Berkshire Hathaway
GM Solves its Pension Problem

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By Tode
June 24, 2003

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GM's solution to its under funded pension problem is breathtaking. WEB has criticized corporate America for burying massive pension liabilities and inflating their earnings by assuming unrealistic pension rates of return. According to today's WSJ article, GM is still assuming 9% pension returns. Rather than reduce that to a more reasonable level, as WEB has urged, GM has elected to float a huge bond issue that likely will yield 6 or 7%, and use that borrowed money to fund the pension plan. The GM official quoted in the article--apparently without any hint of irony--said that this will actually be "slightly accretive" to reported earnings. Wow!

GM could have cut its dividend. But that would be disappointing to investors who are attracted to its 5.6% dividend yield. Bad option.

It also could have issued more equity, but the stock is already beat up. Nix that option, too.

Reducing the assumed return on pension earnings? That would trash reported earnings. An awful idea.

No, the only attractive option that satisfies the needs of all of GM's constituencies is to keep the dishonest accounting and take it one step further by borrowing billions at a fictitious positive spread of 2 or 3%, and thereby--VOILA!!--Create some more fictitious earnings.

Simply amazing. But it is such an elegant solution to a widespread problem that it is certain to be imitated by other corporate treasurers. In economic terms, the company is taking out a huge margin loan and speculating that a new bull market will bail it out of its under funded pension problem. But if the market heads south (and/or interest rates drop further, thereby increasing the pension liabilities by lowering the discount rate used to calculate them), GM will have made a bad wager indeed.

Like I said, this is so bad from the standpoint of honest accounting, and so incredibly SWEET from the perspective of delivering phony "accretive" earnings to desperate management, not to mention huge fees to investment bankers, that it is surely destined to be a big hit on Wall Street. Bankers soon will be tripping over each other pitching this technique to Corporate America. Will the accounting industry and the SEC intervene and nip this in the bud? Of course not--it's perfectly legal. The accountants are already certifying balance sheets that use 9% assumed returns. And there is no law against borrowing money, is there? GM is simply following the GAAP rules, provided they can find a CPA who is willing to bless that 9% projected return. This is nirvana.

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