Chicago Attempts To Bail Itself Out by Neene Jenkins
More than a year after Chicago’s pension predicament sparked a wave of rating downgrades, have the city’s efforts to reduce the amount of its underfunding been enough? Despite significant progress, we don’t think so.
It’s not for lack of trying. Chicago’s decision makers—with occasional help from the state legislature—have taken the following steps over the past year to reconcile the budget gaps created by the underfunded pension:
- Approved the largest property-tax increase in decades and dedicated $544 million in proceeds to fund the police and fire pension plans; the tax is phased in over four years, ending in 2018
- Secured state legislative approval to reduce annual pension contributions to the above pension plans, despite the objection of the governor; this temporary reduction expires in 2020 when costs will again rise based on the actuarial health of the pension funds
- Attempted to reduce liabilities for municipal and laborer pensions, which was later struck down by the Illinois Supreme Court
- Responded to the Supreme Court decision with a plan to fund municipal and laborer pension payment increases with a water and sewer tax, pending state and local approval; under this proposal, the payments would increase beginning in 2022 based on the actuarial health of the pension funds
Measures such as the property-tax increase have improved the city’s ability to pay the higher state-mandated contribution, but it’s only delaying the inevitable. The property-tax measure allows Chicago to continue making contributions well below the actuarial-recommended amounts (Display). It also delays the pensions’ solvency dates by a year or two (less if the asset values decline in the interim).
Chicago Pension Liabilities
Despite the payment increases, the pension liabilities continue to grow at an alarming rate because the annual payment remains well below the “tread water” amount needed to stabilize the liability.
On the Bright Side
It’s not all bad, though. While the city has an outsized unfunded pension liability, Chicago does have some factors working in its favor. For one, its recent efforts have helped stabilize its financial operations. A 24% uptick in property values was another boon: although the increase was below the prerecession peak, it’s been the largest post-recession improvement for Chicago.
Also in the city’s favor is its “home rule” status, which grants it authority over its municipal matters—the ability to levy and adjust taxes, issue bonds and enact other measures, for instance. Home rule is important for Chicago because it can take the actions it thinks are best without relying for approval on the state of Illinois, which has its own share of problems (the state hasn’t approved a budget in nearly two years).
Importantly, Chicago’s improvement efforts haven’t gone unnoticed by investors, who have responded positively. We’ve seen its municipal bond prices rise, and spreads have narrowed. Eventually, however, lower prices are likely.
Running on Borrowed Time
The city has gone to considerable and admirable lengths to improve its pension situation. But it’s only bought itself some time. The measures taken to date are not enough to fully address the pension liability. Additionally, some of the city’s pension-related actions have yet to face Illinois Supreme Court scrutiny, which has not ruled in the city’s favor thus far.
We expect Chicago to continue to phase in tax increases, and we should see revenue growth, but the city will have a reality check in the next four or five years. That’s when many of the temporary bandages it’s applied will fall off, renewing the pension challenge during the next mayoral term.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.