By: Joe Mathewson*

 

Chicago Public Schools’ desperate and very costly quest for buyers of its recent $725-million bond issue (cut from $875 million) is a harbinger of peril ahead, not only for CPS but for the City of Chicago and other Illinois local governments and special districts relying fatuously on borrowing to pay current expenses.

 

If the Illinois legislature finally passes a pending bill permitting municipalities and special districts to seek relief in U.S. Bankruptcy Court, there might be a parade of them knocking on that door. They’d be well received, for Chapter 9 of the Bankruptcy Code is designed especially for units of local government. The Chapter 9 process enables hard-pressed localities to reduce their overarching debts to manageable levels.

 

Municipalities in other states have done it recently, to the undoubted relief of their taxpayers, who are the folks ultimately on the hook for the past irresponsibility of their local government leaders.

 

In that very prominent Bankruptcy Court proceeding ended in 2014, Detroit was able to chop a hefty $7 billion off a hopeless debt of $18 billion; it was the biggest Chapter 9 bankruptcy so far. Jefferson County, the most populous county in Alabama and home to Birmingham, in 2013 obtained agreement in Bankruptcy Court to reduce by $1.4 billion a delinquent sewer-construction bond debt of $4.2 billion. Stockton, California, faced claims of city workers and retirees amounting to $538 million, but they accepted $5.1 million in a 2015 Bankruptcy Court settlement. (Yes, there are limits: a recent offer in Bankruptcy Court by San Bernardino, California, to pay 1 cent on the dollar was rejected.)

 

It’s sometimes feared that filing bankruptcy may ruin a municipality’s general credit quality–as it sometimes does a person’s–but in fact the opposite can be true, another important benefit of Chapter 9.

 

Shortly after Detroit emerged from Bankruptcy Court, Moody’s awarded a series of upgrades to Detroit’s state aid-backed bonds and sewer and water bonds. The agency also revised upward its rating of the city itself to “positive from stable,” following that with a comment a year after the bankruptcy that the city’s “economic and fiscal health are stronger.” Similarly, few months after Detroit emerged from bankruptcy, Standard & Poor’s issued a “solid investment grade credit rating of ‘A/stable’” on a big $245-million bond issue.

 

As Stockton neared the final agreement that would enable it to exit Bankruptcy Court, Moody’s upgraded its water bonds and lease-revenue bonds, and Standard & Poor’s followed suit on the water bonds shortly after the bankruptcy. Stockton’s bonds, which had borne a coupon as high as 6.1 percent, enjoyed a drop to 4.6 percent, narrowing the spread over U.S. Treasury bonds from a high of 3.88 percentage points to just 2.43.

 

Jefferson County, which had paid as much as 9.3 percent to issue bonds before bankruptcy, saw its cost drop later to only 4.9 percent, reducing the spread over Treasury bonds from 7.26 percentage points to 2.62, according to Bill Bergman, research director at Truth In Accounting, a Chicago-based not-for-profit that assesses the financial condition of federal, state and local governments across the nation.

 

Bergman further points out that a new bond issued by Jefferson County after bankruptcy required an interest rate of only 4.9 percent, less than half that of the pre-bankruptcy issue.

 

With all these benefits to local governments and taxpayers, who would be opposed?

 

Some bondholders, to be sure. They might see losses, and perhaps large losses. But these investors are mostly sophisticated asset managers for institutional investors like financial firms and mutual funds. They knew full well the risks of lending money to strapped local government units, but they took the risks willingly in order to gain the higher interest rates that the market imposes on such financially-frail borrowers.

 

Government workers and pensioners may well object, too. Like CPS, government bodies that file Chapter 9 often face insuperable pension-fund obligations. However, just as the Stockton employees accepted cash settlements of their immense claims, Detroit pensioners agreed to a reduction in their monthly checks, knowing that the alternative might be no check at all.

 

It’s past time for our legislature to act. The benefits will accrue to the largest number of interested parties: we taxpayers.

 

*Joe Mathewson, formerly a practicing lawyer in Chicago, teaches at Northwestern’s Medill School of Journalism, Media, Integrated Marketing Communications. Research assistance by Matthew Connor.

 

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Andrew Szakmary

Bankruptcy has traditionally been a last resort; you are only permitted to file when there is no other possible alternative. Given that Chicago and other municiplities still have taxing power and the ability to generate additional revenue by increasing taxes, what makes you all think that a bankruptcy judge would approve a petition, even if the legislature passed a law permitting Illinois municipal governments to file? Chicago is not Detroit; it does have the ability to pay its contractual obligations, and courts will ultimately require it to do so whether you like it or not.

Paul

State law say the benefits cannot be reduced. But it does not say the taxpayer is forced to pay the short comings.

O. B. server
100% agree with “Tough Love’ that the main culprits are the unions & the legislators who were buying votes by giving the unions what they were asking. Why favor the taxpayer representatives over the union representatives? The union members were enriched beyond what they would have received by informed collective bargaining and from truly neutral legislators who were trying to represent the taxpayers in general. The recipients of the unfair enrichment should be penalized rather than the victims (taxpayers). This is particularly the case where those being asked to pay (voters who are taxpayers) have their own savings and wealth reduced in order to increase the benefits… Read more »
Jim from Orland Park

Excellent summary by Mr. Matthewson. If we would stop all these insufficient band-aid patches and get on with the bankruptcy, we would save billions of dollars in the long run. Every legislator and alderman shuld read this.

Steve-Oh

Agree, and the DB pension systems of the govt ees all over the state, should be frozen and cut for all, such that the unfunded liability actually gets reduced to an affordable level. And the future working years of actively employed govt workers should be a 10% ‘Er contribution DC plan which is twice as rich as most private sector arrangements. But the DB pension systems that are 4 or 6 times richer should end. That means the State Constitution should be amended for localities that do not declare bankruptcy, no ?

O. B. Server
The current situation is that many retirees are collecting pensions that never were affordable and health benefits that never were funded. Thus, the pension fund is being depleted much more quickly than the taxpayers can afford. The unions are run by teachers who are closest to retirement and, therefore, closest to the banquet table where they too can feast on taxpayer money for as long as it lasts. The people who will be hurt are the students and the active teachers and the taxpayers. The union is intransigent and will not give up any benefits. Why should they, since the courts agree with them and the judges’… Read more »
Tough Love
Quoting ….. “Many peoples’ expectations will go unfulfilled, but why should taxpayers have to pay? True, the taxpayers’ elected representatives “agreed” to unsustainable benefits, but those “representatives” were agreeing to obligations that they did not understand because the costs were understated by so-called professionals answerable to special interests. ” Sure, SOME …. “did not understand” ….. but many indeed DID understand exactly what they were doing (granting unnecessary, unjust, unfair, and unaffordable pensions & benefits), but they were willing to SELL their favorable votes (on Public Sector pay, pensions, and benefits) for Public Sector Union campaign contributions and election support. The betrayed Taxpayers should pay no more… Read more »
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