Chicago moved forward in its effort to rescue a pair of pension funds and stabilize its finances when Illinois Governor Pat Quinn signed a bill that cuts benefits and makes employees pay more for retirement.
The law is a partial solution to addressing the city’s pension shortfall as it restructures two systems beset with a combined $9.4 billion in unfunded liabilities for about 60,000 municipal workers and retirees. The city council now must come up with a plan to finance the measure.
“I recognize that Chicago’s mission to find real solutions to its financial challenges will not be easy,” Quinn said in a prepared statement after signing the measure yesterday.
The Democratic governor’s move relieves some uncertainty surrounding Chicago’s public-employee pensions. The four systems are almost $20 billion short of what’s needed to pay promised benefits, and ratings companies have said the gap threatens the city’s solvency. Retirement costs were the primary reason behind a March downgrade by Moody’s Investors Service that dropped the city to Baa1, three steps above junk.
Investors punished Chicago debt in the run-up to yesterday’s deadline for Quinn to decide on the bill. Some bonds gained after the governor signed the measure.
Taxable general obligations that mature in January 2032 changed hands at an average yield of 6.07 percent, or about 3.14 percentage points more than benchmark Treasuries. Both the yield and spread are the lowest since June 5, the data show.
The bill is “far from perfect, but it’s a step in the right direction,” said Richard Ciccarone, chief executive officer of Hiawatha, Iowa-based Merritt Research Services, which analyzes municipal finance. “It has a meaningful impact on reducing the liability in two of the four pension funds.”
City council still has to produce a revenue package that would generate the remainder of the savings for the pension fix. A plan that Mayor Rahm Emanuel floated in April would have raised property taxes by $750 million over five years. That proposal met resistance from council members, all of whom face re-election next year.
“I intend to work with city council in the coming months to find alternative options to replace property taxes as the source of the city’s first pension payment,” Emanuel said in a statement.
Retirement-fund pressure is increasing on cities across the nation, including bankrupt Detroit and Stockton, California. Chicago has the highest pension costs as a proportion of revenue -- 17 percent -- among the largest cities, according to a November report from the Center for Retirement Research at Boston College.
A coalition of public-employee unions called the law “unfair and unconstitutional.”
“This is no victory for the mayor, but a huge, missed opportunity to find a truly fair, constitutional solution,” the group, We Are One Chicago, said in a statement.
While Quinn had signaled his opposition to a bill that could result in higher property taxes in the city, there was no clear alternative. The governor is running for re-election in November and his opponent, Republican venture capitalist Bruce Rauner, was urging him to kill the bill.
At the same time, Chicago is under increasing financial pressure. Pension promises and bond obligations have tripled the city’s per-capita debt load in the past decade, to about $20,000 for each of its 2.7 million residents.
The new law doesn’t affect police or firefighter retirement systems, which are due an additional $600 million in payments next year. Nor does it curb retirement costs at Chicago Public Schools.
“It at least gives Chicago a chance to find some resolution to the big problems they face,” said Duane McAllister, who helps oversee $4 billion of munis at BMO Asset Management Corp. in Milwaukee. “This is a small step, a small victory for the city of Chicago.”
The city’s bonds may not benefit much from the governor’s decision, McAllister said, given questions about city council’s next steps and the November election.
Illinois faces its own pressures over pension finances. While the legislature approved a bill in December to eliminate a $100 billion retirement shortfall, a state judge last month halted enactment of the law while public-employee unions challenge its constitutionality.
Buyers demand extra yield to own general obligations from Illinois, the lowest-rated U.S. state. Investors required 1.16 percentage points more to own 10-year Illinois debt rather than benchmark munis, the most since April 25 and more than 10 times the gap on top-rated states such as Maryland, Bloomberg data show.
In Chicago, the city “still has the flexibility to make the adjustments they need to,” said Rob Williams, San Francisco-based managing director of fixed income at Charles Schwab & Co. “The intent seems to be there from the management of Chicago.”