Pension Paranioa -
someone sent me a copy of the Weiss Report
read with trepidation:
SAFE MONEY REPORT
Cover Story -- September 2002
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NEW ACCOUNTING SCANDAL TO GUT STOCKS AND WIPE OUT AT LEAST ANOTHER $2.4 TRILLION IN SHAREHOLDER WEALTH!
Exactly three years ago, in a special Safe Money issue, I exposed widespread accounting scams in Corporate America.
I warned you about the goodwill bubble that created trillions in make-believe assets. I warned you how executives used options schemes to plunder corporate America. I told you
these scandals would gut the stock market and rip the worst offenders to shreds.
Now, the time has come to issue a new warning -- this time about an even larger and more dangerous scandal that could make earlier accounting nightmares appear mild by
comparison:
Many of America's largest corporations are drastically overstating their earnings through manipulations of their employee pension funds.
Once the full scope of the scandal is exposed, it could help impact another $2.4 trillion in investor wealth and help drive the market to my target of Dow 5000.
In this gala 12-page issue, I tell you how, why, and when. I name the 50 large companies that are among the worst offenders. And I give you steps to take immediately for your
protection -- and for potentially windfall profits.
This Is Not A Warning Of A Future Crisis. It's Right Here And Now!
I am not the first to warn about this looming pension fund disaster. Nor is this a crisis that's months or years into the future. Quite to the contrary, the news is already beginning to
spread, with a potentially devastating impact on the stock market:
* GM owes its pension fund $12.7 billion; its stock has plummeted a whopping 34% since mid-May.
* Delta Airlines owes $2.4 billion; its shares are down a whopping 55% just in the last six months.
* Delphi, which also owes its pension fund $2.4 billion, has seen its stock plummet from $17 a share in mid-May to just $9.60 at the end of August -- a loss of 43.5% in just 90
days.
* Goodyear, Exxon, and other major stocks are also being impacted severely.
This certainly isn't the only force that is driving stocks down. But it's emerging as a very significant factor.
Most Regulators Still Don't Get It
The SEC is hoping that simply by getting a few hundred CEOs to swear that their accounting statements are "true," they can miraculously close an ugly chapter in America's history.
But ... the primary problem is not the cheating and lying CEOs that break the rules; it's the distorted and deceptive rules themselves -- rules that allow the CEOs to juggle and
manipulate their books.
To understand this principal, just ask a simple question: What would have been the result if the SEC had asked America's CEOs to certify the truth of their financial statements back
in September 1999, when I issued my warnings about the coming accounting disasters?
The sad answer: Almost every single CEO would have been able to swear on a stack of bibles that his firm's distorted accounting was "100% accurate" and "the gosh-honest truth."
Nearly all those horrendously deceptive financial statements would have passed the SEC's inspection with flying colors!
How is that possible? Because nearly every one of the most destructive accounting manipulations of recent years was considered "technically legal."
I repeat: Right now, major US companies -- the same ones that have sworn their financial statements are accurate -- owe hundreds of billions to their employee pension funds. They
are hiding those obligations through a series of accounting and actuarial gimmicks. And they are twisting the numbers to greatly exaggerate their profits, often hiding seas of red ink
... and it's all blessed by the auditors, and accepted by the SEC.
Please don't misunderstand: I'm not talking about defined contribution plans, such as a 401(k). I'm referring to traditional defined benefit plans, in which an employer promises a
specific benefit to the employee at retirement.
The trouble is, many US companies don't have enough money set aside to fulfill those promises. The shortfall -- just among 234 companies in the S&P 500 that have defined
benefit plans -- is at least a whopping $78 billion.
Sometime soon, that $78 billion (or more!) is going to have to come out of their earnings. And with stocks selling for about 31 times those earnings, that means the market caps
could get hit for 31 times $78 billion, or close to at least $2.4 trillion. But it will probably turn out to be much worse. Reason:
Even This Huge $78 Billion Shortfall Is Based On Very Optimistic Assumptions For The Markets And The Economy
The companies typically assume a recovery in the stock market almost immediately -- despite the fact that there is no evidence of such a recovery taking place.
They assume a steadily growing economy -- despite hard evidence of a choppy economy at best, and despite the real possibility of another deep decline.
They assume high investment returns, ignoring the fact that all returns -- even on the riskier bonds -- are far, far lower.
They're living in a dream world, and no one has bothered to wake them up.
Yet, with these optimistic assumptions, the companies do three dangerous things: They delay putting money into their pension plans. They report that money as a reduction in
pension plan expenses, which boosts profits. And worst of all, many have used old paper gains from their pension plans to boost current profits. When those paper gains disappear
in a cloud of smoke, there will be hell to pay.
To better pin down who and how much, we have pored through the pension plans of each of the S&P 500 companies, and here's a summary of our findings:
1. Two-thirds are in the red: Out of the 354 S&P 500 companies reporting pension data, 234 or 66% owed money to their company's retirement fund.
2. Thirteen corporations owed their employees' pension funds more than $1 billion each: These include GM ($12.7 billion), Exxon ($7.2 billion), Ford ($2.5 billion), Delphi ($2.4
billion), Delta Airlines ($2.4 billion), United Technologies ($2.3 billion), AMR Corp ($1.9 billion), Pfizer ($1.3 billion), and Procter & Gamble ($1.1 billion). Chevron-Texaco,
Pharmacia Corp, Goodyear, and Raytheon -- $1 billion each.
3. Thirty-two S&P 500 companies owed more than half a billion dollars each.
4. More than 100 companies were short $100 million or more.
5. Trillions of dollars involved! The total amount of aggregate pension liabilities for the 354 companies surveyed was $1.06 trillion. The total amount of liabilities (funded and
unfunded) for all private pension funds in the US is $4.3 trillion. That's nearly half the size of the entire US economy.
6. Huge impact on profits. Fully 150 out of the 354 companies we analyzed -- or 42% -- used their pension funds to manipulate their bottom lines, boosting profits, or even turning
losses into profits. These companies took purely hypothetical gains from their pension funds -- based on projections, not actual results -- and added those numbers to their net
income.
And that was based on year-end 2001 data. Now it's much worse. It's also a lot worse than most of Wall Street realizes.
GM Admits It Owes Its Pension Fund A Whopping $12.7 Billion. But It's Still The Tip of the Iceberg.
The revelation that a $103 billion company -- WorldCom -- hid about $4 billion in losses sent its shares into a nose dive and the company into Chapter 11. But that was small by
comparison to the pension fund scam. Take General Motors, for instance. The auto giant has $26 billion in total market value. But its debt of $12.7 billion to its pension fund is the
equivalent of 49% of the company's total value.
This is mind-boggling. Here we have one of the largest automakers in the world ... and just with the money that it has failed to pay into employee pension funds, those employees
could own nearly half the entire company!
The big difference is that WorldCom's manipulations were illegal and relatively rare. General Motors' are perfectly legal and very common.
Here's what's been made public so far: GM assumed that its pension plan will earn average annual returns of 10%. But instead, its plan lost 3% in the first half of this year. That's
when GM announced that it would have to pay up to $12 billion into its plan by 2007 to make up for the mounting losses. And to get started, the company said it was putting $2.2
billion into the fund this year alone.
Here's what GM did not tell you: Although the $12 billion shortfall GM admitted to is already huge, it's based on optimistic assumptions -- that the stock market will rebound and the
economy will resurge. This raises some serious questions:
Question #1. What happens if you don't assume a stock market rebound? Answer: Rather than a 60% decline in profits, we estimate GM would be reporting a net loss of $2.3 billion
right now!
Question #2. What happens if you assume a continuing stock market decline? Add another billion or two to the loss column, depending on its severity and duration.
Question #3. What happens if you assume another slide in the economy? All bets are off! General Motors will be losing money hand over first from its car sales plus taking a beating
in its pension fund. Ultimately, don't be surprised if the company winds up reneging on its promises to retiring employees, canceling dividends to shareholders, and if things continue
to deteriorate over time, filing for Chapter 11 bankruptcy.
Therein lies the accounting scandal that, when uncovered, is going to help send the US equity markets into a downward spiral.
But it's just the beginning ...
Dead Ahead: $144 Billion Pension Shortfall
The rules for calculating pension liabilities have been so lax in recent years, hundreds of major US corporations have been legally manipulating the way they calculate the value of
the portfolios.
The market plunged in 2000, driving their pension fund assets into the hole, and they ignored it. The market plunged again in 2001, and they still ignored it.
But now, as the market continues to fall for a third year, they can't ignore it anymore. So they're starting to admit the shortfalls, but only one small piece at a time.
Here's what we see coming:
* If the corporate pension funds of S&P 500 companies lose just 5% this year, the shortfall in pension funding is going to be at least $109 billion!
* If they lose closer to 10%, then the shortfall is going to be in excess of $144 billion.
* If you look beyond just the S&P companies, the problem is even larger -- thousands of smaller pension funds that could drag down corporate profits for years to come.
* If the pension funds really take a major beating of 20% or more in the next year or two, the losses could set off a chain reaction of events that will make the recent accounting
scams look like a Sunday school picnic. You'll see wholesale dumping of shares by investors ... mass protests by employees ... draconian new countermeasures by Congress and the
SEC.
The crisis could affect $3 trillion, even up to $4 trillion in market cap. Unbelievable? Yes. True? Absolutely! For the evidence, take a look at ...
The Numbers Game Behind The Coming Pension Fund Disaster
There are three fundamentally flawed accounting rules that are at the root of the pension fund scam:
Flawed Rule #1. Companies are allowed to calculate a pension's funding requirements based purely on hypothetical projections of
annual returns, rather than on how well, or how badly, a pension's investments have fared in the real world.
In other words, let's say Company A is projecting an annual return of 10% of its pension fund assets of $100 million, or a $10 million
return. But in reality, Company A's pension has unrealized losses of 5% this year or $5 million. What do you think Company A puts
down on its profit & loss statement? A loss of $5 million?
Sadly, no. GAAP accounting rules let the company spread out the unrealized losses over a period of time. Let's assume it's 10 years. As
a result, Company A shows a net profit of $9.5 million (the $10 million projected gain minus the half million dollar amortized loss) less
any costs associated with maintaining the pension fund. This phantom "profit" of $9.5 million allows the company to postpone
contributing the needed money to its pension fund, and avoid deducting that amount from its corporate bottom line. In short, they
postpone the day of reckoning based on the blind assumption that the losses will "naturally go away."
The original intent behind this kind of creative accounting was to smooth out annual swings in income for pension funds, so companies
can better plan their contributions.
The practical result, however, is far more sinister: Companies are allowed to legally hide massive losses in their pension plans, avoid
contributing additional funds, and therefore exaggerate their profits in any given year.
Flawed Rule #2. A pension fund's projected gains can be based on seriously unrealistic assumptions regarding how well the pension
investments will perform.
Let's say you're managing your own retirement program and you determine you'll need $1 million in 20 years when you retire. If you
assume you can get a 10% annual return on your investments, then you only need to contribute $17,459 a year to reach that goal. But
if, in reality, you only get a 6% annual return on your investments, then you need to contribute $27,184 each year -- or 56% more.
For CEOs with fat options packages anxious to show investors high net earnings, the temptation to exaggerate their estimated pension
fund returns -- and add that money to the bottom line instead -- is almost overwhelming.
It's hardly surprising, then, that dozens of America's largest companies base their pension fund contributions on an assumption of a 10%
annual return or greater -- including Bank of America, Bristol Myers Squib, Campbell Soup, FedEx, General Mills, Mattel, Lehman
Brothers, Pepsi, Sprint, and Weyerhaeuser, among others.
According to Milliman USA's 2002 pension study, the average assumed rate of return in 2000 for the 50 largest American companies
was 9.38%, with an expected projected profit of $51 billion. However, the actual return on investment that year was only $14 billion --
or $37 billion short.
In 2001, the average projected rate of return for the 50 largest companies was a bit higher -- at 9.39%, with an expected profit of $54
billion.
Give me a break. The stock market had just taken a beating in the previous year, and they were projecting even higher returns!? Actual
results for 2001: A loss of $36 billion -- or a shortfall of $90 billion from what companies expected.
And it gets worse ...
Flawed Rule #3. Companies can count the hypothetical gains in their pension funds as part of their own bottom line, even though it has nothing to do with their operations, and
even though the money doesn't even belong to them.
Companies show their projected returns from their pension funds on their P&L statements. As The Times of London put it, "any major U.S. company that is worried about its
earnings can therefore engineer a $100 million boost simply by tweaking its expectations about pension fund returns."
Consider this example: You own a hot dog stand that usually makes $10,000 a year in profits. Plus, you have $100,000 in your pension plan, which you optimistically project will
earn 10% a year.
Now, let's assume this has been a horrible year for hot dogs -- not one meager dime in profits. What's worse, your pension plan, instead of making 10% this year, has actually lost
5% -- or $5,000.
Pretty miserable, right? Not if you use the "legal" GAAP gimmicks to jury-rig the numbers! First you could spread the $5,000 pension fund lost over five years -- just $1,000 each
year. Then, you could assume a $10,000 pension fund gain. Bottom line: Deduct the $1,000 loss from the $10,000 gain, and voilà ... your loss of $5,000 has been transformed into
a $9,000 profit.
How common is this kind of creative accounting? It's systemic ... and massive. As I told you earlier, based on our review of S&P 500 corporations, 150 out of 354 companies
reporting pension data were able to boost their earnings -- or actually turn net losses into profits -- by adding hypothetical pension fund income when calculating the company's
annual net earnings. For example:
* Verizon Communications had multi-billion dollar losses in 2001. But just by adding in its projected pension fund gains exceeding $2 billion, the company was able to magically
report a net profit for the year of $389 million.
* Eastman Kodak lost tens of millions last year. But by including its projected $100-million-plus profit from its pension fund, the losses were magically transformed into a $76
million profit.
* TRW also lost tens of millions in 2001. But by adding in a $100-million-plus projected gain in its pension fund, it transformed the huge loss into a $68 million profit.
* Whirlpool should have told its investors that it lost over $20 million last year, but because of the pension fund accounting rules, it was able to goose up its bottom line, wash
away the loss, and magically create $21 million in profits.
* Honeywell International's loss of $99 million in 2001 would have been several times greater. But they counted the company's projected pension fund gain of hundreds of
millions on the corporate bottom line.
* Prudential Financial's loss would have been equally catastrophic -- over half a billion dollars instead of just $154 million -- if they had not added their pension fund's phantom
"gain" to the corporate bottom line.
* Northrop Grumman's 2001 income of $427 million would have been cut down to about a quarter of that amount. Weyerhaeuser's 2001 profit of $354 million would have
been sliced by two-thirds. Consolidated Edison's profit would have been cut practically in half. Boeing's earnings would have been reduced by about a third.
The examples go on and on. More than 140 other major companies in the S&P 500 did essentially the same thing. Now do you see why I call this the greatest accounting scam of
all time?
When Will This Start To Hit?
Some of the corporations may be able to postpone the inevitable for some period of time. But the accounting rules allow companies to hide the true extent of their losses for only
so long.
When the assets in a company's pension plan lose more than 10% of their value ... or when companies are significantly short of their projected total pension liability ... then they
are forced to contribute more money into the fund, and those contributions must be deducted from corporate earnings.
At the end of this year, and for the next several years at least, corporations will have to make up for shortfalls in their pension funds caused by massive losses on their stock
investments, and deduct literally billions of dollars from their bottom-line profits. And that's even without a deepening of the bear market! It's impossible to pin down exactly how
much will hit when. But here are some good guesses:
* I've told you General Motors will have to pay $2.2 billion into its pension fund this year. Even if the fund makes 5% in 2002, it will have to put up another $3 billion in 2003.
And if the fund loses 5% this year, it will have to put up another $4.5 billion!
* Also assuming just a 5% decline in fund assets this year, United Technologies will have to kick in $1.3 billion next year ... Ford Motor will have to pay out $1.1 billion; Delphi,
another $1 billion; and Pfizer, at least $784 million.
The stock market will get killed -- either when the losses are announced, or more likely, in anticipation of the losses.
Right now, most investors are just beginning to get wind of the problem. Once the general public realizes how serious the problem is, you can expect another hair-on-fire stampede
out of stocks.
What You Should Do Right Away
Step #1: If you haven't done so already, get the heck out of the stock market. This is way too big to be limited strictly to the companies with pension fund problems. Take
advantage of the lull in the market to sell right now, before the next wave of panic selling hits.
Step #2: Check this list of the S&P 500 companies reporting pension fund data. The list is sorted by the companies with the worst unfunded pension fund liabilities. If you
still own shares in any of these companies, it's one more major reason to sell them immediately.
Step #3: Don't forget to liquidate equity mutual funds. With so many major companies embroiled in the pension fund scam, it's virtually impossible to find equity funds that
do hold substantial amounts of their shares. Besides, the pension fund problem -- plus a sinking economy -- will drive nearly all stocks down. The so-called "diversification" that
mutual funds provide does you no good at all in this environment.
Step #4: Although I recommend that you steer clear of all stocks, if you do own stocks and want to investigate the problem on your own, call the Investor
Relations department at the company and ask for these three numbers: (1) The company's pension fund's projected rate of return; (2) How much profit from the pension
fund the company is adding to its bottom line for the year; and (3) What the company's current estimated unfunded pension liability is.
Step #5: If you have a defined benefit pension plan at work, find out as much as you can about its current status. Remember: Unlike 401(k) plans, which employees
control, defined benefit plans are under the direct control of the employer. If they're mismanaging it, don't count on the government to bail it out. Instead, do more yourself to
supplement your retirement income and make up for any shortfalls.
In sum: Get out of the market ... keep the bulk of your money safe ... get in gold shares ... start profiting from our speculative recommendations.
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