Rahm Emanuel was sworn in for a second term in Chicago on Monday and with a special guest, former boss and President Bill Clinton, to add a little star power to a somewhat rocky election campaign after he was challenged by Cook County Commissioner Jesus “Chuy” Garcia, only to face Moody’s bond service downgrading the city’s bonds to junk status, a move that enraged him, and that he called irresponsible.
When the last song has been played and the floors swept in the Chicago Theatre, Emanuel has an unenvied “to-do” list to tackle, not the least of which is crime, whose near daily stats reveal muggings, and shootings, subway robberies and rapes, drive by shootings, gang warfare, and retail theft on posh Michigan avenue, where thieves recently simply drove cars into the windows, after closing, and grabbed luxury merchandise and disappeared into the night.
“It’s time we stopped talking past each other and joined together and start finding solutions,” Emanuel said. “When young men and women join gangs in search of self-worth, we as a city must and can do better.”
One major solution that he has to try and solve is city finances — the recent downgrade not only angered him, but gave rise to comparisons to Detroit – a name that is now almost synonymous with municipal bankruptcy, and which critics are saying that Chicago could become, if immediate action is not taken.
One issue that probably keeps the fifty-five year old mayor up at night is the pending payment of over $500 million dollars to the police and fire pensions, and one that Alderman Brendan Reilly may have referred to, when he he said, “We’ve got to find a lot of revenue quickly.”
That may be an understatement as the city faced not only downgrades for itself, but also for its schools and parks, with the former holding a $1 billion deficit and the prospect of dealing, once again, with the Chicago Teacher’s Union, and its feisty president, Karen Lewis, who despite a recent neurological diagnosis, has remained an active player.
Many people recall the historic 2012 teachers strike that brought support to them at the expense of Emanuel’s reputation, which made him seem to be the grinch that wanted to steal teacher raises and benefits.
The numbers don’t lie
There is also $8.1 billion in general obligation debts, and the $64,000 question is whether buyers will accept Moody’s view, and buy, to help fill the $20 billion underfunding that gives a $32 billion total debt obligation in pensions alone.
Some community organizers, including many citizens, have accused Emanuel of not listening, and perhaps the threat from Garcia has made him listen more, because he noted in his inaugural remarks that “We owe you a better chance. And you owe it to yourself and your family to make the most of it. We will never give up on you, so don’t give up on yourself,” he said.
It’s a given that the mayor, and the new city council members, will have to be creative when it comes to solving the financial challenges, which some say Moody’s did their downgrade deliberately to force action by Emanuel. But, where to start? Political observers and pundits have said that an increase in sales tax is the answer, others have said that it’s time to legalize and tax recreational use of marijuana, and even more have said that suburbanites who regularly do business in the city should buy city stickers.
The only, way to begin, many lawmakers say, is with a tax increase, but yet Chicagoans already pay some of the highest property tax in the country. According to Illinois Policy.org, “Illinois’ property tax rate is second only to the rate New Jersey residents pay, which is 2.32 percent annually,” and says that the high rate is because, “The average property tax rates as a percent of home value has soared from 1.93 percent in 2010 to 2.28 percent in 2012. This represents an 18 percent property tax rate increase in just two years. This rate spike is due to declining home values and local taxing bodies increasing property tax levies.”
Chicago also has one of the highest “total sales tax of all major U.S. cities (9.25%). It was previously higher (10.25%), however, it was reduced when Cook County lowered its sales tax by 0.5% in July 2010, another 0.25% in January 2012, and another 0.25% in January 2013.”
In addition, “Chicago charges a 2.25% food tax on regular groceries and drug purchases, and has an additional 3% soft drink tax (totaling 12.5%). An additional 1% is charged for prepared food and beverage purchases in the Loop and nearby neighborhoods (the area roughly bordered by Diversey Parkway, Ashland Avenue, the Stevenson Expressway, and Lake Michigan).”
Ratings are only the beginning
It’s definitely a ratings game, and the ante was upped last week when Chicago’s credit rating took another hit by Standard & Poor’s, when it decided “to lower the rating of the city’s general obligation bonds two notches to A- from A+, still investment grade,” citing recent action by Moody’s as their influence.
As we’ve noted before there will be concerted effort to reverse the financial moves of the Daley administration, particularly with swaps a move that allows the exchange of one security to another often with shorter maturity for bonds, or for stocks, quality of issues.
To gain some perspective on municipal finances, and to get a broader perspective on Chicago’s dilemma, I spoke with David Fernandez, an attorney with Buchanan, Ingersoll, & Rooney, who specializes in counseling clients on a wide variety of capital markets, securities,leveraged finance, tax-exempt and taxable bond finance transactions; some of his most notable representations include the Bond Trustee in the Bank of America Tower and representing the Bond Trustee in the Liberty Bond financing in the new One, Two, Three and Four World Trade Center.
In our phone conversation, the first thing that he emphasized was that he agreed with Emanuel’s description of the downgrade by Moody’s as irresponsible. “This was beyond the gun, and it’s timing before the sale of the GO’s [general obligation bonds], was awful, it threw gas on them and added doubt, for the investor, and also damaged the value of the sale.”
Bad timing aside, many of the mayor’s more vociferous critics have said that the Moody’s downgrade was a metaphorical kick to get him started on the road to financial reform, a metaphor that Fernandez rejects, “I don’t agree with this foot-dragging by the city there is nothing in the cut that would have changed the value to finance a restructuring,” he said.
Can this pension be saved?
Investors are expected by many in City Hall to reject Moody’s assessment and embrace the bond offerings, which are expected to be sold beginning June 14; and even yet some are calling for the police and fire pensions to be rescinded, but to have contractual agreements to be shorn, belies not only the history of the funds themselves, but also a formula that many feel might be outdated.
It also has a structural format has not been able to keep up with inflation and the rising costs of healthcare, but yet again, we see the following: “The structural funding problem with Chicago’s four pension systems is not entirely responsible for the current crisis, experts and observers say, but it left the funds ill-equipped to deal with the market downturns of the early 2000s,” noted Chicago Public Media outlet WBEZ, in the final days of 2013.
Others, more conservatives, blame the “greedy” unions and even single parent homes for the financial debacles that many cities have seen, yet Fernandez said, “I’m not going to get into any of that, but yes, the unions did their jobs, and provided the benefits, but the cash has morphed, and to continue doing it that way, without backup, means that their outlook has got to change,and they have to think outside of the box, and maybe have a standard 401 K in place; so things cannot stay the same, union members can have different opportunities.”
He emphasizes that benefits for the future might include government payments, and afterwards “restructuring to support benefits, or else pensions will go straight off the cliff.”
Gov. Bruce Rauner has suggested something similar that there should be a different type of program, and on the campaign trail against former Gov. Pat Quinn, he suggested that it might look like one that voters already have, meaning 401K types, and also the removal of state constitutional protection for pensions, which did not win him any support at the time, and suggested to some, that he devalued the work of state employees. But, now that idea is gaining traction among some, and getting media attention.
Jeffrey R. Brown, the William G. Karnes Professor of Finance and the director of the Center for Business & Public Policy, College of Business, University of Illinois, Urbana-Champaign, in an interview with Pensions and Investments said “there are only three things you can do: change the non-impairment clause of the Illinois Constitution, which I’m not suggesting is feasible; come up with the money by raising taxes or expanding the tax base, including ending the state’s tax exemption on retirement income; or cut all other government spending to the bare bones.”
While an amendment to change the pension mandate, may not be feasible, Detroit’s restructuring team took an approach that preserved their pensions, kept constitutional protection, but also had unions contribute more, the brainchild of Rep. Jase Bolger, in an action that was later praised as “a grand piece of work.”
Taking another look at taxes
Some of the most strident voices, including some of the city council members, have advocated a tax increase, and Ald. Pat Dowell, pointedly said that “We are gonna have to look at an increase in property taxes . … [there is] no way around that at some point.”
Fernandez has a different idea, “Why hasn’t anyone thought of a V.A.T? It would work well, give a single percentage and gain a revenue stream.”
For those unfamiliar with the V.A.T., from the buyer’s perspective, it is a tax on the purchase price. And, for that of the seller, it is a “tax only on the value added to a product, material, or service, from an accounting point of view, by this stage of its manufacture or distribution. The manufacturer remits to the government the difference between these two amounts, and retains the rest for themselves to offset the taxes they had previously paid on the inputs.”
Fernandez’s idea is simple, and attractive enough, but might require an education on the part of both the consumer and the seller; an effort that Chicago might not have time for, but seems a worthwhile option for a much-needed solution to the crisis.
One vital aspect of any restructuring program, he feels necessary is the need for an oversight committee that might have to say, “Gee, Mr. Mayor, I’m sorry,but you just can’t do that,” in order to preserve a straight path towards success.
He also feels strongly that “a 5-10 year fixed rate that is later reconverted to an adjustable to meet obligations,” is one of the best routes to use along with the fail safe, last resort use of a Municipal Assistance Corporation (MAC), if needed, much like New York did in the 70’s when its back was against the wall and insolvency was eminent. These were paid off by 2007, 2008, and this would be a lightning bolt if needed by Chicago,” noted Fernandez.
With so many ideas being floated, pundits, city residents, pollsters, and even the governor’s office can only wonder when the games begin. And, some say it started on Monday with the beginning of the unenviable task of a second administration by Emanuel.