Pension Reform

In Face of Chicago Downgrade, State Legislature Looks to More Pension Borrowing

When Fitch Ratings downgraded the city of Chicago’s bond ratings at the end of last week, it seemed like just another step on the road to financial disaster for the Windy City. The decision puts Fitch’s ratings on par with those issued by Moody’s Investors Services back in June, and just two steps below that of Standard & Poor’s.

The first “key driver” listed by Fitch?

“Lack of pension solution.”

The agency explained in a statement that its decision to downgrade the city was due in large part to the “lack of meaningful solutions to both the near- and long-term burden. The city has been unsuccessful in its attempts to negotiate a solution with labor unions and lobby the state legislature, which ultimately controls the benefit formula.”

Fitch went on to say that it “believes a pension solution that enhances funding levels while preserving sustainable budgetary balance is necessary to stabilize the credit. Inaction, or affirmative steps to avoid a solution leading up to the looming pension cost increases scheduled for fiscal 2016, will have a negative impact on the rating.”

Despite the repeated warnings from ratings agencies and countless other observers, the “pension solution” for the nation’s third largest city remains illusive. And one recent bill passed by the legislature shows that, even when agreement can be found, the solutions may not be ideal.

SB1523, which included an amendment reforming the Chicago Park District’s defined benefit pension plan, flew through the legislature last week. Like most of Chicago’s pension funds, the Park District’s system is extremely underfunded. According to the plan’s own optimistic assumptions, it has a $971 million unfunded liability and is just 43 percent funded.

The bill is designed to put the pension plan on pace to be fully funded by 2053 through a combination of benefit reductions, increased taxpayer contributions, and in a clear indication that the state’s leaders have not learned any lessons from the past, debt.

The Chicago Tribune notes that the Park District currently pays around $11 million into its pension fund each year. That will continue, but it will contribute an additional $12.5 million in both 2015 and 2016. It will kick in an extra $50 million in 2019, but that will be funded by digging the Park District further into debt through the issuance of pension obligation bonds.

Basically, the Park District will borrow and invest the money, hoping that investment returns outpace the interest rate of the bond. Pension obligation bonds, however, are a risky undertaking at best, and a complete financial disaster at worst.

A 2010 study out of the Center for Retirement Research examined nearly 3,000 pension obligation bonds from 236 governing entities. It found that “[o]nly those bonds issued a very long time ago and those issued during dramatic stock market downturns have produced a positive return; all others are in the red.”

Indeed, the legislature could have learned from the state’s own pension obligation bond failures. The state issued pension obligation bonds totaling $10 billion, $3.5 billion, and $3.7 billion in 2004, 2010, and 2011, yet its pension plans remain underfunded by as much as $287 billion.

The Chicago Park District operates just one of Chicago’s struggling pension plans. If pension obligation bonds become part of the “solution” to every underfunded system, it may be a long time before the city receives any good news from ratings agencies.

The pension crisis is a huge part of the state’s budget problem. The report “Peering Over Illinois’ Fiscal Cliff” from the The Institute of Government and Public Affairs of the University of Illinois showed that Illinois has a “has a chronic, structural fiscal problem.” The report estimates that the state’s structural budget gap will grow from $4 billion today to $14 billion in FY 2025.

Without swift action from lawmakers, the experts agree that Illinois faces a bleak fiscal future.

In Depth: Pension Reform

Modern, 401(k)-style plans are now commonplace in the private sector. For state workers, however, traditional pensions are still the norm. As former Utah State Senator Dan Liljenquist wrote in Keeping the Promise: State Solutions for Government Pension Reform, this is not a partisan issue, but a math problem. State Budget…

+ Pension Reform In Depth