DRI-322 for week of 7-21-13: Detroit: Postmortem on a Once-Great American City

An Access Advertising EconBrief:

Detroit: Postmortem on a Once-Great American City

On Thursday, July 18, 2013, Detroit, Michigan’s emergency financial manager Kevyn Orr filed a Chapter 9 bankruptcy petition on the city’s behalf. Detroit became the largest American city ever to declare bankruptcy. Although the handwriting for this action had been on the wall long before it appeared on court documents, it still sent shock waves throughout the country.

The interminable interval between recognition of reality and capitulation to it was partially explained by the ruling issued the following day by Ingham Country Circuit Judge Rosemary Aquillina. She ordered the withdrawal of the bankruptcy petition on the grounds that it would violate the Michigan Constitution to endanger the pension benefits of government employees. And retiree pensions do indeed represent roughly $9.2 billion of the $11.5 billion in unsecured claims listed under the bankruptcy petition. “It’s cheating, sir, and it’s cheating good people who work,” was her reaction to the bankruptcy. “It’s also not honoring the President, who took General Motors out of bankruptcy.” This was the same intractable attitude that had prevented Orr from negotiating any concessions from the city’s creditors, particularly pensioners who refused to relinquish the lucrative defined-benefit contracts that had made them the new aristocracy of Detroit’s organized labor community.

Americans are habituated to viewing Detroit as an economic basket case. Thus, it comes as a shock to realize the relative speed and steepness of the city’s fall from prosperity and prominence. Even more shocking is the similarity between Detroit and most other major American cities.

Various sources, particularly the website “Economic Collapse” and the Rush Limbaugh radio program, have assembled a shocking compendium of facts detailing the decline and fall of Detroit. In just over a half-century, Detroit went from one of the premier American cities to a burnt-out wasteland, comparable to a European city devastated by the effects of World War II.

The Glory Days of Detroit

Detroit was founded during colonial times. It got its name from one of the leading Indian tribes. Its location on the Great Lakes assured its economic prominence, but its development took off in the late 19th century with the invention of the automobile. Detroit became the home of the three leading U.S. automakers – Ford Motor Company, General Motors and Chrysler. Henry Ford developed and perfected the automotive assembly line in Detroit and environs. In the second half of the 20th century, General Motors became the phenomenal success story of the U.S. automotive industry.

The first half of the century belonged to Ford. Henry Ford didn’t invent the automobile, but he might as well have. He produced versions that ordinary Americans embraced wholeheartedly: Models A and T. He perfected the assembly line that revolutionized automobile production. His wage policies were public-relations triumphs in a realm where capitalism has historically taken it on the chin. (Detroit was already a high-wage city and the company was merely competing for labor with its $5-per-day wage offer, not practicing altruism.) Henry Ford presided over the automotive world and American industry from his home in Dearborn, Michigan.

When General Motors shouldered Ford aside as the premier automaker, it established a corporate reputation to rival Ford’s. CEO Charlie Wilson’s famous declaration that “what’s good for General Motors is good for America” may have ruffled feathers, but it certainly dovetailed with the thinking in Detroit. When GM decided to build a brand new auto plant in the venerable neighborhood of Poletown, even the black-separatist municipal administration of mayor Coleman Young hastened to grant the company eminent-domain rights and approve the dispossession of longtime residents. As late as 1971, Economists Roger Miller and Douglass North marveled at GM’s “phenomenal ability to generate profits.”

Led by the “Big Three” automakers, Detroit became the manufacturing center of America. As of 1950, it was home to 276,000 manufacturing jobs. During an era when America’s manufactures led the world, those jobs earned good incomes. As of 1960, Detroit boasted the highest per-capita income in the U.S. This attracted people. As of 1953, Detroit was the 4th-largest city in the U.S., behind New York, Chicago and Los Angeles, with just under 2 million people. In 1966, Look Magazine named Detroit as an All-American city.

Today, Detroit is the Dregs

Today, in 2013, Detroit is the dregs. Its 276,000 manufacturing jobs have shrunk to less than 27,000. This might not be so bad if other jobs had taken their place. They haven’t. It has lost 63% of its former nearly two-million population. Those who remain have a median household income of $26,000 and suffer from unemployment of 16%. Less than half of Detroit residents over 16 years of age are employed. 60% of Detroit’s children live in poverty. Only 7% of 8th-graders are rated “proficient in reading,” which helps explain why 47% of Detroit residents are functionally illiterate.

There are over 78,000 abandoned houses within the city. Many houses are up for sale at prices of $500 or less. One-third of Detroit’s 140 square miles are either vacant or derelict. The city hosts more than 70 Superfund hazardous-waste sites.

City services have declined pari passu with the general decline in incomes and employment. Detroit’s murder rate is eleven times greater than New York City’s. The size of the police force is 40% lower than in 2003. Average response time to a 911 emergency call is 58 minutes. Most police stations are open to the public for only eight hours per day. Police solve fewer than 10% of crimes committed in the city. One-third of Detroit’s ambulances do not run. At least 40 streetlights do not work. Two-thirds of the city’s municipal parks have closed since 2008.

The city earns $11 million of its municipal revenue from… its casinos. Police advise travelers to enter Detroit at their own risk.

In the UK’s Daily Telegraph, MP Daniel Hannan recalls the prescient novel Atlas Shrugged, by Ayn Rand. The book describes the town of Starnesville, home to the fabulously successful Twentieth Century Motor Company. Socialism has reduced both the company and its hometown to ruins. Hannan quotes Rand’s evocative portrait of Starnesville to haunting effect:

“A few houses now stood within the skeleton of what had once been an industrial town. Everything that could move, had been moved away; but some human beings remained. The empty structures were vertical rubble; they had been eaten, not by time, but by men: boards torn out at random, missing patches of roofs, holes left in gutted cellars. It looked as if blind hands had seized whatever fitted the need of the moment, with no concept of remaining in existence the next morning.

“The inhabited houses were scattered at random among the ruins; the smoke of their chimneys was the only movement visible in town. A shell of concrete, which had been a schoolhouse, stood on the outskirts; it looked like a skull, with the empty sockets of glassless windows, with a few strands of hair still clinging to it, in the shape of broken wires.”

Hannan compares Rand’s prose – circa 1957! – with a description of Detroit in the London Observer:

“What isn’t dumped is stolen. Factories and homes have largely been stripped of anything of value, so thieves now target cars’ catalytic converters. Illiteracy now runs at 47%; half the adults in some areas are unemployed. In many neighborhoods, the only sign of activity is a slow trudge to the liquor store.”

Hannan is astounded by the similarity between Rand’s fictional Starnesville and the Detroit of today. Even more astonishing, Rand predicted the effect of socialism on a preeminent auto manufacturer in 1957, when U.S. automakers bestrode the world like colossi and Detroit stood atop the U.S. league tables.

What Happened to Detroit?

In Atlas Shrugged, socialism decimated both the Twentieth Century Motor Co. and Starnesville. The real-world municipal analogue to socialism is liberalism, which features unwieldy bureaucracy spending vast sums on tasks that are none of its business. That describes almost all major U.S. cities, including New York, Chicago, San Francisco, Los Angeles, Boston, Philadelphia, San Diego, Seattle, et al. Liberals are Democrats and all these cities are governed by Democrat majorities, mostly machine-made. Only Houston can fairly be called an exception to the rule of liberalism, though even here Democrats cling to a majority in the city.

Detroit certainly fit this pattern. The last Republican mayor won office in Detroit in 1957, during the city’s glory years. Since 1970, only one Republican has been elected to the City Council. Republicans have occasionally gained statewide office – John Engler’s stint as Governor was a notable recent example – but if anything Detroit’s clout was so formidable that the city’s tail usually ended up wagging the state dog when it came to policy.

When Democrat Jerome Cavanaugh became Mayor of Detroit in 1962, he was one of the brightest lights of the Democrat Party. Cavanaugh was a young New Frontiersman, a JFK-image clone. He was determined to use the city’s prosperity as a tool to eradicate poverty and enact social justice. He raised property and income taxes and increased spending. He inaugurated a utilities tax. The failures of Cavanaugh’s policies were manifest by the 1970s and helped pave the way for the long reign of Coleman Young.

One common denominator behind the serial failure of municipal liberalism is the failure of public education. A handmaiden to educational failure in the 1960s, 70s and 80s is school desegregation and its complement, busing. Cities like Boston, St. Louis and Kansas City lived through historic desegregation sagas, all featuring savage disagreements, shocking expenditure of funds, forced taxation and virtually nothing of educational value to show for it. Detroit was a leader in the field. District-court judge Stephen Roth supervised a massive desegregation plan involving 53 Detroit suburbs and some 780,000 public-school students. Average time spent on daily bus travel hovered at 1.5 hours per day. The effect of the plan was to reinforce the separatist vision of Mayor Coleman Young and drive whites to the outer suburbs, beyond the plan’s reach.

Unions played an important role in Detroit’s downward spiral. Municipal unions do not face the private-sector competition from non-unionized labor that private-sector unions face. This gave them the impetus to negotiate fearlessly with government to increase compensation and defined-benefit pensions while lobbying endlessly for expansion of bureaucracy. The United Autoworkers treated the automakers like piñatas to be cracked open for goodies, heedless of the effects on the company.

Technically, one should acknowledge the role played by the federal government in burdening automakers with safety and mileage standards that vastly increased the companies’ costs with no commensurate offsetting gains to anybody except politicians. (Longstanding research, beyond the scope of this article to reproduce, has reaffirmed the net harm done by these categories of federal legislation.) Still, this was at most a glancing blow felt by Detroit during the reign of liberalism.

“America’s First Third-World City”

In addition to the standard drawbacks of 20th century municipal liberalism, Detroit suffered under its own unique handicap. From 1974 to 1994, it experienced the mayoral reign of Coleman Young. Young was a veteran of World War II who became the North’s first black mayor at the same time as Atlanta’s Maynard Jackson became the South’s first black mayor. Young was elected to five terms before retiring and dying of emphysema in 1997.

Although Young followed in the wake of the so-called civil-rights movement, he was really a black separatist in the tradition of Malcolm X rather than a reformer a la Martin Luther King, Jr. Young accused the Army of discriminating against him and carried that chip on his shoulder throughout his public career. When he became Mayor of Detroit, he alienated whites by insisting that only white people can be racists. His frequent diatribes induced whites to abandon the city, whereupon Young excoriated them as “racists in the suburbs,” according to Patrick Mallon’s memoir of his formative years in Detroit, entitled “Detroit: Coleman Young’s Triumph of Self-Destruction.” Mallon feels that Young was principally responsible for changing the course of his childhood by [teaching] me, my parents and my friends that we were all in the [racist] class of people.”  Likewise, writer Tamar Jacoby claims that “Detroit was governed by a black demagogue from the moment Coleman Young was elected Mayor.” Rather than take corrective measures to retain white citizens, Young encouraged the concept of black “independence.” This led writer Ze’ev Chafets to label Detroit “America’s first Third-World City.”

The loss of revenue stemming from white flight was partially offset by millions in payments by auto companies for what has been called “riot insurance.” The granddaddy of all riots occurred in July, 1967, when police tried to break up a party at an after-hours nightclub. When they discovered 82 guests celebrating the return of two Vietnam veterans, they tried to haul off all celebrants to jail. The doorman, son of the club owner, hurled a rock through the back window of a squad car, triggering a melee that spread into general rioting. Local and state police could not contain the violence and looting that killed 43 people, injured over a thousand others and caused millions of dollars in property damage. Ironically, although chronic ill will between the police department and blacks was the spark that set off the misbehavior, the first person killed was a white looter. Subsequent violence and looting was perpetrated by and against blacks, particularly harming innocent store and business owners. The riot was classified as America’s third-worst riot, ranking behind the New York Draft Riot during the Civil War and Los Angeles’ Watts riot in 1992. Despite the terrible toll taken by the riot, Young refused to condemn rioting by blacks, calling it “rebellion.”

Whatever psychological benefits blacks may have gained from Young’s posturing, it provided no economic benefits whatever. Detroit gained a reputation as “America’s blackest city,” but this carried little or no economic value. The racial makeup of the 53 Detroit suburbs became lily white, but this did not prevent Michigan from losing roughly half of its manufacturing jobs in the first decade of this century.

What Killed Detroit? “Liberalism,” Sings the Chorus

The response to the bankruptcy announcement has been well-nigh unanimous. Commentators declare that liberalism killed the city. This verdict is easy to understand.

Detroit has been run by liberals for nearly six decades. In approved liberal fashion, municipal government expanded explosively and spent money lavishly, borrowing when necessary. Detroit was not a run-down, underdeveloped community in Appalachia. It was the most prosperous city in America when the liberals took over.

Still, there were poor people – too many, apparently, to suit liberals. The best and brightest of the Kennedy New Frontier generation took a firm grip on the reins of power and set out to lift the poor out of poverty using the levers of government – government programs, welfare, affirmative action and the full-scale liberal agenda.

There were racial problems in Detroit when the liberals took over. A rift existed between the “black community” and the police department. Liberals attacked the problems full bore. They ushered in Detroit’s first black mayor. They gave him his head. He immediately identified whites as the problem. He substituted blacks for whites throughout the city, much as a producer might substitute a more efficient or cheaper input for a less efficient one. In particular, the mayor gave blacks majority status within the police department. The result was that whites fled the city for the suburbs.

In addition to having too many white people, Detroit was also adjudged to have too many rich people. Not only did rich people inhabit the wealthy suburbs like Dearborn, they also lived in enclaves within Detroit proper. One of the first liberal actions taken in the early 60s was to raise existing taxes and create new ones. These were intended to fund the liberal programs, pay the wages and salaries of burgeoning municipal payrolls and to promote social justice by correcting the unfair distribution of income.

If the creed of liberalism is to be believed – if liberalism actually worked – these measures should have enshrined Detroit in prosperity for the indefinite future. Instead, they succeeded only in immizerizing the city. “America’s blackest city” became so crime-ridden and murder-ravaged that police have now declared it unsafe for entry by outsiders. Capital fled Detroit as if it were a banana republic undergoing a revolution. Detroit was dubbed “America’s First Third-World City.”

After a half-century of undiluted, full-throated liberalism, Detroit became the largest American city ever to declare Chapter 9 bankruptcy. Much of the city has the look of a bombed-out, abandoned wasteland.

Michael Barone, author of The Almanac of American Politics, is America’s acknowledged authority on politics. “When people ask me why I moved from liberal to conservative,” he wrote recently, “I have a one-word answer: Detroit. I grew up there…I got a job as an intern in the office of the mayor in the summer of 1967… [Mayor Jerome] Cavanaugh was bright, young, liberal and charming. He had been elected in 1961 at age 33 with virtually unanimous support from blacks and with substantial support from white homeowners – then the majority of Detroit voters – and he was reelected by a wide margin in 1965… He was one of the first mayors to set up an anti-poverty program and believed that city governments could do more than provide routine services; they could lift people, especially black people, out of poverty and into productive lives. Liberal policies promised to produce something like heaven. Instead they produced something more closely resembling hell.”

The First Municipal Domino

While Detroit’s mayoral leadership may have been memorably incapable, other major U.S. cities are following in its wake. Eric Scorsone, economist at Michigan State University, concludes that “it’s the same in Chicago and New York and San Diego and San Jose. It’s a lot of major cities in this country [that] face the same problems.” After all, virtually all major U.S. cities are controlled by Democrats and governed by large, bureaucratic, wasteful administrative mechanisms. They all contain huge unfunded liability time bombs ticking loudly and conspicuously in the form of defined-benefit retirement programs for civic employees. All are spending far beyond their means, often borrowing in order to finance it.

The federal government’s debt, which now exceeds annual gross domestic product, has garnered most of the dire predictions associated with government finance. State and local government finance has a hard time competing in the doom-and-gloom prophecy business when its competitor has the biggest numbers all sewn up. The problem is that the federal government has the advantage of time on its side, as the Detroit bankruptcy shows. The feds wear square-toed financial boots in the form of money-creation powers and interest-rate manipulation powers. These enable them to kick the financial can down the road longer than state and local governments can.

Consequently, we can expect to see more cities stand in the financial dock before the day finally comes when members of Congress have to shape up or get a real job.

DRI-316 for week of 6-23-13: Is It Time to Start Selling The Wall Street Journal at the Grocery Store Checkout?

An Access Advertising EconBrief:

Is It Time to Start Selling The Wall Street Journal at the Grocery Store Checkout?

For three-quarters of a century, The Wall Street Journal has been one of the world’s financial periodicals of record. It has battled London’s Financial Times for supremacy since about the time that the sun set on the British Empire; i.e., the close of World War II. World leadership is a responsibility not lightly assumed or relinquished, and the Journal has taken its role seriously.

The American press has long followed the Journal‘s lead on financial and economic stories, citing it as the primary source of information and analysis. Business schools and economics departments at colleges and universities have offered Journal subscriptions at reduced rates, both to whet student interest and improve the student’s vocabulary and grasp of fundamentals. The need for an intermediary between the public and the professional elite of business, finance and economics is perennial. It has never been greater than today, when the tools of the trade are sophisticated and complex and the threat of economic collapse looms.

The advent of the Internet drove a stake through the heart of the American newspaper business, which had preyed on its public. High advertising rates, particularly for classified ads, were its life’s blood. Its left-leaning editorial stance gradually alienated its readership. Despite declining circulation, the industry obstinately continued to disdain its customers. The Journal and USA Today were lonely exceptions to this trend. Virtually alone, they have maintained circulation and operational scale.

Still, ominous signs are visible. The most disturbing has been the obvious divergence in viewpoint between the editorial page and reporting in the Journal. Technically, reporting is not supposed to reveal a viewpoint; it is supposed to present the “who, what, when, where, why” of the news impartially. Nowadays, though, this is apparently considered passé. And the viewpoint of Journal reporters is left of center, albeit to the right of (say) Mother Jones or The Nation. Meanwhile, Wall Street Journal editors remain a rare bulwark of support for free markets and political conservatism in the print media.

But that disturbing divergence is not stable. The Journal‘s reporting is showing increasing signs of the economic illiteracy and rabid anti-business, anti-market populism that characterizes the popular press. The latest example appeared in the Tuesday, June 25, Wall Street Journal‘s “Marketplace” section. The headline read: “McKesson CEO Due a Pension of $159 Million.”

The $159 Million “Pension”

The article’s byline belongs to one Mark Maremont. The piece opens with the unfavorable characterization of “executive pension plans [that] sometimes grow to a hefty size…as extra retirement cushions for long-serving CEOs.” The curious description of a retirement plan as an extra retirement cushion is advance notice that class warfare is about to break out. After all, the executive pension itself may run to millions of dollars, so it is difficult to justify the pejorative use of these words except as a lubricant for class envy.

That is merely the warm-up for the lead that, contrary to standard journalistic practice, follows in the second paragraph. “Then there’s the record $159 million pension benefit of John Hammergren, the current chairman and CEO of drug distributor McKessonCorp. That’s how much he would have received in a lump-sum benefit had he voluntarily departed on March 31,” according to a company proxy filing.

Mr. Maremont cites unnamed compensation consultants who declare this the largest pension on record for a public-company CEO, and maybe the largest in history. His one named source, James Reda of Gallagher HR Consulting, calls the pension “excessive” because Mr. Hammergren has been very highly paid in recent years. (Mr. Hammergrens annual compensation has averaged over $50 million.) Understandably, Mr. Hammergren refused the opportunity to comment on Mr. Maremont’s findings.

That is understandable because it is difficult to remain both calm and lucid in the face of anything so outrageous. Begin with the obvious; namely, the article’s characterization of the $159 million as a “pension.” To just about everyone in the English-speaking world, the word “pension” connotes a fixed, periodic (classically, annual) payment made according to the terms of a retirement plan. It is essentially synonymous with what insurance calls a “guaranteed life annuity.” Merriam Webster’s Collegiate Dictionary lists “a fixed sum paid regularly to a person” as the first definition of “pension.” According to Wikipedia:

A pension is a contract for a fixed sum to be paid regularly to a person, typically following retirement from service.[1] Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum. The terms retirement plan and superannuation refer to a pension granted upon retirement of the individual.

Given the everyday meaning of the word “pension,” a $159 million pension certainly ought to be a record. The sight of that headline must have set eyes rolling and brows rising throughout the world, because it said that McKesson’s CEO would receive $159 million a year for the rest of his life the equivalent of winning a lottery every year. And it is perfectly obvious that he will get nothing of the kind.

Those two words, “lump-sum benefit,” in paragraph two of Mr. Maremont’s article, are the tipoff to the charade he is staging. Diehard readers who inspect all 24 paragraphs of the article and its accompanying 13-paragraph sidebar detailing the calculation of Mr. Hammergren’s “pension,” eventually learn the truth; namely, that what Mr. Maremont calls a pension is closer to what Wikipedia calls a “severance.”

In journalism as it was formerly practiced – that is to say, reputable journalism – accuracy and clarity were the watchwords. Style and viewpoint were never issues. And political issues such as the fairness of CEO compensation belonged on the editorial page, not the front page of the “Marketplace” section. Ambiguity about the meaning of the word “pension” would never, ever have been allowed to mar the meaning of a story.

If It Doesn’t Waddle Like a Duck, Quack Like a Duck or Have Feathers…

One has the paralyzing suspicion that, when pressed to account for his conduct, Mr. Maremont would reply with a shrug, “But McKesson calls it a pension. I just accepted their terminology. It wasn’t my place to question or interpret it.”

If the Journal received a fisherman’s report touting a “world-record sardine” weighing a ton, possessing a pointed dorsal fin, skin instead of scales, double rows of sharp teeth and two unblinking eyes, would it unquestioningly print this account unedited and unqualified? Would it put “world-record sardine” in the headline, burying the likelihood that the sardine was really a shark somewhere in the fine print of the article?

Presumably not. But that is what the Journal has done here. We know this because Mr. Maremont himself grudgingly discloses it over the course of the article. After having spent the first 17 paragraphs implicitly flogging McKesson (and, by implication, Mr. Hammergren) for trying to put something over on shareholders and the public, Mr. Maremont comes clean about what is really going on. In paragraph 18, he discloses that in 2006 federal regulators changed the rules of disclosure for executive pensions. Under the new rules, companies were required to calculate a present discounted value for the pension each year under the hypothetical assumption that the executive retired that year.

Like many regulations, this initially seems weird and pointlessly complicated but actually has a logical purpose behind it. One obvious way to enable shareholders and analysts to understand how much executives are being compensated by boards of directors is to compare their compensation with that of executives at other firms. But coming up with a valid comparison for executives in different circumstances – different ages, different health profiles, etc. – is impossible without finding a format in which relevant values can be expressed in a common denominator. Thus, regulatory requirements have demanded that companies express compensation in just that common-denominator form – the present discounted value of the future pension payments. This is evaluated in various termination contexts, one of which is current termination of service.

And that is that Mr. Hammergren’s reported McKesson “pension” represents – not a pension in the generally understood sense, but in this special regulatory sense. There is no way under heaven that this pension – a lump sum representing the present discounted value of all future pension payments – belongs in the same comparative category as an ordinary “annual pension,” which is only one of those payments that gets discounted in computing the lump-sum payment. The lump sum can be compared to other executive pensions that are expressed identically – and this is the only comparison in which it should figure. Presumably, this is the comparison Mr. Maremont really refers to when he claims “record” status for it. Or rather, that is presumably what he would say if called upon to defend his article.

It is impossible to believe that a bylined reporter on the world’s leading financial daily could or would innocently mislead readers by suggesting one thing, then reluctantly and inferentially removing the suggestion through information supplied later. There is no innocent explanation; Mr. Maremont is either too incompetent to realize that he has confused his readers or he intended to profit from the confusion. That is, he is either a fool or a knave. There is no third possibility.

Either way, the episode indicates that The Wall Street Journal should take its place alongside The National Inquirer and News of the World on the tabloid rack at the grocery-store checkout.

Never Ascribe to Venality That Which Can be Explained by Mere Stupidity

Was Mr. Maremont devious or merely stupid? That remains to be determined. There is evidence on both sides.

Go back to the beginning of the article, where Mr. Maremont cites James Reda’s denunciation of McKesson’s lump-sum pension benefit as “excessive” because Mr. Hammergren is already making so much money. This is bizarre, to say the least. Every compensation specialist knows that the foundation of the pension calculation is the employee’s salary or wage. Mr. Hammergren is making lots of money, so of course his lump-sum benefit will be relatively large; that is how the system works.

But that’s not all. For years, the political left has complained about benefits that are not tied to performance. Here, Mr. Hammergren’s benefit is tied to his performance, which is a key factor in Mr. Hammergren’s high pay. “Under his leadership, the company’s stock price has more than tripled, significantly outperforming the overall market.” This came after his ascension to co-CEO in 1999 “after an accounting scandal decimated the company’s top ranks and led its stock to tank.”

Next, consider Mr. Maremont’s handling of the discount rate, which is usually the most contentious issue whenever the matter of present discounted value arises. In order to value benefits scheduled to occur in the future, a means to reduce the future value to its current equivalent must be found. The theoretically correct way is by “discounting” them; that is, dividing the benefit by a discount factor that embodies the relevant opportunity cost of generating the benefit. In the special case of a perpetuity – a fixed sum available forever – the perpetual benefit is divided by 1 + i, where i represents the interest rate or discount rate that reflects the opportunity cost. The general principle applies in slightly more complicated form to non-perpetual future benefits, which are discounted and summed to yield the present discounted value.

Mr. Maremont implies that the discount rate used by McKesson inflates the value of Mr. Hammergren’s pension; e.g., that it would give him too much money if he retired this year. Moreover, this point is anything but academic since he also says that “McKesson pays its executive pensions as a lump sum rather than annually.” Apparently, the company computes the pension in the conventional manner, using a formula based primarily on the executive’s final salary, years of service and performance. Then, using actuarial age to derive the length of the future payments, they calculate the present discounted value of the pension and pay it.

Mr. Maremont claims, quite correctly, that the selection of the discount rate can influence the outcome of the calculation. In general, the lower the discount rate, the higher will be the present discounted value. Mr. Maremont claims that “most firms” use “a rate set by the Internal Revenue Service of about 3.7% for a similar-age person [to Mr. Hammergren].” Thus, according to Mr. Maremont, McKesson’s chosen rate of 1% results in a windfall of some $52.4 million to Mr. Hammergren, compared to the IRS rate.

A good way to start a fistfight in a roomful of economists is to pose a problem involving selection of a discount rate. No problem is more contentious among forensic economists, the occupational niche that specializes in hiring out their services for legal testimony on valuation, regulation and antitrust. There is an excellent a priori case for assuming that “most firms” accept the IRS valuation simply because they don’t want to start a beef with the IRS, not because the government is a better economic evaluator of discount rates than private firms.

But rather than debate that point at length, ponder the implications of another admission by Mr. Maremont. “Mr. Hammergren will be eligible for full retirement benefits next year, when he turns 55. If interest rates rise, his lump-sum pension could decline [my emphasis].” Mr. Maremont’s conditional prediction clearly suggests that McKesson chooses the discount rate by linking it to current market rates, perhaps by pegging it to an interest-rate index. Indeed, this is just the sort of discount-rate-choice mechanism that appeals to economists generally. And this is tremendously important, not only to Mr. Hammergren but to our analysis, since it means that the CEO’s pension is running interest-rate risk. This would be important under any circumstances, but in today’s world it makes Mr. Maremont’s casual remark that “his lump-sum pension could decline” just about the biggest understatement since Noah said it looks like rain. If the difference between 3.7% and 1% is worth a $52 million gain to Mr. Hammergren, how big do you suppose the loss would be if interest rates rose from the (indexed) 1% up to 7%, or 10%, or 15% or 20%?

The Fed has just announced its anxiety to end the QE process. The market reaction has fallen just short of complete hysteria. Interest rates have already risen markedly. An interest-rate rise that could cost Mr. Hammergren tens of millions of dollars between now and next year is entirely plausible. This loss of value would occur within his retirement account, on the putative eve of his retirement. Elsewhere in the article, Mr. Maremont bemoans the special privilege ostensibly given to executives by these pensions and the detriment suffered by “rank-and-file employees” who have been stuck with defined-contribution plans instead defined-benefit (e.g., pension) plans. Yet now, in the face of his own admission of the special risk Mr. Hammergren is running, Mr. Maremont suddenly becomes analytically mute.

This is clear evidence of bad faith on his part – venality rather than mere stupidity.

Come to think of it, wouldn’t it have made much sense to run a piece on the phenomenon of companies paying executive pensions in lump-sum form rather than in standard life-annuity form? This would have alerted the general public to the existence of this new form of “pension” while simultaneously providing a valid forum in which to compare executive pensions in a truly valid way. For example, Mr. Maremont’s chart shows two line items – “added years of service” and “boosting bonus in formula” – that account for $50 million worth of the $159 million. We cannot evaluate them because he does not give us any information about them, but a genuine news article might have had the time and space to remedy that omission. This would have been The Wall Street Journal operating in traditional fashion; reporting the news and the facts, educating the public while informing them. But Mr. Maremont couldn’t very well have profited from the ambiguity attached to a “pension” by dispelling that ambiguity. That would have nixed the class-envy angle that apparently motivated him, and these days it’s the angle that drives the story.

Just about the time that the triumph of venality seems complete, the reader’s eye is caught by Mr. Maremont’s assertion that McKesson’s 1% discount rate “increased the size of its chief’s lump-sum pension benefit 52%, according to Bolton Partners Inc.” Wait a minute – Mr. Maremont’s chart shows a gain of $52 million (actually, $52.4 million), but now the gain is instead 52%? Confusing dollars with percentages is just plain stupid.

It’s beginning to be clear were our aphorism came from. It may derive from the fact that stupidity and venality are not independent of each other but positively correlated. Consequently, when they arise it becomes difficult to sort out their effects.

It isn’t difficult, alas, to associate their incidence with the decline of a great newspaper.