Monday, June 1, 2015

Chicago's Financial Dance of Veils

Chicago's pension funding problems and recent credit rating downgrade from only one of the three credit rating services has caused some salesmen who are also bloggers/commentators to try to work a fear frenzy that Chicago will go bankrupt and provide them with willing victims/clients.  In fact, Chicago's bond auction last week was significantly over subscribed providing a lower yield.

While the situation is serious and in need of fundamental restructuring of current bonds and the funding process, Chicago is not likely to go bankrupt.  The Illinois General Assembly is currently considering two bills: one would allow a Chicago casino with the profits going towards the pensions but the bill is being held and the other which allow a five year slow down in pension payments has, as of Sunday, passed both houses.  Chicago pension funding costs were going from approximately $300 million to approximately $840 million next year, but the legislation would decrease next year to approximately $619 million with annual increase each year (but less than current law) until 2020 when payments would be calculated to meet 90% full funding by 2055 (15 years longer than current law).  This is just punting the ball down field to a future date.

Kristi Culpepper, writing as munilass, has written three excellent posts which explain Chicago's situation, credit rating analysis, and the municipal bond market.

The first was how Chicago has used financial engineering to paper over its extensive budget problems.  One of the positives of Chicago's bond auction last week was the beginning of the necessary process to convert variable interest rate bonds to fixed interest rate.

The second details shopping for ratings and the insolvency of the Chicago school system.

The third evaluates Chicago's fiscal emergency and the quality of credit analysis.  One issue she discusses is the relatively low effective residential and commercial  property tax rate in the city of Chicago compared to other Cook county municipalities.  Chicago should be looking at the property tax base and optimal taxation, but they are probably not familiar with the economic work of Frank Ramsey.  Additionally, there are some politicians in both parties in Illinois who want to freeze property taxes.

If you are looking for a current analysis of Chicago and its municipal bond problems, you need look no further than these three articles by Kristi Culpepper (munilass).

The Chicago problem precedes current Mayor Rahm Emanuel who, despite is "experience" in finance, has not substantially helped the situation other than to ask for bailouts.  The failure of the city of Chicago to properly fund its pensions over the years and put off payments until the problem becomes a potential crisis (not to mention the State of Illinois doing the same inadequate delayed funding with the worst funded pension systems of any state).

All of this a financial dance of veils.  What happens when the veils fall?  Chicago had better be in better fiscal shape.  And they can sell only so many parking meters and skyways.  How about the El, subway, bus system, and ....?

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