Wall Street Journal: Chicago New Idea to Fix Its Pension Deficit: Take on More Debt

Article by By Heather Gillers on Wall Street Journal

Chicago tried to lower its pension deficit with budget cuts, benefit reductions and tax increases. Now the third-largest U.S. city is considering a controversial new fix: more debt.

Finance Chief Carole Brown said she would decide in the next week whether to endorse a $10 billion taxable bond offering that would be used to help close Chicago’s $28 billion pension funding gap. If the proposal is accepted by Mayor Rahm Emanuel and approved by the City Council, it would become the biggest pension obligation bond ever issued by a U.S. city.

The bet is that Chicago can earn more, investing the proceeds than it paid to issue the new debt, setting an example for other large governments wrestling with sizable pension deficits.Many cities and states around the country don’t have enough assets to afford all future benefits owed to retirees. The soaring costs are squeezing budgets across the U.S.

But if Chicago’s gamble doesn’t pay off, it could end up with more debt that it can’t afford to pay. Pension obligation bonds have backfired on other cities, contributing to the chapter 9 bankruptcies of Detroit, Stockton, Calif., and San Bernardino, Calif.

“It’ll be a big test for sure,” said Vikram Rai, head of municipal strategy at  Citigroup Inc.

More than 400 governments have issued pension obligation bonds over the past 30 years. The volume was highest in 2003, the year the state of Illinois issued a $10 billion bond—still the largest ever by any U.S. city or state government.

But that deal didn’t solve Illinois’s problems. Fifteen years later its state employee pension fund has just 35% of what it needs to afford all future benefits owed its workers.

Performance of these bonds also can vary depending on how the market performs at any given time. In 2009, Boston College’s Center for Retirement Research examined pension obligation bonds issued since 1986 and found most had lost money for the states or municipalities that issued them because their pension-fund investments returned less than the amount of interest they were paying on the bonds.

By 2014 those losses had reversed and returns were exceeding borrowing costs by 1.5 percentage points, the study found.

No U.S. city is in a deeper pension mess than Chicago, where four pension funds have a combined shortfall of $28 billion, according to city financial records. It is in this position because of some of the same problems that tripped up other governments: decades of low government contributions, overly optimistic assumptions and overpromises on benefits. Two recessions added additional losses.

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