Chicago debt downgraded to junk status

Chicago mayor Rahm Emanuel must be wondering why he bothered to get re-elected.  The unfunded pension liability financial crisis that the Windy City has been ducking for years now just got a step closer to what everyone dreads: catastrophic property tax increases.  After all, the average Chicago household owes $83,000 (as of 2013) as its share of the city’s debt and unfunded pension costs, and paying that nut off is going to be painful for those residents who do not flee when the fan really gets its excrement coating.

Photo credit: Chicago Sun-Times

What triggered the downgrade was an Illinois Supreme Court ruling.  Fran Spielman of the Chicago Sun-Times explains:

The decision to drop the bond rating that determines city borrowing costs — from Baa2 to Ba1 with a negative outlook — comes just days after the state Supreme Court unanimously overturned state pension reforms and placed Emanuel’s plan to save two of four city employee pension funds in similar jeopardy.

The rating applies to $8.1 billion in general-obligation debt, $542 million in outstanding sales tax revenue debt and $268 million in outstanding and authorized motor fuel tax revenue.

“Based on the Illinois Supreme Court’s May 8 overturning of the statute that governs the State of Illinois’ pensions, we believe that the city’s options for curbing growth in its unfunded pension liabilities have narrowed considerably,” Moody’s wrote.

“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.”

Moody’s noted that the “magnitude of the budget adjustments” that will be required to solve the combined, $30 billion pension crisis at the city and public schools are “significant.” Chicago’s tax base is “highly leveraged by the debt and unfunded pension obligations” of the city and overlapping governments, the rating agency said.

Chicago has already sold off many assets, such as parking meter revenue, an airport, and other revenue-producing assets.  Now, with this downgrade, it will have to pay higher interest rates, and even worse, some complicated deals, rate interest swaps, it just completed are going to unwind:

Budget Director Alex Holt said Tuesday the city plans to forge ahead with that plan, even though “swaps that overlay variable rate debt” could be called in immediately as a result of the double-downgrade.

“If they do, there will be termination payments we’ll need to make. But we were going to take out $200 million in variable rate debt anyway over the course of this year,” Holt said.

As for the city’s ability to borrow to fund capital projects, Holt said, “We think the capital markets will continue to be available to us. We think investors still have confidence in the city.”

Moody’s described the penalties in much more dire terms.

“Immediate credit challenges include potential draws on liquidity associated with rating triggers embedded in the city’s letters of credit, stand-by bond purchase agreement, lines of credit, direct bank loans and swaps,” Moody’s wrote.

“The current rating actions give the counterparties of these transactions the option to immediately demand up to $2.2 billion in accelerated principal and accrued interest and associated termination fees.”

Chicago’s financial crisis reflects decades of financing the Daley political machine with patronage jobs (such as that held by Michelle Obama’s father) handed out to campaign supporters.  In order to disguise the cost of these jobs, lavish pensions (to be paid for by future taxpayers) were handed out, and not funded.  But the future is now, and Moody’s recognizes it.

It is going to get very ugly when Chicago starts raising taxes to pay for its debt.  Unquestionably, businesses and residents will flee, the tax base will decline, and the burden on the remaining residents and businesses will spiral.  This is exactly what happened to Detroit.  Pretending it won’t happen to Chicago is dreaming.  

Hat tip: Peter von Buol, Michael Bargo