Is Chicago Heading Toward Bankruptcy?

Published June 2, 2015

Moody’s Investors Service, a credit rating agency headquartered in New York City, is downgrading Chicago’s government-issued bonds to one of its lowest ratings, citing the city’s massive underfunded pension liabilities as a significant credit risk for investors.

Labeling Chicago’s debt as “Ba1,” or “junk,” increases the city’s financial costs, as fewer banks will lend money and fewer investors will purchase bonds. Loans from banks that choose to lend the city money will have higher interest rates compared to cities with better credit ratings.

‘A Lot of Tumult’

Municipal bankruptcy is not currently a legal option for struggling Illinois cities, but Bill Berman, director of research for Truth in Accounting, says that may change in the near future.

“It’s something that could possibly happen, depending on Springfield and how it plays out in the legislature,” Bergman said. “In the next two or three years, we might have the kind of pressures in our cities’ and state finances that lead to a lot of tumult.

“It’s still possible, and it’s sad that it is a possibility,” Bergman said. “Some people think [bankruptcy] the right thing to do, and it’s a very sad situation.”

Outlook: Negative

Moody’s analysts are pessimistic about Chicago’s economic future, expecting the city’s problems to continue to worsen. In May, the Illinois Supreme Court ruled cuts in pension payments to public sector retirees violated the state’s constitution.

“We believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably,” Moody’s Investor Service (MIS) Analyst Matthew Butler wrote in the report. “Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures.”

‘Fund the Pensions’

Don Ohannes, a former municipal financial analyst for Allstate Insurance Company and current member of the National Federation of Municipal Analysts, says Chicago elected officials should accept the truth behind the downgrade and make a priority of finding a way to fund the city’s pension plans. Ohannes is also a policy advisor for The Heartland Institute, which publishes Budget & Tax News.

“The only advice I would give the mayor is to concentrate on finding a way to fund the pensions,” Ohannes said. “Because of the downgrade, it will cost more to borrow, which will have a negative impact on the budget.”

Chicago Mayor Rahm Emanuel has criticized the MIS report as “irresponsible,” but Ohannes says city officials should work with Moody’s to identify and fix the problems listed in the report.

“Rather than getting into a contentious relationship with Moody’s, I would hire an outside consultant to work with Moody’s to attempt to remedy the problems that have led to the downgrading,” Emmanuel said. “That will not be an easy task. You have to remember that the mayor inherited the problems that led to the downgrading, and that during his first term he did nothing to right the ship.”

Identifying the Problem

Bergman says bankruptcy hurts cities and their taxpayers, but facing facts will help Chicago avoid what he calls an “unfortunate way” to resolve financial crises.

“Everybody takes a hit [under bankruptcy], and it’s an unfortunate way to resolve very difficult problems,” said Bergman. “More importantly, I think we’ve got to try to address the reasons why we got into this situation in the first place. Part of the way out is being honest, as soon as possible, about our own knowledge of the finances and how we present those finances to the public.”

Jesse Hathaway ([email protected]) is managing editor of Budget & Tax News.