The Next Financial Mess

The Washington Post draws attention to the looming problems at the Pension Benefit Guaranty Corporation (PBGC)--the government agency that back-stops private defined-benefit pension plans. Here is the essence of the issue:

Defined benefit pension plans should remind us of the character Wimpy in old Popeye cartoons, whose motto was, "I'll gladly pay you Tuesday for a hamburger today."

The defined benefit pension plan says, "I'll gladly pay you 40 years from Tuesday for a hamburger--namely your work--every day until then." What if, when the hamburgers are all eaten and the distant Tuesday finally arrives, the pension plan's assets don't cover the promised payments--and neither do the assets of the PBGC?

The answer may be that the taxpayer will be on the hook, at the same time other looming financial liabilities--Social Security and Medicare for baby-boomers--are coming due. The longer-term solution is to transition away from defined-benefit pension plans toward defined-contribution pension plans, as is in fact happening. But that does not solve the more immediate problem.

Notice the parallel between these problems with private defined-benefit pension plans and the problems with Social Security. Last year, in the New Republic, I wrote:

One problem with traditional Social Security is that liabilities are implicit and, therefore, easy to ignore. Politicians have found promising higher benefits too attractive, because the cost of those benefits has been too well-hidden. Indeed, the funding shortfalls now facing Social Security are like those many companies face with defined-benefit pension plans. Recognizing these problems, younger businesses are more likely to set up defined-contribution plans like Harvard's. A defined contribution system is more transparent--the worker knows what he is getting, and the employer knows what he is paying.

If every private company had a defined-contribution pension plan, we wouldn't be having PBGC problems. And if Social Security had been set up with a defined-contribution structure, we would not be facing funding shortfalls.