Is Chicago’s $10 Billion Pension Bond Sale Decision the Answer?

State’s bond history and already badly funded pension shows little room for maneuver.

Chicago is considering a massive $10 billion bond sale to fix its floundering pension system, and while the decision could come as early as this week, is it really the only option?

The Second City’s municipal pension fund has a $28 billion funding gap, and Chicago Mayor Rahm Emanuel hopes the taxable $10 billion debt investment’s returns will beat the city’s interest payments on the bond to help pay off the problem.

If successful, the move will alleviate some of the pain and preserve the funds for retirees. Failure, however, would mire the city in debt, diminish its credit rating —which was upgraded to an A rating by the Kroll agency in February to help move the potential biggest pension bond—and potentially bankrupt it. Similar bond issues helped Detroit and San Bernardino, California, to go belly up. The state of Illinois, whose pension plan is only 36% funded, is not in much better shape than Chicago.

Moody’s Investor Service, however, has kept the city at a junk bond rating. On the bright side, Moody’s revised the city’s outlook from negative to stable in July, and also raised the bond rating for the Chicago public schools one notch, from B3 to B2.

Carole Brown, Chicago’s chief financial officer, is expected to give her recommendations to Mayor Emanuel this week or sometime in September, reports the Chicago Tribune. Brown could not be reached for comment.

The hope is that the bond proceeds could be invested to garner a return that is larger than the expected 5.25% interest rate. A recent example where this strategy has worked is Houston, which issued a $1 billion pension bond last year. Moody’s Investor Service labeled the Texas move “credit positive,” reports The Wall Street Journal.

The municipal pension’s current interest rate and rate of return are currently at 7%.

Investment returns can vary, and the possibility of a recession in the next year or so would surely harm them.

“It’s a sign of distress,” Alan Schankel, a bond analyst and managing director/municipal strategist at Janney Montgomery Scott, told CIO. “It also reduces the community’s flexibility because you have to pay bond interests and now you’re locking that in, whereas you have some flexibility on pension payments.” He said that years of unpaid state contributions is what brought the Windy City to its current situation.

Schankel said that other options are to increase revenues by either raising taxes or cutting expenses, such as by closing public pools and pulling back on police, firefighters, or educational outlays. Some tax increases have been made over the past few years, but they’re still not enough. It’s also unlikely that politicians such as Emanuel, who is up for re-election in November, would raise taxes or cut police and firefighter spending.

Another way to boost income is for Chicago to go to the state, but due to Illinois’ lack of funds, it’s unlikely the state will be willing to cut the city a pension check anytime soon, as it too recently considered a titanic $107 billion bond sale.

This is also not the first time Illinois has tried to bail out its pension debt with bonds. It also did a $10 billion bond sale in 2003, but then-Gov. Rod Blagojevich’s mismanagement of the money only helped create a larger bubble that’s one pinprick from bursting. Since the ’03 bond sale, the pension deficit has tripled, according to Crain’s Chicago Business.

“To be honest, there may not be a solution. The solution might be restructuring,” Schankel said, although the state is very protective of its benefits laws. “It would take perhaps a constitutional amendment for Illinois to be able to do that…or maybe a negotiated settlement with unions to reduce pensions. That would be pretty hard to imagine.”

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