By DAVID MOON, Moon Capital Management, LLC
July 22, 2012
When General Motors failed in 2009, its problem was not a decline in competitive position. Ford held a smaller market share than GM, yet it never declared bankruptcy.
General Motors’ eventual downfall was that the company was eaten alive by its retiree pension and healthcare costs.
The company had a legal and moral obligation to make those payments, but it entered into those contracts without fully appreciating their long-term consequences. In the years approaching the company’s bankruptcy, the business existed solely to provide benefits to its employees and retirees. Every penny of company revenue was consumed by either the manufacturing process or the payment of contractual retiree benefits.
That is obviously an unsustainable business model. And it is the same business trajectory on which entities across the United States are rapidly traveling.
In 1940, the percent of the federal government budget spent on social services, health, Medicare, Social Security, income security and VA benefits was negligible. By 1950, this “human resources” component totaled 36 percent of federal tax revenues. (“Human resources” is the government superfunction classification for these expenditures. Some people call these items entitlements.)
By 1970, these expenses had increased slightly, from 36 to 39 percent of revenues.
By 2011, the federal government spent $2.4 trillion on these human resources items. Our entire tax collections totaled only $2.3 trillion. From 1970 to 2011, this portion of federal expenditures had grown from 39 percent of revenues to 104 percent of revenues.
Every other federal government expenditure, including interest on the national debt, was made with borrowed money.
The problem was both predictable and foreseeable. For the past 20 years, federal revenues have grown at an average rate of 4.65 percent annually. The human resources type expenditures, however, grew 6.51 percent annually.
Over the past 40 years, the difference was even greater. Federal revenue grew at a robust 6.2 percent annually, but entitlement spending grew at an even greater 8.63 percent annually.
This is the same type of relationship experienced at General Motors.
With respect to government spending, the problem is not limited to Washington. Knox County’s growing pension problem is well documented. It’s little different in the city.
In the past six years, the budget for the City of Knoxville grew a total of 13.2 percent. The pension and healthcare costs grew 100 percent. More than 40 percent of the City’s $31 million in new revenues were spent on pension and healthcare. Pension and healthcare expenditures almost doubled as a percentage of the budget in those six years.
That is a GM trajectory. That is a US government trajectory. Except neither Knoxville nor Knox County can print money.
Both the City of Knoxville and Knox County enjoy investment-grade bond ratings. At one time, so did Jefferson County and Prichard, Alabama. So did Vallejo, San Bernardino, Stockton and Mammoth Lakes in California. And Central Falls Rhode Island. Today, at least partially or mostly due to pension costs, they are all insolvent and have filed Chapter 9 bankruptcy.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).