By Ted Dabrowski and John Klingner
Chicago Mayor Rahm Emanuel has floated a new plan to borrow $10 billion to plug part of the city’s nearly $30 billion dollar pension hole. It’s a horrible idea and it needs to be slapped down for two key reasons: First, it simply won’t work. You can’t borrow your way out of a debt problem.
Second, it requires Chicago to sell parts of its financial future. To make the borrowing work, the city will have to pledge future tax revenues to its bankers. And that means prioritizing bondholders over Chicagoans in case of bankruptcy.
1. Borrowing simply won’t work. Illinois already has a miserable history of borrowing through pension obligation bonds. Chicagoans and Emanuel would be wise to learn from that history by avoiding it altogether.
In 2003, Gov. Rod Blagojevich came up with the idea of borrowing $10 billion from the bond market so he could plug part of the state’s then $43 billion pension hole. He sold the illusion that taking on a new debt to pay down another one was the equivalent of pension reform. And everyone bought it.
The result? Fifteen years later, the state’s unfunded pension liability is at $129 billion, three times higher than what it was in 2003.
And Illinoisans will be paying off the bond borrowings until 2033 – there’s still $13.6 billion more in principal and interest left to go (COGFA, appendix N).
The idea was a disaster in many respects. It didn’t fix the pension problem. It delayed real pension reform. And, as always, arbitrage is a dangerous game to play, especially when it’s taxpayer money.
What’s worse, the borrowing didn’t end with Blagojevich. Gov. Pat Quinn copy-catted the idea by issuing $3.46 billion and $3.7 billion of POBs in FY 2009 and FY 2010, respectively.
That’s had a real impact on Illinois’ overall debt burden – excluding pensions – since 2000.
In fact, Illinois politicians are so addicted to debt that they’ve even considered an impossibly massive POB. Illinois Rep. Robert Martwick (D–Chicago) proposed $107 billion in pension borrowing earlier this year. It was met with wide criticism, including from Wirepoints, for good reason.
The bottom line is governments can’t borrow their way out of a debt problem. That’s easy to see in the state’s growing pension shortfalls year after year.
Which makes Emanuel’s proposal all the more absurd. He wants to pull a page from the Blago playbook to resuscitate the city of Chicago’s nearly bankrupt pension plans. His CFO Carole Brown formally floated the idea of a $10 billion pension obligation bond recently with a group of investors, as reported by Reuters and the Bond Buyer.
But it’s easy to see why a politician like Emanuel might try something like this. The city’s finances are temporarily off the edge of a fiscal cliff – Moody’s recently removed a negative watch from the city’s credit rating – so Emanuel has wiggle room to try and paper over his fiscal and political challenges.
By borrowing the money and putting it into pensions, making them nearly 50 percent funded, he’s hoping to change the required jump in city contributions that’s coming in a few years. If nothing is done, city contributions next year will be $1.2 billion and then jump to $2.1 billion in 2023.
The city will obviously have to pay down the cost of the POB over time. But through the securitization scheme described below, Rahm would hope to negotiate a funding plan that defers repayment of the bond for as long as possible.
But borrowing doesn’t solve Chicago’s structural pension problem. Chicago’s costs will skyrocket again when the city is forced to more honestly calculate its pension promises. A more conservative assessment by Moody’s Investors Services in its July 13, 2018 Credit Opinion puts the FY 2017 unfunded liability for the city’s four pension funds at $42.1 billion – nearly $14 billion more than the funds’ official numbers. That increase is not even contemplated in future pension contributions.
2. It requires Chicago to pledge financial assets. The borrowing plan is even more insidious than that. To induce bond investors to lend money cheaply – the city is junk rated by Moody’s – Emanuel and team are willing to pledge more and more of the city’s future revenue streams to bondholders. That kind of deal prioritizes bankers over everyone else, including city residents, over who gets those funding streams.
According to Reuters, “Brown said she would look to the most-cost effective financing model, noting the current model was Chicago’s Sales Tax Securitization Corp, which has been able to issue higher-rated debt by giving investors a statutory lien on the city’s share of state sale taxes.”
That means Chicago has already pledged some of its future sales tax revenues to bondholders. Next up could be local government shared revenues, personal property replacement taxes or motor fuel taxes. As Wirepoints’ Mark Glennon likes to say, Chicago is selling off body parts to generate funding. If bankruptcy comes, there’ll be far less left to fund city services for residents. The bankers will have priority over city revenues, not Chicago residents. And Chicago could find itself in an “assetless bankruptcy.”
Rather than restructuring and scaling back spending, Emanuel is taking risk with everyone’s money with a POB, including those dependent on core government services
It’s easy to see why Emanuel might be so attracted to the idea of borrowing to fund pensions.
If the city successfully issues bonds, Rahm will be able to say he “fixed” the city’s pension crisis. In the short term, he won’t have raise taxes on residents or try to pass actual pension reforms that anger the city’s unions.
That helps his reelection chances. And if he does it right, he might remove a lot of pressure from his entire next term, assuming he wins.
But in the long run, nothing he’s doing solves the underlying risk of insolvency for Chicago. Chicagoans still face the same amount of debt, pensions remain unreformed, and every risk that existed before still remains.
Emanuel’s game only kicks the can down the road…and the can keeps getting bigger and bigger.