Walking Between the Law and Disaster

The Postal Regulatory Commission held its public forum on the Postal Service's Annual Compliance Review (ACR) yesterday.   The tenor of the discussion suggests that the Commission facing the challenge in this proceeding of walking the fine line between the law and disaster.

Simply put, the ACR proceeding raises two questions relating to the law.

• Did the Postal Service's ACR filing show that it complies with the requirements of 39 U.S. Code to 1) provide prompt, reliable, and efficient services to patrons in all areas[39 U.S.C. § 101 (a)] ; and 2) "to assure adequate revenues, including retained earnings, to maintain financial stability?" [39 U.S.C. § 3622(b)(5)].
  
• If it did not, what actions can or should the Postal Regulatory Commission take?

Did the Postal Service's ACR filing show that it complies with the requirements of 39 U.S. Code to 1) provide prompt, reliable, and efficient services to patrons in all areas; and 2) "to assure adequate revenues, including retained earnings, to maintain financial stability?

The first question  raises the question about both service quality and postal finances.   As service quality in transportation firms often depends on both efficient operations and financial strength focusing on the financial issues raised by this question is sufficient for understanding the challenge facing the PRC.

During the public forum no party other than the Public Representative directly indicated that they understood that the Postal Service did not generate sufficient revenue in 2009 to maintain financial stability.  Most parties requested that the PRC take the long view in looking at the question of financial stability.  This focus hinted that most parties believe that the Postal Service's business plan did provide service at a sufficiently efficient level to ensure that current rate levels generated adequate revenues to cover operating and legislatively mandated costs and generate retained earnings sufficient to maintain financial stability.

This sentiment is consistent with the public statements of the Postal Service's CFO Joe Corbett who stated in an interview with the Federal Times, "We will need [some assistance from Congress] or we will have difficulty paying all of our obligations this year. And going into next year, we might not have enough cash to operate. ... We are dangerously close to running out of cash."

If the Postal Service is insolvent, as the Federal Times headline implies, then by definition the Postal Service is not sufficiently efficient and does not generate sufficient revenue to maintain financial stability.    While the pension and retiree health care issues affect the question of financial stability the PRC is faced with the challenge of making a determination on this issue prior to any action by Congress.  Furthermore, the Postal Service has numerous other operating and market challenges that threaten its financial stability that go beyond its retiree benefit issues.

Given the information available to the Commission, both on the record and in the public domain,  it may have little choice but to come to the same conclusion that CFO Corbett and the Government Accountability Office have drawn, that it is not now a financially stable enterprise.   This question then forces it to address the second question listed above.  

What actions can or should the Postal Regulatory Commission take?

The Public Representative has presented a serious, but highly unpopular proposal to deal with the issue of financial stability.  It proposed that the Commission order the Postal Service institute rate increases in 2010 and 2011 that would cumulatively raise rates between a 6.3% and 21.2%.   The public representative noted that these increases would only return the Postal Service to break even.  In a recent post, I noted that a more realistic proposal that included retained earnings could raise rates between  25% and 42.6%.


The prospect of such large rate increases, clearly have large mailers concerned and created a conundrum for the Commission.  Large rate increases raise the possibility that large rate increases now would accelerate the diversion of mail to digital alternatives, worsening the prospects of financial stability in 2011 and beyond.   (Further study is needed to understand how rates, convenience of recipients, or communication cost-effectiveness drive the switch to digital delivery.)

Commissioner Dan Blair, in his comments raised procedural concerns that the ACR review could turn into a mini rate case.   His concerns reflect the intent of the PAEA to generally eliminate the traditional processes of setting postal rates.

So what options do he and other Commissioner's have if they join the consensus that the Postal Service is nearly insolvent?  It is this question that inspired the title of this post, "walking the line between the law and disaster."

In my view, the Commission can walk this line if it focuses less on the obvious, the Postal Service's near insolvency. Instead, it should use the ACR Review to advance a framework for discussing the options available to make the Postal Service a financially stable enterprise.   Then, the Commission would provide the Postal Service, postal stakeholders, and Congress a method to understand the financial impact of current law and how that law may need to change to create a financially stable enterprise.  To that end, I would suggest that parties to the proceeding and the  Commission focus on answering or at least asking the following questions.

• What financial goals indicate financial stability for the Postal Service?   We know that a financially insolvent Postal Service cannot pay its bills. We know that accounting break-even does not produce financial stability under any financial management theory. We do not know what financial goals a financially stable Postal Service should have, if accounting break-even is no longer appropriate.  Nearly all foreign posts have addressed this question first in examining reform of their postal policy.   Postal policy in the United States has never addressed this question.
  
• What level of retained earnings is sufficient?   Under the Postal Reorganization Act, accounting break-even was considered sufficient.  The 3-year rate cycle, combined by actions of Congress resulted in the Postal Service having almost no retained earnings.  In the near term, the Postal Service will soon need to end deferment of capital projects and maintenance, and improving operating efficiency will require capital expenditures to reduce the number of facilities and locate these facilities in locations that promote both cost efficiency and better service quality, transition costs to reduce the workforce at a rate at least equal to the impact of new technology and reduced mail volumes.   All of these actions cost money and there is no information on how much it would or could cost or the level of earnings necessary to implement these plans.
  
• What impact do restrictions on capital have on postal efficiency and service quality?   Currently capital spending is limited to what cash is available. The ability of any enterprise to rightsize its operations in the face of changing demand depends on the capital available to restructure its operations and provide incentives for excess employees to leave.  Showing how capital constraints are linked to cost efficiency and service quality could provide Congress with a better understanding as to how serious the current situation truly is.  

In focusing on these questions, the Commission can provide postal stakeholders with a greater understanding of the problems that the Postal Service faces without making these problems worse through imposing significant rate increases.  In this way, the PRC will use its authority in a way that forces Congress, the Postal Service and the Obama administration to seriously discuss the financial details of what it will take to ensure that the Postal Service is a financially stable enterprise far beyond 2010.

Taking Control of the Board of Governors

My first reaction to President Obama's announcement of his intention to appoint Paul Steven Miller and Dennis J. Toner to the Postal Service Board of Governors was that the appointments violated the spirit if not the letter of the Postal Accountability and Enhancement Act (PAEA). The PAEA modified the qualifications for the Board of Governors to add the requirement that at least four members Board "shall be chosen solely on the basis of their demonstrated ability in managing organizations or corporations (in either the public or private sector) that employ at least 50,000 employees." 39 US Code Sec. 202 (a)(1)  Neither of the two appointees have that experience..

Both of these proposed appointments meet all other requirerments for the Board of Governors.   They clearly have substantial experience in "experience in the field of public service, law or accounting."  

The current Board of Governors currently has one member with significant experience managing businesses or large organizations.  Louis J. Giuliano, Chairman of the Board of Governors is the former CEO and President of ITT Corp.  Retiring Governor Carolyn Lewis Gallagher was the President and Chief Executive Officer of Texwood Furniture, Inc., a manufacturer of educational furniture, but it is unclear whether Texwood had 50,000 employees.  The experience of all of the other Governors, including the experience of the two nominees, is in law or public service.  The Senate may need to ask the administration how it plans to increase the number of governors with the appropriate management experience to 4 members.

The two appointees do differ from the current board in one important respect that buttresses their case for appointment to the Board of Governors.   They have close personal and professional relationship with the White House.  Mr. Miller spent the past year working in the White House.  Mr. Toner has spent 30 years on the Senate staff of Vice President Biden including ten years as Deputy Chief of Staff.   The close ties suggest that the Obama Administration feels that it must take a more "hands-on" approach in dealing with the problems facing the Postal Service.   This is clearly different from the benign neglect that has characterized the postal policy of most Presidents since the passage of the Postal Reorganization Act.

In making these appointments, the Obama administration is taking seriously the federal government's role as the primary creditor and only shareholder of the Postal Service.   These appointments are not much different than what happened at GM, Chrysler, and AIG when the Federal Government traded loans for shares and made appointments to the boards of these companies.      Their appointments also suggest the administration may require changes in the size of the existing board in order to speed changes at the Postal Service, as a condition for changing the formula used to calculate the pension and retiree health care benefits of the Postal Service.

These appointees clearly will join the Board of Governors with the goal of putting the Obama administrations imprint on both senior management and strategic thinking at the Postal Service.   They will likely bring to the board ideas for turning around the financial position of the Postal Service, including those that require changes in the business model and regulatory framework, that were developed outside the confines of L'enfant Plaza.   It is possible that they may put significant pressure on existing senior management at the Postal Service to speed up the pace of change or risk the fate of Fritz Henderson, the former chairman of General Motors. 

In the coming weeks, Senators and their staff will vet these two nominees and eventually hold hearings on their appointment.   This process provides the Senate with a clear opportunity to determine the Obama administration's approach to postal policy and its current thinking about the Postal Service's challenges.   It is an opportunity that the Senate cannot afford to pass.

Could the Budget Kill Efforts to Save the Postal Service?

In the next few days, President Obama will deliver the State of the Union Address and reveal the 2011 budget.   White House spokesman have already announced that the budget will include a freeze in discretionary spending in fiscal years 2011 through 2014.    The spending freeze creates an additional barrier on top of the normal budget scoring process to efforts to find a solution to the Postal Service's financial problems.   

The budget scoring process put the retiree health care payment schedule in place in order for the Postal Accountability and Enhancement Act (PAEA) to pass.   The budget scoring process derailed the normal legislative process as a method to deal with the Postal Service's financial problems last year.   The relief that was granted was included in last-minute legislation that did not require budget scoring.

The relief that Congress granted last year did not solve the long term problems of the Postal Service.   Congress will soon see a report from the Government Accountability Office (GAO) on potential business models and regulatory frameworks that could offer long term solutions.   It is unclear whether the GAO's mandate will cover key financial questions regarding the Postal Service's true liabilities for CSRS pensions, retiree health care benefits, and workers compensation payments which affect the viability of all business modes that the GAO is likely to consider.


The Problem with the retiree health care liability was studied by both the USPS - Office of Inspector General (USPS-OIG), and the Postal Regulatory Commission (PRC) and both studies recommended lower payment schedules than the current schedule.   Choosing either the USPS-OIG or the PRC schedules would reduce the Postal Service's payment to Office of Personnel Management (OPM) and in the budget scoring process would require cost savings in non-postal programs or other payments from the Postal Service for the change to be budget neutral.

A new report from the USPS-OIG, The Postal Service's Share of CSRS Pension Responsibility, creates even more budgetary problems if the results are accepted.   This report indicates that the Postal Service has overpaid its liability by $58.7 billion more than previously estimated.   If this overpayment is transferred to cover the Postal Service's retiree health care liability, the Postal Service's obligation for retiree health care costs would be even smaller.   Again, the primary obstacle to accepting the USPS-OIG analysis is the Congressional budget scoring process.

Fixing retiree and other liabilities was critical in postal reform efforts outside the United States.   In these countries, legislatures realized that a viable national postal operator and universal service required that the postal operator not be burdened with retiree obligations at levels that would force layoffs or price increases. 

The Postal Service and nearly all stakeholders realize that the first step to solving the Postal Service's problems will involve recognizing that 1) retiree payments reflect actual obligations and 2) the payment schedule for this actual obligation should follow private sector standards for funding retiree obligations.  The National Association of Letter Carrier's Fact Sheet presents the arguments that stakeholders will make before Congress over the coming month. 

Given budget scoring, these arguments will fall on deaf ears unless stakeholders can find ways to replace the "funds" that fixing the pension and retiree health care obligations creates.   Failure in the effort to find a fix will force the Postal Service to raise rates substantially, make cuts in service beyond eliminating Saturday, and reduce the workforce faster than it has proposed to date.   

Is there a solution?  Is there a solution using a governmental business model?   My paper, Examination of Postal Business Models, tried to answer these questions in assessing potential business models and concluded that there is a solution and governmental business models did not offer one.   It is time for others looking at Postal business models, and in particular those stakeholders that want to retain a governmental model to explain how their model can solve the problem of Postal liabilities and get the changes that they envision passed by Congress. 

Postal Service and the Federal Budget

More than anything else, the greatest political obstacle to a new business model for the Postal Service is the Federal budget deficit. Every legislative action to maintain postal services in light of current financial losses, and fund the transition that will create a new business model will have budgetary implications. Thee budgetary implications will likely become the primary arguments of postal competitors and other opponents of reform for delaying necessary changes that would make the Postal Service a viable and customer-focused provider of delivery and delivery related services.

Currently, the Postal Service is seeking relief from the demand of the Office of Personnel Management as included in the Postal Reorganization and Enhancement Act (PAEA) for accelerated funding of retiree benefit. The accelerated payments had a positive budget impact that smoothed the passage of the PAEA. However, the accelerated payment schedule reflected three misconceptions about the Postal Service that made the accelerated schedule seem reasonable.

• First, demand trends for mail were sufficiently strong to generate the revenue necessary to cover the payments. Congress, like many governmental and business executives at the time assumed the rosiest scenario for the Postal market and in particular demand for advertising mail and the mail revenue that it generated. When the recession hit and the revenue disappeared, the Postal Service lost its ability to meet the new payment terms.
  
  
• Second, the Postal Service was sufficiently capitalized to continually modernize its distribution and retail networks to reduce costs and improve service. The Postal Service had aggressively reduced its debt through the good fortune of strong demand for advertising mail, improved management of operating costs, and parsimonious spending on capital projects. Congress did not have an independent assessment of the true capital and cash needs of the Postal Service, particularly as they related to the legislation demand for improved cost management and network realignment.
  
  
• Third, cutting operating costs does not require significant one-time expenses if they are to be done quickly in ways that are transparent to customers. Both Congress and the Postal Service assumed that it had the time to reduce its workforce and streamline its network through the nearly costless method of employee attrition and minimal capital spending to move postal operations to locations that better fit today's mail distribution patterns. With no funds to reduce the workforce, the Postal Service is limited to those streamlining efforts that can be accommodated through moving employees to new jobs within the network that will not require payment of moving expenses.
  
  Unfortunately, markets can and did change more rapidly than either historical attrition rates or the slower attrition rates caused by the sagging stock market and economy. Accelerating reductions in the workforce, including supervisors and management at all levels, requires either early retirement incentives or severance pay. With an average hourly wage ranging from $25.70 for bargaining unit employees to $42.10 for headquarters employees, these incentives or severance payments can be a significant challenge for a Postal Service with limited or no cash reserves and the need to reduce its workforce faster than what attrition will allow.
  
  Similarly, limited cash reserves restricts both planning for and funding capital projects that can improve the placement of postal facilities in an effort to both reduce costs and improve service. While no company managing an operating network would replace an operating network with a new green-field one, all well capitalized transportation companies know that a continuously improving network requires having sufficient capital to fund moving operations over time as demand, technology and distribution patterns shift.
  

Right now, the increasing visibility of deficit politics affects the viability of proposals designed to enable the Postal Service to survive the next two years. In requesting that the GAO complete its report on potential business models in April, the Senate appears to acknowledge that more needs to be done. Given the political calender, dealing with the misconceptions of the PAEA and the financial reality of funding the needed transformation that each alternative business model suggested by GAO would require could put the impact that proposed alternatives will have on the deficit right in the middle of the 2010 political debate. If that happens, developing a long-term solution that the Postal Service continues to meet the needs of its customers will be far more politically charged than any previous efforts at postal reform.