There may be a mayoral runoff going on in the nation’s third largest city, but whichever candidate wins the April 7 contest will probably wish they hadn’t.
Moody’s downgraded Chicago’s rating to just two steps above junk. The action may trigger a series of financial maneuvers with the city’s creditors that could cost tens of millions of dollars.
Chicago is already facing a $300 million structural deficit. The downgrade means they are going to have to spend a lot more to finance that deficit — if they can finance it at all.
Chicago drew closer to a fiscal free fall on Friday with a rating downgrade from Moody’s Investors Service that could trigger the immediate termination of four interest-rate swap agreements, costing the city about $58 million and raising the prospect of more broken swaps contracts.
The downgrade to Baa2, just two steps above junk, and a warning the rating could fall further still, means the third-biggest U.S. city could face even higher costs in the future if banks choose to terminate other interest-rate hedges against fluctuations in interest rates. All told, Chicago holds swaps contracts covering $2.67 billion in debt, according to a disclosure late last year.
“This is an unfortunate wake-up call for anyone still asleep over the fiscal cliff facing the city of Chicago,” said Laurence Msall, president of the Chicago-based government finance watchdog, The Civic Federation.
Chicago’s finances are already sagging under an unfunded pension liability Moody’s has pegged at $32 billion and that is equal to eight times the city’s operating revenue. The city has a $300 million structural deficit in its $3.53 billion operating budget and is required by an Illinois law to boost the 2016 contribution to its police and fire pension funds by $550 million.
Cost-saving reforms for the city’s other two pension funds, which face insolvency in a matter of years, are being challenged in court by labor unions and retirees.
State funding due Chicago would drop by $210 million between July 1 and the end of 2016 under a plan proposed by Illinois Governor Bruce Rauner.
Given all the financial pressures, both Moody’s and Standard & Poor’s, which affirmed the city’s A-plus rating, warned on Friday that Chicago’s credit ratings have room to sink.
Moody’s said Chicago’s rating could be cut if Illinois courts find pension reform laws enacted to shore up the state’s financially ailing pension system and for two of Chicago’s retirement systems are unconstitutional. A ruling by the Illinois Supreme Court on one of the laws could come as early as this spring.
S&P warned of a multi-notch downgrade if the city fails to come up with a sustainable plan this year to pay its escalating pension contributions.
Why should we care if Chicago goes belly-up? It’s questionable whether the city could file for bankruptcy like Detroit. The $32 billion in unfunded pension liabilities is 10 times greater than the Motor City’s pension crunch. Chicago is nearly 4 times bigger than Detroit and any bankruptcy judge is going to be forced to cut police, firefighters, teachers, sanitation employees — the entire panoply of municipal workers, leaving residents underserved. Also, unlike Detroit, Chicago is not being depopulated. The city lost less than 1% of its population since 2010 while Detroit dropped 3.5%
Given that Chicago’s pension funds are funded, on average, only about 40%, and the city’s deficit is expected to grow thanks to an exodus of businesses and high income individuals, bankruptcy would probably not fix what ails the city. In fact, it would probably worsen the fiscal situation and cause civic chaos.
That’s why, unlike Detroit, Chicago might come begging to Washington for a taxpayer funded bailout before it goes bankrupt — something along the lines of the 1975 bailout of New York City that was first resisted by President Ford but eventually approved by Congress.
But before Washington accedes to the city’s needs, Congress should read this investigation of how city government finances itself:
When municipal officials want to build for the future, they have a powerful financial tool at their disposal: general obligation bonds that yield millions of borrowed dollars. The money is meant to let cities move forward on costly projects that will serve the community for decades.
But in an unprecedented analysis of Chicago’s finances, a Tribune investigation found that city officials have long abused their borrowing privileges, spending funds meant for long-term initiatives on problematic short-term expenses from library books to legal settlements.
Residents know little about it, as Illinois law doesn’t require Chicago to ask voters’ permission before issuing bonds. And when the city can’t pay what it owes, it uses yet more borrowed money as leverage to push off payments on old bonds.
This pattern of fiscal recklessness, which started under former Mayor Richard M. Daley, created a mountain of debt that threatens the financial future of the city. Now Rahm Emanuel is groping for ways to deal with the problem along with a looming pension crisis and chronic budget deficits.
Any bailout deal should make this practice illegal and require the city to come up with a sound plan to pay down that debt in a reasonable manner.
City government policies have driven businesses out of the city, made it difficult to start a business or relocate a business to the city, and punished taxpayers who are successful with ruinous taxes. This has resulted in a shrinking tax base — not nearly as bad as Detroit’s debacle but obviously serious enough to wreak havoc on Chicago’s budget.
This crisis is entirely of the city’s own making and before any federal bailout is granted, massive, meaningful reforms will be necessary that deal with the short term crisis as well as the potential debt bombs in the future.