Chicago mulls $10 billion pension bond plan
Friday, Aug 3, 2018 - Posted by Rich Miller
* Reuters…
Chicago is looking at the feasibility of bond financing as a way to stabilize funding for its four retirement systems, the city’s chief financial officer said on Thursday.
The city’s unfunded pension liability is $28 billion, down from $35 billion last year. That liability and chronic budget deficits have resulted in low credit ratings and high borrowing costs.
“I’m at a point where I feel like we need to look at (options) seriously and see whether or not there is a financing plan that would meet the kind of objections the mayor would have, our (city) council would have, the rating agencies would have,” CFO Carole Brown told reporters. […]
Sacks raised the idea of securitizing about $950 million of city revenue to raise $10 billion for pensions, boosting the funded ratio to 54 percent from the currently low 26 percent.
* Bond Buyer…
The Government Finance Officers Association recommends against the use of pension obligation bonds. Several recent Chapter 9 cases have cast a pall over POBs as investors suffered greater losses than pensioners did and some analysts have suggested that POBs contribute to distress. Chicago’s use of its securitization structure would give bondholders more protection. […]
The city last year established the Sales Tax Securitization Corp. and the City Council has approved up to $3 billion in sales tax and general obligation refundings. The city issued $704 million last year, $680 earlier this year, and has plans this fall to sell $750 million.
Other revenues, like the city’s share of local government shared revenue and personal property replacement and motor fuel taxes, could be leveraged. Critics have said diverting those revenues from the corporate fund damages GO value. […]
There’s also the gamble posed by the arbitrage play given that borrowing rates remain low but the proceeds would be invested in an expensive equities market with the risk that future returns won’t exceed the bonds’ interest.
The arbitrage play is a risk here, as well as dedicating existing revenues for years in advance.
* Crain’s…
The core of the idea is that city pension fund managers currently assume they’ll make 7 percent to 7.5 percent a year on their investments, and figure that assumed return into the actuarial projections that are the basis for what taxpayers pay to the funds each year. Since the funds now have $28 billion in “debt”—the unfunded liability—the city and its taxpayers are effectively paying 7 percent to 7.5 percent interest on the shortfall, Brown says. So, if the city can borrow at a cheaper rate of perhaps 5 percent to 5.5 percent and turn the money over to the pension funds immediately, the end cost to taxpayers will drop. […]
But Brown and Sacks insist the city won’t make the error the Blagojevich administration did, when savings from the POB were used to substitute for normal state pension payments, driving up total debt long term. Savings from this plan could be big enough that the city will be able to make its entire normal annual contribution, but at a lesser rate because the pension funds would have more to invest, Brown contended. Nor would the city’s financial flexibility be reduced much because, after recent changes in law, debt payments “are just as hard of an obligation as our bond debt.”
It’s basically converting pension fund debt to market debt. But that’s a lot of money.
- Snapper - Friday, Aug 3, 18 @ 3:06 pm:
Dumb. I understand the Arbitrage play, but risk is too high for a pension fund to do something like this. Market is at all time highs. Buy low, sell high. Chicago is going to borrow money to buy high. Can’t wait to see how this all works out.
- Precinct Captain - Friday, Aug 3, 18 @ 3:07 pm:
==Several recent Chapter 9 cases have cast a pall over POBs as investors suffered greater losses than pensioners==
If it screws bean counters in NY, I’m all for it.
- Southside Markie - Friday, Aug 3, 18 @ 3:12 pm:
To make these situations work financially, there is often lower payments at the beginning of the schedule and a huge balloon “the next guy’s problem” payment at the end. It seems like they’re playing more “kick the can”.
- Al - Friday, Aug 3, 18 @ 3:15 pm:
Great deal for the bond houses and politicians with undeclared offshore accounts.
- 47th Ward - Friday, Aug 3, 18 @ 3:16 pm:
===The arbitrage play is a risk here,===
Agreed 100%. Expecting the current stock market to grow from here without a major correction is wishful thinking. A lot of folks argue it’s overdue for a correction, citing price to earning ratios that are way too high among other factors. I was just reading an article in the Economist that said the following:
“Just before each of America’s most recent three recessions the yield curve for government bonds “inverted,” meaning that yields on long-term bonds fell below those on short-term bonds. Economists and stockmarkets seem unconcerned that inversion looms again. But despite generally strong economic data, there is reason to heed the warning signs flashing across bond markets.”
Given the enormous tax cut that is driving up the national deficit, the Fed will have few options available to come to the rescue if the economy slows down.
This seems like a bad time to put taxpayers on the hook for $10 billion, especially if repaying the debt relies on arbitrage.
- jake - Friday, Aug 3, 18 @ 3:17 pm:
It could be a good idea or a bad idea, depending on the details, specifically on whether the interest the City would have to pay on the bonds would exceed the return on the investments in the pension fund. Averaged over time, that should be be case, but as insurance against being killed by unanticipated short term fluctuations in the markets, the debt transfer should be done in increments over time.
- 44th - Friday, Aug 3, 18 @ 3:23 pm:
Don’t be the last man standing. See you in Florida when its time to pay off these debts. Until then , freeeeee money, enjoy.
- Lucky Pierre - Friday, Aug 3, 18 @ 3:31 pm:
Why is this type of shell game necessary?
Because the pensions are unsustainable but refoming them is the political 3rd rail for Democrats.
- Jibba - Friday, Aug 3, 18 @ 3:35 pm:
Structured correctly, this would have been a really smart play any time in the last decade, when interest rates might have been up to 4 interest points or so below the average projected earnings. Not now, when you’re borrowing at only a couple of interest points lower, expecting a correction too. A day late and a dollar short, so to speak.
- Anonymous - Friday, Aug 3, 18 @ 3:36 pm:
”
This seems like a bad time to put taxpayers on the hook for $10 billion”
Already on the hook for $10 billion. $28 billion actually. Question is do you want to be on the hook at 5% interest or 7%?
Also, pension funds don’t put all their money in equities. Or they better not. They have diverse portfolios with all levels of risk. The more cash they have the more protected they are from stock market because they can choose long term illiquid investments.
- 47th Ward - Friday, Aug 3, 18 @ 3:38 pm:
Sorry, I know we’re already on the hook for unfunded pensions. But if this POB tanks, we might be better trying pay-as-you-go than trying to repay both unfunded pensions and under water POBs.
- Rep. Rob Martwick - Friday, Aug 3, 18 @ 3:48 pm:
The House Committee on Personnel and Pensions explored this idea for the state systems. Given the difference in size, the bond issuance we would have needed would have been $107 Billion. There were many problems with this idea, but the math underlying it is actually sound. According to Prof. Feng, who is the head of actuarial sciences at the University of Illinois, a long term bond issuance can and will absorb any short term market volatility. So, risk is not really the problem. The biggest problem is credit worthiness. Given Illinois’ and Chicago’s history of ignoring financial problems, and the fact that our Governor has recently only made those problems worse, the cost of bonding the money comes at a premium and so the returns are not as good as they could be otherwise. Add to that the lack of confidence in our ability to adequately address our financial problems means there is a possibility that you will not find enough buyers for the bonds. All of this is what I was told by the myriad of financial experts I talked to about this concept. However, if we were able to show a concrete plan to address our debt, bonding could (and probably should) play a part in that solution, especially as a tool to reduce the cost of the debt repayment.
- lakeside - Friday, Aug 3, 18 @ 3:55 pm:
“But Brown and Sacks insist the city won’t make the error the Blagojevich administration did…”
Because they know that no one Blago-adjacent will never become mayor? I doubt Jim Edgar and the ramp planners thought a governor that followed him would just stop making pension payments (or that there could be, say, a major recession).
- Texas Red - Friday, Aug 3, 18 @ 3:58 pm:
These are self inflicted wounds, the city can’t blame the Gov or past state budgets for missed payments. Pay your way out, and institute measure to slowly help with future costs - things like a hiring freeze, limiting pay increases, utilize more PT staff and hire contract staff.
- Lucky Pierre - Friday, Aug 3, 18 @ 4:00 pm:
Representative Martwick blaming the pension crisis on Governor Rauner and not Speaker Madigan who has presided over this for decades and torpedoed the bipartisan Cullerton bill?
LOL
- Arthur Andersen - Friday, Aug 3, 18 @ 4:11 pm:
$10 billion in POBs? Somewhere John Filan just dusted off his best suit.
Lakeside, your point is well made, but once bonds are sold, the risk to the City’s credit rating is too high for a future mayor to skip a bond payment and put the whole shebang in default.
My biggest worry right now would be constructing an asset allocation plan for the bond proceeds that is not overly risky, but has a high likelihood of meeting the investment return assumption over the life of the bonds. Pension funds across the country are struggling with this issue, including the big Illinois funds. The major California funds just recently lowered their return assumption to 7.25% based on expected market returns.