Mayor Rahm Emanuel’s financial team is considering borrowing billions of dollars to pour into Chicago’s ailing pension funds — a move they contend could save future taxpayers hundreds of millions of dollars but experts say comes with risk.
The idea is to issue bonds at relatively low interest rates and use the money to reduce the city’s $28 billion in pension debt. The pension funds would invest the bond proceeds and ideally earn returns that outpace the interest the city would have to pay on the bond debt.
Issuing so-called pension obligation bonds would be a first for Chicago, which for years shortchanged four city worker pension funds and is now trying to catch up.
Emanuel’s close friend and confidant Michael Sacks, CEO of the GCM Grosvenor asset management firm, floated the concept Thursday at an annual conference for buyers and raters of city debt, sparking mixed reactions among investors across the nation, according to participants.
City Chief Financial Officer Carole Brown confirmed Friday that the city is evaluating the idea, although it has yet to draw up a detailed plan.
In an interview, Brown noted that investors and debt rating agencies are constantly questioning how the city will handle required annual pension contributions that are expected to increase by more than $900 million between 2019 and 2023. Those looming costs are the primary reason the city’s general obligation bonds are rated mostly at junk or near-junk levels.
If the city could lower the overall cost by issuing bonds, perhaps by hundreds of millions of dollars or more, “how can I not look at that?” Brown said, adding that she hopes to make a decision this year because of concerns that the bond market could become less favorable to the city after that.
Richard Ciccarone, a bond analyst who long has sounded the alarm over Chicago’s pension debt and took part in Thursday’s conference, said the market’s reaction to the idea has been “very mixed.”
“The market has hated pension bonds for a while here now,” said Ciccarone, president and CEO of Merritt Research Services, noting defaults in Detroit, Puerto Rico and three California municipalities. “Many people got burned on them.”
But he also said what Chicago is contemplating appears to be different, in that the bonds as discussed would have a dedicated revenue source, under a structure called “securitization,” that might give investors greater confidence and result in lower interest rates.
Puerto Rico had a form of securitization for its bonds, but the city maintains it wasn’t as well thought out and safe as the one Chicago used late last year to fetch lower interest rates between 2.4 percent and 3.6 percent. Those bonds have a dedicated sales tax revenue stream that investors get first dibs on in the unlikely event of a bankruptcy. That borrowing saved Chicago $94 million this year, according to city budget documents, though the savings will diminish over time.
“I’m open to all ideas and brainstorming, because frankly the situation is such that it requires it,” Ciccarone said. “We have to be open to ideas.”
But one key concern, Ciccarone said, is that the return on fund investments could fall behind the interest rates on the bonds.
“Your annual returns have got to beat the (rate) you borrowed at,” he said, noting that pension fund investments recently haven’t achieved the 7 percent to 7.5 percent returns that the funds projected. “If the current market continued on into the future, you wouldn’t be better off, because now you’ve even lost something because of the cost of doing the bond issue.”
Another bond analyst, Matt Fabian, frowned on the whole idea.
“There is no best practice for pension obligation bonds,” Fabian, a partner at Municipal Market Analytics, said in an email response to Tribune questions. “When you invest borrowed money, you lose twice if the stocks you buy decline in price.
“The ‘hysteria’ about pensions is very effective in marshaling fiscal discipline,” Fabian added. “Would be a shame to lose that.”
Brown dismissed the potential downside identified by the analysts, saying the city already faces the risk of an economic downturn that would lower the funds’ return on investments.
“If we decided to do this, we would not be adding any new risk to our profile as it relates to pension and debt,” Brown said. “If there’s an economic downturn today and we do nothing, it just means it is the same economic impact: We have to put more money in later, because they’re losing money. Until (the pensions) are 100 percent funded, I’m not increasing the risk by putting more money into the fund.”
Brown also said that if the pension funds had more money, managers might be able to alter their investment strategies to secure better, more stable returns over time.
New revenue, possibly through tax increases, would still be needed, but the amounts could be reduced and smoothed out over time, Brown said. “I am absolutely not eliminating the need for new revenue, but … I’m lowering the need for new revenue,” she said.
Emanuel and the City Council already have increased city taxes by more than $820 million since 2015 to boost contributions to the city’s four worker pension funds.
The increases coming due after next year’s elections could dramatically compound that pain. If Brown were to recommend issuing a pension obligation bond, Emanuel could tell voters he has a plan to address that problem.
But Paul Vallas, a mayoral candidate who was the city’s budget director under former Mayor Richard M. Daley, on Friday was already trying to turn the idea against Emanuel.
“Taxpayers in Illinois should well know pension obligation bonds are usually just another way of kicking the financial can down the road,” Vallas said in a statement issued Friday. “For a mayor who claims to be dealing head on with the city’s financial mess, this looks to be only adding to the city’s problems.
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