By: Mark Glennon*
In Chicago, “they do things they don’t do on Broadway,” goes that Frank Sinatra song, My Kind of Town.
They also do things they don’t do on Main Street, and for good reason.
So it was for $1.5 billion of new bonds issued by the city last week. Bond buyers liked it, but should service recipients and taxpayers?
Imagine refinancing your mortgage to get a lower rate. However, instead of taking the savings over time in the form of lower payments, you’re able to get your lender to give you those savings in cash up front, which you quickly blow on current bills.
That’s what Chicago did in its refinancing. The city faces an $838 million budget gap this year. Forty percent of the plan to fill that hole relies on on-time measures which include that $210 million of cash up front from the refinancing. It won’t be replicated next year, when some other source must be found.
The new bond offering, however, was more popular with investors than expected so the city was also able to pocket some additional money for use next year, according to The Bond Buyer, though the amount is unclear.
Why did investors like the deal so much? Largely for reasons that should frighten everybody else. To ensure that investors are paid ahead of others, even in bankruptcy, the city again relied on conveyance of full ownership of certain assets – its share of future sales tax revenue that flows to it from the state.
A Bloomberg article called that approach alchemy turning junk into gold. We’ve called it a sale of body parts, and we’ve been warning about its dangers since the idea first surfaced in the state legislature. In the business, they are called a securitized bonds. About two-thirds of the new bonds sold were securitized. The seller of the bond is actually not the city, but an entity called Sales Tax Securitization Corporation, into which Chicago transferred ownership of the future sales tax money.
The arrangement is all about bankruptcy. Some may still scoff at the possibility that Chicago will go bankrupt, but municipal bond investors fear exactly that for Chicago and other Illinois municipalities. To sooth them, the Illinois General Assembly in 2017 authorized the new form of secured bonds, the purpose of which is indeed to make sure that bondholders will get paid in full in bankruptcy if there’s not enough money for everybody. Taxpayers, service recipients and unfunded pension obligations, being junior, would get cut.
The more the city resorts to securitized bonds, the higher the risk of the worst scenario, which is an assetless bankruptcy. The city then would have nothing to work with to get a fresh start even in bankruptcy.
Couldn’t the state just change the law that created securitized bonds if Chicago ever really needed help? Sorry, that law contains a “nonimpairment” covenant by the state prohibiting any such attempt.
The way the law authorizing securitized bonds was passed in 2017 was scandalous. The bill’s House sponsor, Barbara Flynn Currie, flagrantly mischaracterized it, denying on the House floor that it had anything to do with bankruptcy, though it plainly did. After a veto by former Gov. Bruce Rauner, it was stuck in the 756-page budget-implementation bill in the closing hours of the legislative session, which lawmakers had only hours to read. A lawmaker who opposed the new law, then Rep. Jeanne Ives, gave a scorching summary of the sordid affair linked here.
It gets worse. That future sales tax revenue used in the new deal was already sold off. So, for the new bonds, the city conveyed a junior interest to the buyers. Think of it as a junior mortgage on body parts already pawned off.
The city also benefited from an exceptionally good market for municipal bonds. From The Bond Buyer: “The municipal market has been on a tear and Chicago is benefiting from a demand imbalance,” said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners. “It doesn’t portend that things are getting better and it’s not an endorsement” that Chicago finances have improved.
That strong market also enabled the city to tack on a tender offer for older bonds which generated another $40 million in savings. A tender offer like that is a “rare move for a city not in bankruptcy,” said Caitlin Devitt on Twitter. She’s a reporter for Debtwire Municipals. Details on that aspect of the new bonds are still murky.
The bottom line on all this should be clear. The city made bond investors happy but most of the savings from it will be gone quickly and won’t be available next year. The structural budget gap remains and the political establishment has nothing on the table to fix it.
“Chicago, Chicago — that toddlin’ town,” says that same Sinatra song.
The toddlin’ continued for now, but the music will end at some point.
*Mark Glennon is founder of Wirepoints.