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.