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By: Ted Dabrowski and John Klingner

Seems there’s very few willing to stand in the way of Chicago Mayor Rahm Emanuel’s harebrained $10 billion pension bond idea. Not the press, not the City Council, and certainly not the city’s civic institutions.

Fortunately, the market just might. Rising interest rates and a jittery stock market could kill Emanuel’s bad idea before it’s ever formally proposed.

The mayor is looking for any move he can make to protect his legacy from a looming pension disaster. He thinks he’s found it in a pension funding scheme known as a pension obligation bond, or POB. That scheme would borrow $10 billion from the bond market, put the money into the city’s four pension funds – boosting them to more than 50 percent funded – and leave Chicagoans paying back that $10 billion borrowing over some 35 years.

Emanuel’s goal is to borrow the money as cheaply as possible. Then hope the borrowed billions make more in investment returns than it costs to pay back the interest on the bond.

The idea is irresponsible, a can kick and a reckless gamble. It’s not pension reform; it only delays real reform. Wirepoints covered that here, here and here.

Emanuel publicly put his $10 billion bond plan “on hold” recently, but that means next to nothing in Chicago politics. Lame-duck Emanuel still has plenty of time to bring a last-minute deal together before he leaves office – just like Mayor Daley did with the parking meter fiasco.

Emanuel can ignore the multitude of experts who’ve criticized the bond plan. Fortunately for Chicagoans, he can’t ignore the market.

Higher interest rates may make the POB math unworkable, killing the deal before it starts. And the jittery stock market may help aldermen realize just how risky the POB bet is anyway.

Interest rates rise

The cost of borrowing is quickly becoming more and more expensive. The interest rate on the 10-year treasury bond has risen to the highest it’s been since August 2011.

If interest rates keep climbing as they are, it will be very difficult for Emanuel to borrow money at the cheap rate he needs for the POB to even be worth the gamble. Chicago CFO Carol Brown reportedly said that as rates go up, borrowing “makes less sense,” and is even “infeasible” if interest rates go up another percentage point (100 basis points).

That’s true even with Emanuel securing lower rates by selling off city assets through the city’s securitization scheme.

Jittery markets

And even if Emanuel manages to borrow the $10 billion at a low rate, the riskiness of the stock market could still kill the plan.

Investing $10 billion now, at what could be the top of the longest-ever bull market, is a terrible idea. The markets are already jittery. Over the past week alone, the Dow lost over 7 percent of its value in just over a week.

A big correction could happen any time, given the volatility of the market and the current geopolitical environment. That fact alone should give aldermen reason to oppose Rahm’s POB.

A major market downturn could eventually turn the POB into a bad gamble for Chicago. It’s what happened when the CTA issued its own POB back in 2008. And it’s what happened in both Stockton, Calif., and Detroit.

Steven Malanga from the Manhattan Institute explains what happened to those cities:

“The problem is that those kinds of returns are far from a sure thing. That’s why pension bonds have been behind some of the biggest fiscal meltdowns in recent years. Stockton, Calif., for instance, borrowed $125 million in 2007 to bolster its underfunded retirement plans and gave the money to California’s public-pension system to invest. The system’s investment professionals promptly lost more than a quarter of the principal, exacerbating an already-emerging crisis, which provoked city officials to file for bankruptcy.

Detroit, eyeing the same kind of sharp increases in pension payments that Chicago faces, created a complex pension-financing scheme in 2005 to raise money by circumventing Michigan’s limits on municipal debt. After the market crashed in 2008, the deal blew up. A financial manager brought in to clean up the mess took one look at Detroit’s retirement obligations and hauled the city into federal Bankruptcy Court.”

Legacy over reality

Emanuel wants the POB to avoid a near-term pension crisis that could tarnish his legacy as mayor. He’s willing to gamble with $10 billion dollars of taxpayer money to avoid that crisis.

It’s potentially a great deal for the mayor, but a terrible risk for Chicagoans.

 

Read more about Chicago’s potential POB:

 

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Craig

It’s obvious Chicago and Illinois will eventually default on their obligations after the next significant recession or two. Anyone who purchases these bonds should understand that they are likely making a donation and will only get a small portion of their investment back. Transferring the pain from pensioners to voluntary contributors might be the best possible outcome.

Buh-bye

I don’t think reality has any impact on Tiny Dancer’s ego trip