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Brown: Bond rating downgrade is bad news for you

Moody’s decision this week to downgrade Chicago’s bond rating to junk status doesn’t automatically make us America’s next Deadbeat City.

But make no mistake: It’s a frightening step in that direction.

At its most basic level, the Moody’s downgrade is a giant warning sign to the large institutions that lend money to the city.

“Watch out, folks,” the sign reads. “It’s getting more likely by the day Chicago won’t be able to pay you back.”

Maybe that explanation leads you to believe you don’t have anything to worry about. After all, you didn’t lend the city any money or buy any city bonds.

The reality is quite different. If you’re a city resident, you’re the borrower in this situation, and that bond downgrade is nothing but bad news for you; probably for suburbanites, too.

As you may know from personal experience, the banks always want their money and there are unpleasant consequences if they don’t get it. That money has to come from somebody.

I walked back from the Daley Center on Wednesday after watching lawyers representing Mayor Rahm Emanuel and city retirees mix it up over whether last week’s Supreme Court ruling that overturned state pension reforms applies to the city’s new pension law as well.

If a court rules it does apply (as seems likely to me), then Moody’s warns the city could be in store for a further downgrade, and at that point, those comparisons to Detroit will seem less silly.

Looking around at the bustling city in the gleaming light of a brisk spring day, signs of prosperity everywhere from construction cranes to new restaurants, it was hard to imagine I was in a place on the verge of financial calamity.

Unfortunately, beneath the surface of that prosperity is a city government drowning in debt, the highest per person debt among the 10 largest cities in the U.S.

Part of the debt is money owed for those pensions to city workers and teachers, money that was never set aside as it should have been. Part of it is plain old unrestrained borrowing, mostly from the Richard M. Daley years, to keep city government afloat and maintain that veneer of progress.

In a court document filed in December in connection with the city pension lawsuit, city Chief Financial Officer Lois Scott set forth Chicago’s money problems so plainly that even I think I understand.

Scott was trying to explain to the judge what would happen if the city experienced exactly the sort of credit rating downgrade that Moody’s announced this week.

In essence, the city must borrow money to conduct its business, not only for capital improvement and maintenance projects but also for operations.

When the bond rating falls as it has now, the cost of that borrowing goes up by hundreds of millions of dollars. Repaying that interest crowds out the delivery of basic city services.

In addition, Scott warned, a downgrade could cost the city $350 million immediately in termination costs on existing city borrowings and force the city to refinance up to $3.75 billion in various credit instruments — “all on substantially worse terms than the city has now.”

Beyond that, a downgrade means there are fewer banks willing to lend money to the city the next time, along with a shrinking pool of institutional investors willing and able to purchase the city’s debt.

“Given these realities,” Scott told the court, “additional downgrades could quickly send the city’s finances into a downward spiral and leave the city unable to obtain sufficient financing. The result would be massive cuts in spending for infrastructure, capital projects and essential services, including public safety.”

Now those downgrades are a reality.

Some of the retirees following the pension case believe Scott was crying wolf.

I think Scott, who recently announced she isn’t sticking around for Emanuel’s second term, was scared to death about what she would have to do if it came to this.

I’m sure you want to know what’s going to happen next, and I think the scariest part is that we’re getting into uncharted territory where nobody really knows.

But don’t be surprised if you start hearing the word “default” a lot.