America's private companies and state and local governments share a financial challenge that makes today's economic downturn seem small by comparison. The problem is their pensions: They've made promises to their employees in the form of retirement pensions and health benefits that they simply can't afford to keep.

In a 2005 SmartMoney feature, columnist Roger Lowenstein chronicled how overgenerous benefits dragged down General Motors. In his new book, While America Aged, he examines just how broad the scope of the problem has become nationwide, especially for local and state governments. Pension and health care obligations could ultimately become a much heavier burden for taxpayers than they are for shareholders of companies like GM. In the following excerpt, Lowenstein describes a showdown between a New York State agency and the transit union that brought New York City to a standstill and thrust pension issues into the headlines.

Beginning in 2001, when he became chairman of the New York Metropolitan Transit Authority, Peter S. Kalikow worried constantly about the agency's pensions. The MTA oversaw New York's subway system, along with bus service and various commuter-rail lines. From 2000 to 2005 the pension bill for the city subway and bus systems soared tenfold. And the agency was projecting an alarming continued escalation.

This crisis was partly due to demographic trends, which made the pension math unworkable as workers lived longer. In the subways a typical employee in an earlier generation worked for 40 years and then lived off his pension for, say, another 10 years. Now employees retired after 25 years, after which they were likely to collect a pension for an equivalent quarter-century or even longer. It was as if two conductors were aboard each train one of them doing the steering and the other lazing in his rocker and both at taxpayer expense.

To Kalikow this seemed inherently unsound. He worried that the MTA was repeating the mistakes of General Motors. A serious car buff, Kalikow had admired GM as an undergraduate and followed its fortunes ever since. He found it astonishing that a company once emblematic of success a company that had been profitable even during the Depression was now on the verge of collapse. Kalikow once told an aide, "The greatest company in America is going broke over pensions. We have to do something before it catches up to us here."

By the time Kalikow took office, though, the problem had caught up to the public sector and not just in New York. It's no accident that many states and municipalities are in bad shape, because negotiations in the public sector are inherently tilted in the direction of higher benefits. Public unions can organize politically and influence elections which is to say that, unlike GM employees, they can vote their bosses out of office. Politicians thus face huge temptations to increase benefits, even though this is costly in the long run.

Public-sector pensions also enjoy an enhanced legal status that makes them ultimately far more costly. A private company at least has the option of "freezing" its plan. When that happens, employees keep the benefits already accrued, but from the time of the freeze onward, they do not accrue more credits. To employers this can be a very significant saving. In contrast, a public agency can never stop the meter not even with a union's permission. And governments do not even have the option of escaping pensions via bankruptcy.

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Though GM's benefit structure had been ruinous to its shareholders, it had not hurt the public at large. Public pensions are different. The MTA pensions, for example, are financed by taxes and fares; they are paid for by the public, especially the riding public. And riders and taxpayers, more than the employees, were Peter Kalikow's chief constituency or so he maintained. Why should the public pay for employee pensions? Most of the people riding the trains could not hope to retire after 25 years, nor did they earn as much as the average transit worker, who made $58,000 a year in 2005.

As it was, the public was already footing the bill. Squeezed by rising costs, Kalikow had been forced to defer subway expansion projects; he was trimming service, eliminating bus routes, closing token booths and reducing late-night operations. The fare had been bumped, from $1.50 to $2. The MTA's capital needs were massive, and Kalikow was in a perpetual battle for state and federal subsidies.

The pension obligation was simply staggering. Transit contributed $381 million, or 14 percent of the payroll, to the city pension funds. By 2009 the bill was expected to nearly double, to $620 million more than four times the total of a decade earlier. Health care cost the authority an additional $410 million, and it, too, was rising at double-digit rates. And transit workers contributed only 2 percent of their salaries for pensions and nothing for health care. Meanwhile, they as well as spouses and dependents got full medical coverage including vision and dental for life with free generic drugs and a minimal $15 copay on doctor visits.

THIS SET THE

stage for a confrontation that pitted the interests of the public against those of public servants. In 2005 Kalikow demanded that the transit pension be cut. Legally, he couldn't touch the pensions of employees already on the payroll. What he wanted was to reduce the benefit for future employees and ease the burden on his successors. Kalikow was amenable to a small wage hike, but he demanded modest cuts in health care benefits. What's more, he insisted that for employees hired after 2005, the retirement age be moved to 62 from 55 and that to qualify for full pensions, employees serve 30 years rather than 25.

This would require the acquiescence of the state legislature as well as the governor and the mayor. Most of all, Kalikow would need the agreement of Roger Toussaint, president of Local 100 of the Transport Workers Union of America. Local 100 had a deserved reputation for being unflinching, divisive and embittered. By comparison it made the United Auto Workers, GM's tormentors, seem a model of reasonableness. And like the UAW, Local 100 wielded fearsome power over its employer. The 35,000 hourly transit workers were as essential to the city's ordinary life, its healthy circulation, as were its police and fire services.

The matter came to a head as the TWU's contract expired in the week before Christmas 2005. Both parties sensed that something larger than transit pensions was at stake. To Kalikow it was the viability of a public institution; to Toussaint, the middle-class lifestyle his members had fought for. He insisted he would never give in on pensions even for future employees, whom he called the "unborn" an inflammatory term that invested the debate with moral overtones. As the deadline neared Mayor Michael Bloomberg warned that a strike would cost the city's economy upwards of $600 million a day and issued emergency instructions for a walkout.

Thursday, Dec. 15, the day of the deadline, was foggy and cold. New Yorkers made contingency plans for getting to or skipping work. TWU members gathered outside the Grand Hyatt, where negotiations were limping along. Toussaint, his close-cropped beard showing a dapper streak of gray, sauntered outside and, leading the crowd in a rehearsed chant, asked for guidance should the MTA fail to make a "fair" offer to which the multitude gleefully shouted, "Shut it down!"

Kalikow joined the bargaining and faced Toussaint for the first time at 11 p.m. Thursday night. With the 63-year-old chairman at the table, the pace quickened. The MTA upped its wage offer to 9 percent over three years. At 2 a.m. Kalikow cut his health care demand in half. That left the pension. Kalikow sensed that the moment for reaching a deal, so long elusive, had perhaps arrived. He made a final concession: Employees could continue to retire after 25 years' service. However, he insisted on raising the minimum age to 62. "It's only for the future," he noted. "Nobody working now will lose a penny."

The invitation to punish the next generation made Toussaint bristle. He would never sell out the unborn. He and his aides, their patience exhausted, made ready to leave. Kalikow's spirits sagged; he had thought they were close. Exasperated, Kalikow said, "Roger, if you strike you go to jail." Toussaint said Rosa Parks had gone to jail; he could too.

At 4 a.m. the union delegates left. The chance to strike was gone; the morning trains were rumbling. After a raucous meeting at their headquarters, union members voted to reject the authority's offer and set a new strike deadline, for a minute after midnight Tuesday. To the city it felt like the briefest stay of execution. Department stores on Friday were empty; shoppers had taken no chances.

On Monday morning the union began a strike against two private bus companies in Queens. This sent an SOS to the 7 million New Yorkers who daily relied on the subways and city bus lines. At 10:45 a.m. the bargaining teams reassembled at the Grand Hyatt. They were down to their final day again.

The MTA offered yet a steeper wage hike 3.5 percent a year and a 12th paid holiday. The union failed to counter. By early evening representatives from the other New York unions, including the umbrella AFL-CIO, had converged on the Grand Hyatt. Publicly, they offered support for Local 100. Privately, they were desperate to ward off a strike. Seeing Kalikow in the halls, Randi Weingarten, the teachers union president, declared, "It's important that we settle this." The developer shot back, "I made them a good offer."

AFTER MORE

back-and-forth, Gary Dellaverson, the MTA's veteran labor negotiator, had a brainstorm. He began to thrash it out: Normal retirement would be at 62, as the MTA wanted. But the employees would also get a 401(k) account. The authority would throw in 1 percent a year; the employees could invest the same or more. When they reached 55 they could use the 401(k) money to buy extra years on their pension, enough to retire earlier. The MTA wouldn't guarantee the outcome, nor would it shoulder all of the burden. But transit employees still could plan on a youthful retirement. Dellaverson thought he had found the sweet spot, the sort of deal that each side could live with. But though the MTA and the union were fingertips apart, the unborn would still get nicked, and Toussaint wouldn't allow it. He began to shut down, like a man who knew his fate.

A little after midnight the union delegation caucused; then it left for headquarters. Toussaint, giving a summary of the talks, weighed in favor of a strike. The vote was tabulated at 1:15 a.m.: plenty of time for the trains to finish their runs and drop off passengers. By 3 a.m. the trains were safely in the yards. At just that hour Toussaint announced that the union had voted "overwhelmingly to extend strike actions to all MTA properties." For only the third time in 40 years, the famous New York City subways had been silenced.

Schools opened late on Tuesday, and classrooms remained half empty. Manhattan streets were eerily quiet. Rather than snarl the city in traffic jams, people in the outer boroughs and suburbs had stayed home. The winter weather was thankfully mild. Mayor Bloomberg walked or, rather, bounded across the Brooklyn Bridge. Attired for his trip in a leather bomber jacket and stonewashed Levi's, the mayor lashed out at the union leadership for having "thuggishly turned their backs on New York City and disgraced the noble concept of public service." His comment was much rehashed by those who took offense at the modifier "thuggishly"; little was said about the other part, "the noble concept of public service." It was the sort of phrase that rolled off the tongue, an unobjectionable clich ; most listeners barely paused over it. But it was there, in the meaning of public service, its rights and its responsibilities, where the meat of the pension dispute was to be found.

The strike lasted two and a half days. With a mediator pressing for resolution, the parties agreed to leave the pension unchanged. However, workers would contribute 1.5 percent of their salary for health care, giving Kalikow a concession on benefits that would save the authority $100 million over the contract's three years. Wages were hiked a total of 11 percent. In 2006 Toussaint won reelection; with the election of a Democrat as governor, Kalikow resigned. But as the real estate market cooled, New York had to deal with rising budget pressures just as Kalikow predicted. The MTA, facing a squeeze, hiked its fares on bridges and commuter rails.

New York, at the very least, had dealt with the issue openly. The city had raised taxes to pay for pensions and then, finally, it had said enough. There were governments in many other jurisdictions that utterly lacked such courage. For them pensions would truly be a recipe for disaster.

Fixing It

America sits on a retirement time bomb because of pension and health care obligations. Most decision makers described in my book behaved like credit card abusers who charged to the limit and made only the minimum payments. The best remedy is to banish the credit card. Benefits should not be charged to a future generation; they should be paid for now. Health Care In a world in which people change jobs every few years, there is no reason for health care to be tied to the workplace. And as General Motors discovered, it cannot compete if it has to provide benefits that Toyota does not. The way out of the mess is financing by the federal government. That does not mean the government would become the universal provider of health care; instead, it should subsidize basic coverage. Already, at companies with medical plans, employees receive tax-free income in the form of insurance, which amounts to a huge subsidy some $125 billion a year. A more direct subsidy a voucher that could be used to purchase insurance would be universal and thus fairer. It could be accomplished by extending Medicare to people younger than 65, with the level of coverage varying according to income. Private Pensions and 401(K)s Today only 18 percent of private-sector workers have pensions, with most firms having replaced them with 401(k)s. For many employees it's a calamity in the making: 401(k) plans don't offer anything like the security of a pension, and most 401(k) account holders don't have nearly the savings they'll need in retirement.Washington should sponsor national 401(k) accounts and offer matching credits to lower- and middle-income earners. Congress should also overhaul the legislative framework of private 401(k)s, demanding protections for beneficiaries as it does with pensions. The government should require 401(k) sponsors to offer annuities to employees as they retire, to provide an annualized stream of income. (Think of them as do-it-yourself pensions.) Public Pensions Public-sector employers need stability in the workplace, so pensions still make sense. The problem is, they are so often underfunded. States should require that every dollar of pension benefits be funded as the benefit is accrued. If the system were stripped of the illusion that pensions are "free," lawmakers would presumably make wiser choices.Social Security Workers and employers now pay taxes that support current retirees; when today's workers retire, their children's generation will support them. But this leaves the system vulnerable to a decline in birth rates. Social Security should function like a well-managed pension plan, with each generation supporting itself. The payroll tax should be increased, and the federal government should stop "lending" surpluses to itself. These steps are similar to what President Bush proposed in 2005. But his plan would also have converted Social Security into a system of 401(k)s lacking any collective guarantee. A well-financed collective system would be better. With companies increasingly refusing to guarantee old-age security, only the government can do it.

Also See:

• 7 Ways to Lobby for a Better 401(k)

• Got a 401(k) Question?

• Lowenstein: Is the Fed Really Helping Us?

Published by arrangement with The Penguin Press, a member of Penguin Group (USA), Inc. Copyright Roger Lowenstein, 2008.