Dueling Inspector Generals or Revenge of the Creditor

Yesterday the Office of Personnel Management - Office of Inspector General (OPM-OIG) published a  report, entitled "A Study of the Risks and Consequences of the USPS OIG's Proposals to Change USPS's Funding of Retiree Benefits," that is devastating for anyone who had hoped that the Postal Service's financial issues could be resolved through changes to retirement funding issues were dashed. 

The OPM-OIG took different positions on each of the three proposed changes it investigated.  The OPM-IG generally supported a change in law to deal with the FERS Surplus.   It punted on changes on the allocation of CSRS liabilities for POD/USPS employees and reaffirmed testimony OPM made last year that OPM will follow whatever direction Congress gives it on that matter.  It rejected all proposals to fund Postal retiree obligations at less than 100%.

The OPM-OIG report reflects one of the eight challenges facing the Postal Service that this blog noted some 18 months ago, "Minimizing Risks to the U.S. Treasury."   Its conclusions are similar to what the first report of the consultant to the creditor committee would say regarding a firm facing bankruptcy. The report would oppose any change in terms that increase the risk of less than payment in full and any changes in the terms of the obligations.

The OPM-OIG goes even further suggesting that the USPS is not viable.  “Of Greater Concern to us is the fact that during the course of our research, we did not find any viable projections indicating that the USPS could restore its operations to profitability”  Creditors of firms in this position often require placing the debtor into bankruptcy so that the creditor committee can then choose to invest capital into the business to turn it around or liquidate it.

The OPM-OIG does a major service regarding the Postal Service even as it dashes the hopes of many stakeholders by making the following points that should focus the policy debate.

• The Postal Service does not have a plan to become profitable that a creditor would find credible.
• The Postal Service needs operating capital under its current plan and would likely need operating capital under any plan that a creditor would find viable as a path to profitable operations.
• OPM, as a creditor, should not put its solvency or its obligations to other Federal employees at risk as a source of working capital for the Postal Service.
• Changing Postal Service retiree benefit payments would not fix the fundamental problems in the Postal Service's business.
• If the Postal Service stops making its retiree health-care payments, health care benefits for retirees of the Postal Service retirees are at risk.  It is not clear how soon they would be at risk or if just future or current retiree health benefits are at risk. (Italicized addition added at 9:30 am.) For more information see "Could Postal Employees Lose Retiree Health Benefits?"
• If the Postal Service needs Federal assistance, then that assistance should be examined and debated independently and not within the context of funding retirement obligations.  (In other words, the fix cannot come out of our budget.)

The Postal Service Should Default on its Retiree Healthcare Obligation

The Postal Service is broke.   It has expenses far above revenue and has contract agreements and accounts payables far above its ability to pay.    Besides payroll its largest obligations are to the Federal government and transportation companies like FedEx.  It cannot afford to offer the services it is required to provide.  A recent report from the USPS Office of Inspector General states that the Postal Service is even less likely to be financially viable under the current operating model if volumes continue to decline.

In this financial state, the Postal Service must default in its obligations to the Federal Government and force Congress and the administration to choose between restructuring and liquidation.  Clearly, liquidation is not an option as the economic impact of ending mail service would be catastrophic and shifting mail delivery to the private sector would require a significant gap in time when no service would exist.

Default would force OMB and Congress to act and should force changes both at the Board of Governors (BOG) and senior management.  As such, the BOG and Postal management need to take an action that could cost them their jobs.

What would a restructuring look like?

• Introduction of a financial target requiring revenue greater than what is needed to ensure accounting break even as that target does not ensure financial self sufficiency.
  
• Immediate implementation of the Office of Inspector General's plan to cut area and district level employees.   Even if the plan is not perfect, there is not the money available to wait for a better plan.
  
• A new operating plan for handling bulk flats and sorting them to carrier route sequence order using a network of between 50 and 100 facilities.
  
• Streamlined review of network consolidation proposals under consideration.   The goal would be to implement consolidation proposals already announced in the second and third quarters of FY '11.  This cuts the normal time needed to implement consolidation efforts by six months or more.
  
• A second set of consolidations would be introduced for FY '12 by July of 2011.
  
• Increases in rates.   Rates would rise immediately on single piece mail to generate revenue to cover severance and other costs of reducing the workforce for this rapidly declining product and parcel services to both cover costs and/or match rate increases of UPS and FedEx.  Increases in rates for advertising focused mail would likely follow both the timing and size in increases in rates that other traditional advertising media charge as advertising rebounds with the pick-up in consumer spending that appears to be accelerating.
  
• Introduction of geographically based prices for drop shipped mail and parcels.   This will raise rates in low density areas and lower them in high density areas.  On average this will not affect rates and could expand mail use in areas that have lower delivery costs.
  
• All labor contracts would expire with the restructuring.    New contracts would show limited deference to work rules, compensation and other provisions in existing contracts.
  
• Consolidate retail services into fewer locations open for longer hours and self service locations by the end of FY 2012.

What would the Federal Government have to cover?

•  Most if not all of the retiree heath care costs.   Congress would have to accept modifications in the CSRS calculation and use the overpayment to pay off most of the retiree health care
  obligation and accept modifications in retiree health care calculations in order to reduce the remaining liability.
  
• The costs of early retirement incentives and severance payments to reduce the work force.
  
• All capital costs to rapidly expand self-service to retail using proven technology.  
  
• All capital and other transition costs associated with consolidation and closing facilities.

This is not a pretty picture.  Statements from members of Congress do not suggest that they are yet ready to give current management another year of relief from retiree health care payments, and forcing receivership of the Postal Service goes far beyond that step.  However, Postal management should eschew their self interest and default on the retiree health care payments to force Congress's hand. Then and only then, will Congress look for solutions that go beyond tweaking the status quo.


9/30/2010 - Two changes were made in this post from the original version to correct errors.   Accounts payable replaced accounts receivable in the first paragraph.  Both are bad but as the USPS collects revenue up front it has minimal accounts receivable.  It does have substantial accounts payable and other liabilities that need to be paid for which it does not have needed revenue.  The paragraph on geographically oriented rates would was changed to correct an error regarding rates to high density areas.   Rates there would go down not up.  Geographically oriented rates are used outside of the US by postal operators for providing only last mile services as a means to prevent cream skimming either in terms of creating a competing delivery service or exploiting anomalies in the rate structure as compared to the cost structure in ways that would cause the Post to handle substantial volumes below costs

Is the Postal Service facing "bankruptcy?"

In a recent article D. Volt highlights Postal Service Chief Financial Officer's near term and long term liquidity problems.   Mr. Volt's analysis is correct that the Postal Service's inability to cover its near and long term cash obligations is a serious problem. He is incorrect in his analysis that the Postal Service's liquidity situation does not put it at risk of being "bankrupt."

In order to understand why " may be appropriate for describing the Postal Service's current financial situation, one need only compare the liquidity of two other firms that have gone through major restructuring processes recently These are General Motors and YRC Corporation, a large unionized less-than-truckload trucking firm.    The following table compares the Postal Service's liquidity problem to that of General Motors and YRC Corporation at points prior to restructuring efforts that wiped out all or nearly all of the value of the equity held by shareholders prior to the restructuring.

If the Postal Service was a private sector firm, its current liquidity position would force its financial and legal officers to investigate bankruptcy as a means of restructuring its obligations to ensure it could cover them with projected cash flows.   The bankruptcy proceeding would allow it to restructure its loans, leases, unpaid bills, and contracts with suppliers of real estate, materials, services, and labor subject to the approval of a bankruptcy judge.  Bankruptcy could result in an orderly restructuring of these items if all creditors agree to the modification prior to filing.   Otherwise, bankruptcy could result in litigation among secured creditors over whether liquidation, sale, or restructuring of the enterprise is the best way for them to recover what is owed to them.   The structured bankruptcy of General Motors, supported by finances from the U.S. and Canadian governments allowed the company to restructure its operations under fairly strict guidelines set by the government as the provider of financing while General Motors adjusts its assets, operations, labor contracts and internal processes to fit what would allow it to be a profitable enterprise going forward. As part of the restructuring GM shareholders were wiped out and the restructured enterprise was owned by the major creditors prior to the bankruptcy filing.  Following over a year of restructuring, GM has emerged as a viable enterprise which will attract significant interest in the public offering of stock in the next few months.  

Bankruptcy is not the only option.    The threat of bankruptcy alone may be sufficient reduce the financial burdens of a financially troubled firm, especially if bankruptcy might mean liquidation of the enterprise in cases where the liquidation value is minimal.   In such cases the threat of bankruptcy  causes the creditors and holders of material, service and labor contracts to renegotiate terms of their agreements rather than face the prospects of restructuring within a bankruptcy proceeding.  This is what happened in the case of YRC Worldwide.  YRC Worldwide has been in serious financial difficulties dating to at least the fall of 2008.  In order to survive YRC converted a significant portion of its debt to equity and restructured its union agreements.  Creditors agreed to swap their loans for common stock and the Teamsters employees agreed to contract changes that included a freeze in pensions due to the company's stopping its contributions to its pension plans and multiple cuts in wages.  All of these are actions could occur in bankruptcy but the parties involved concluded that restructuring the enterprise outside of bankruptcy gave them a better prospect than what would have occurred if YRC Worldwide had filed for bankruptcy. 

It should be noted that shareholders of YRCW fared not much differently than they would have under bankruptcy.   YRCW shares that were worth $40.16 at the end of March in 2007 are worth only $0.34 today.  That is not much different than the results in a bankruptcy where existing shareholders could have the total value of their investment wiped out to pay creditors. 

Mr. Volt correctly notes that the Postal Service cannot file for bankruptcy.   In addition, the Postal Service cannot not just stop service and liquidate its assets in order to pay its obligations.   Therefore, it has less leverage over creditors and holders of contracts to renegotiate their agreements in order to ensure payment of at least a portion of what they are due.  The Postal Service also less leverage over unionized employees who face neither the prospect of major job losses that would occur in liquidation, nor new less favorable contracts, if there were contracts at all which would happen if the Postal Service went into bankruptcy.

So what options does the Postal Service have?

1. Raise rates - This is what it has chosen to do with the exigent rate increase.   Raising rates provides some short-term increase in cash.  However, it is not clear whether increases, as proposed in the exigent rate increase, are justified under current market conditions especially in regards to those products that are most sensitive to the economic cycle.   For private firms in the Postal Service's position, raising rates is not an option for most products that they offer as prices are set in competitive markets and the firm facing financial difficulties is a price taker not a price setter.
   
   
2. Reduce service - The Postal Service has proposed two options for reducing service, closing post offices and eliminating Saturday delivery.   It appears that legal restrictions make it nearly impossible for it to close the tens of thousands of money losing retail facilities or eliminate a day of delivery.   
   
   However, it still can reduce service in ways that limit regulatory or legislative blow back.   It can reduce the hours that existing post offices are open.    For example, there is no requirement that retail facilities be open a particular number of hours per day.    So it could reduce the losses from money losing offices by restricting opening hours to the bare minimum.  If it were possible, it could try to reduce its opening hours to one or two days per week rotating clerks among multiple retail facilities, the way some optometrists rotate between multiple offices.  (Check the hours that a Sears or J.C. Penney's optical department has an optometrist available for illustration.)
   
   It could also reduce the reliability and speed of service for its customers.    Reducing reliability  could cause it to violate its "modern service standards" but it is unclear how the Postal Regulatory Commission could compel the Postal Service to improve service quality.    While this reduction in service quality would generate complaints, regulatory proceedings and possibly even Congressional hearings, it represents a cost cutting strategy that has been used by firms like Conrail, Greyhound, and Trailways during periods when they no longer had the financial resources to meet service obligations under required under their common carrier obligation to customers.   This is the equivalent of the Postal Service no longer having the financial resources to meet service related characteristics of its universal service obligation.  The deterioration in service was a prime mover behind deregulation and the eventual restructuring of the rail and bus industry in the United States.   
   
   
3. Renegotiate its obligations -   The Postal has begun the process of renegotiating its obligations that are coming due in the next few months through a request for a waiver of its $4 billion payment to cover disputed retiree health care obligations.  While this will allow it to put-off its liquidity crisis another year it would not eliminate the risk that mailers would have that the Postal Service would be forced to look at price increases and service changes degrading quality described above in a subsequent year.

In conclusion, Congress and the Obama administration need to begin looking at the challenge of fixing the business model of the Postal Service through the equivalent of a bankruptcy restructuring.    Only through this lens can the Postal Service make the necessary changes needed to ensure a revenue stream and cost structure that would allow it to thrive as a financially self-sufficient enterprise.   Without a restructuring equivalent to bankruptcy, Congress could find itself dealing with a "postal financial crisis" as frequently as it has to pass a Federal budget.  

Postal Service Bankruptcy

The headline says it all, "The U.S. Postal Service: Our Next Bankruptcy?" While the stark headline is startling, the potential impact is even more so. The article by Delia Lloyd was published on the website Politics Daily, a new politics website that now attracts 3.6 million unique users every month. It is not clear whether the article and the millions that will read it will sufficiently raise awareness of the Postal Service's difficulties to move postal policy higher on the agenda of Congress and the White House.

The problem right now for the Postal Service is that its troubles have been moved into the high pitched debate over health care reform. By mentioning the troubles of the Postal Service at two health care forums, President Obama made an easy but ill-informed comparison of the Postal Service with its largest private sector rivals FedEx and United Parcel Service.

While it is true that FedEx and United Parcel Service are weathering the economic storm, a more realistic comparison would be with the printing, mail preparation, and advertising industries that generate mail that represent over 80% of the Postal Service's revenue. The more realistic comparison would also include foreign postal operators whose business mix more closely matches the Postal Service's revenue sources.

An examination of the mailing industry worldwide clearly shows that the industry is suffering and that entities that plan to survive and continue to serve their customers and meet universal service obligations are making significant changes quickly. Both large and small printers have declared bankruptcy and some have liquidated. Advertising agencies are hurting so badly that some have begun to offer services at no cost just to keep talented employees on staff until the economy turns around. Throughout the industry, production facilities are shutting down and businesses are shrinking to levels that management believes will allow the enterprise to survive.

Overseas, postal operators have reacted aggressively to deal with the changing mail market and economic conditions. Postal operators in Great Britain and the Netherlands are taking a hard-line in their labor negotiations with their ability to settle with their unions depending upon how well labor understands that bailout of the postal operator to save jobs is unlikely. Deutsche Post is closing its remaining stand-alone post offices and replacing them with contract offices run by either its former subsidiary Poste Bank or other contractors. Operators in numerous countries are redoubling their efforts to streamline processing networks and optimize their delivery operations. Privatization proposals are popping up in Japan, Denmark, Sweden, and Latvia as the capital needs of dealing with the changing marketplace and modernizing operations become greater than what governments are willing to provide or what the operators can raise through postage rates without affecting demand so much to threaten the continuation of universal service.

But realizing that the entire American mail industry is in trouble, does not excuse Congress for creating a postal policy that has resulted in the Postal Service being the only western postal operator that is in such a precarious financial position and without the means to weather the economic downturn. In many ways, the modification of Postal Policy is reminiscent of Congress's initial foray into reforming railroad policy with the passage of the Regional Rail Reorganization Act of 1973. That act opened up some flexibility in pricing and service just as the Postal Accountability and Enhancement Act did but did not fully recognize the extent of change required to ensure that railroads could survive the technological and competitive changes that they faced. It took additional trauma in the railroad industry and two more legislative efforts before the modern framework for the railroad industry developed within which railroads are profitable, growing and able to provide substantial number of highly paid jobs.

By raising the concept of bankruptcy, Delia Lloyd illustrates how Congress has to rethink postal policy. In a bankruptcy reorganization, the objective is to create a new company that will be a viable enterprise with the prospect of paying back its creditors and new investors who provide the debtor-in-possession financing that funds the restructuring necessary to fund the restructuring and operating losses during the transition. In bankruptcy, creditors have it in their interest that all contracts entered into prior to bankruptcy are subject to renegotiation. Renegotiation of labor contracts is often critical because creditors are unlikely to fund the transition unless they believe that labor agreements reflect the new business reality. This is exactly what happened in the GM and Chrysler bankruptcies and the Federal Government's loans were dependent upon new agreements with suppliers, dealers, and organized labor. Creditors have significant leverage over bankrupt companies and their employees as they can raise the threat of liquidation if the company's management cannot develop a viable path through reorganization.

As the Postal Service's largest creditor, Congress is on the hook for scores of billions of dollars for retirement health benefits, workers compensation payments, and postal debt. Its financial interest is similar to the interest that creditors have in companies undergoing bankruptcy reorganization.

The one challenge to the bankruptcy model is the Postal Service's universal service obligation, as that for all intents and purposes takes the liquidation threat off the table. The Federal government has a constitutional responsibility to ensure the continuation of mail service, let alone the responsibility to ensure that mailer needs are met. Fortunately, there are models that deal with the challenges of reorganizing a financially bankrupt company whose business is such that liquidation is not an option. These models are the models that have been used to restructure railroads, shareholder-owned public utilities, and government-owned public utilities.

As the postal policy debate moves forward, the term "bankruptcy" will likely remain a favorite of editorial pages, columnists, headline writers, and politicians. While a real Postal Service "bankruptcy" is unlikely to move beyond the rhetoric of postal policy, the use of term will likely force postal stakeholders to make changes in all of their business and contractual relationships with the Postal Service as a condition for giving the Postal Service the time flexibility, and the resources needed to ensure that Congress's financial interests are secured.