and thus not stimulating the economy and (b) paying less in taxes. In neither case - public or private sector - it’s not the fault of the creditors or the workers - both of which operated in good faith. Yet they are the ones being called on to resolve the problems. It’s a business model designed to re-distribute the wealth of the United States into the hands of a few. It’s intended to decimate small businesses, workers, their pensions, and particularly unions.


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