Chicago is head and shoulders over Detroit, but the city is “paying Detroit’s bills” now that a $30 billion pension crisis has dropped the city’s bond rating to junk status, a municipal finance expert warned Tuesday.
Matt Fabian, a partner at Municipal Market Analytics, told a tale of two cities during a lively panel discussion on city finances before a packed house at a City Club of Chicago luncheon.
“Detroit is Iraq. Detroit is a disaster zone. They have no economy. Their economy is in the rubble. They have raised revenues repeatedly, and it’s been unsuccessful,” Fabian said.
“Chicago is the third-largest city in America. It’s nothing like Detroit. Chicago is a real city. There are people. There are jobs. There are solutions. There’s growth. If anything, the Loop is too crowded. It’s a completely different ballgame.”
But Fabian said Chicago is “paying Detroit’s bills” when it comes to the hundreds of millions of dollars in penalties and higher interest rates it will pay, now that its bond rating is no longer investment-grade.
“Chicago may not have been downgraded below investment grade if Detroit hadn’t happened . . . Detroit fractured trust between borrowers and lenders in the municipal bond market. That has created an extra cost for Chicago. Now, trying to assure those same investors that it is not going the same way” will cost more, Fabian said.
“The longer the city waits, the more expensive the solutions will become. If the city had changed course five years ago, four years ago or three years, they wouldn’t be in this position now. Interest rates for the city’s debt wouldn’t have risen by one- or two-hundred basis points in the last few days.”
Fabian said Detroit “taxed as much as it could” and still “ran out of revenue.” Chicago and Illinois, by contrast, have a problem that’s “absolutely on the revenue side. . . . They have not taxed the way others have,” particularly when it comes to the third rail of local politics: raising property taxes.
“A 50 percent property tax hike would be destabilizing. But a modest property tax increase” will likely need to be part of the mix, he said.
Joining Fabian in discussing the fiscal cliff Chicago is nearing were Civic Federation President Laurence Msall and Rachel Cortez, a vice president with the U.S. Public Finance Group of Moody’s Investors Service.
Moody’s is the Wall Street rating agency that dropped Chicago’s bond rating to junk status after the Illinois Supreme Court overturned state pension reforms and placed Mayor Rahm Emanuel’s plan to save two of four city employee pension funds in similar jeopardy.
Emanuel has branded the double-downgrade by Moody’s “irresponsible,” “far beyond reality” and “out of step with other rating agencies — by as many as six steps.”
He has further accused Moody’s of trying to “force a decision” on a post-election property tax increase “while we’re in active negotiations” with police and fire unions on cost-saving reforms.
On Tuesday, Cortez was on the hot seat to explain why the rating agency had gone so much farther than its competitors in downgrading Chicago when it was the state reforms that were thrown out.
“Our interpretation of the Supreme Court decision on May 8 was that benefit reductions are not permissible. That . . . warranted a movement of the rating,” Cortez said.
Cortez was asked whether it was “irresponsible” for Moody’s to drop Chicago’s bond rating to junk status — and impact the market — while the city was poised to convert $800 million in variable-rate debt to fixed-interest rates.
The city has still not pulled the trigger on the first phase of that refinancing as it attempts to get the best price under difficult circumstances.
“We cannot consider that. Our analysis is independent. It’s subjective. We cannot forebear. When we think a rating needs to be placed at a certain level, we have to take rating action and we cannot let those sorts of concerns guide our opinion,” she said.
At $26,000-per-person, Chicago has twice the debt and unfunded pension liability that Detroit has and $8,000-a-person more than New York City.
Still, Cortez said, there is only a “5 percent probability” that Chicago will default on its bonds.
She also noted that Chicago has “tools available” to “reverse the trajectory.” That’s even though there are hurdles to overcome, including a court ruling on Emanuel’s previously negotiated reforms to the Municipal and Laborers pension funds.
“If that is overturned, we’ll look to see what the city will do in response. If the city will seek new legislation that will allow it to increase contributions to those plans, that will be something that will factor into our rating decisions going forward,” she said.
“We’re also going to see how the city will fund its police and fire pension contribution due in 2016. That’s a pretty steep increase, and we’ll be looking to see how the city accommodates that in the 2016 budget.”
Msall said bankruptcy is “not a foregone conclusion” for Chicago or its public schools provided the Illinois General Assembly “uncuffs” the city and assumes responsibility for teacher pensions.
But Msall said he was in Springfield the other day and does not see the “sense of urgency” that Chicago’s financial crisis should have triggered.
“We cannot allow our elected state representatives, senators and the governor to think that we can fix the state’s budget on paper and allow the city of Chicago and, in particular, the Chicago Public Schools to swing in the wind and think we can call that victory,” Msall said.
“The biggest immediate challenge for the city will be — in addition to managing the debt and its continued need to go to the market now more than ever because of the downgrade and the triggers that sets off — [is] how do we get the Chicago Public Schools open with a $1 billion budget deficit, of which $700 million is pension contributions for the coming year with the Supreme Court ruling. . . . It has to come from Springfield.”
Msall said it would have been “inconceivable” five years ago that Chicago’s bond rating would be at junk status, adding, “It’s a terrible place to be.”
And he argued that it’s a crying shame that former Mayor Richard M. Daley so badly bungled the 75-year, $1.15 billion deal that privatized Chicago’s parking meters by the way he structured the lease and spent the proceeds instead of using them to reduce the daunting unfunded pension liability.
“There is an enormous distaste now — not just for parking meter privatization, but for any privatization or alternative service deliveries that are offered,” Msall said.
“And that’s a shame because, when you’re the worst-rated credit of any municipality in the United States — with the exception of Detroit, which has already filed for bankruptcy — you need every option available.”
Tuesday’s City Club audience included Ald. Joe Moore (49th), one of 50 aldermen who will soon be forced to bite the bullet.
Does Moore agree that Chicago has a “revenue problem” that will require a post-election property tax increase and a whole lot more?
“We have a revenue problem. We have, to a lesser degree, a spending problem. And we have to tackle those problems from both of those vantage points,” Moore said.
“You’re never gonna get me to say that our property taxes are too low [compared to the suburbs]. But you will get me to say that our financial situation, as these experts have so clearly outlined, is very dire and we have to undertake steps to address that. And that obviously will involve some painful choices on the revenue side.”