Author: Cezary Podkul, ProPublica

Cezary Podkul is a former investment banker and reporter who has covered finance for Reuters and now ProPublica. This story was originally published at ProPublica.

What happens when you’ve been kicking the fiscal can down the road for years, but the road suddenly hits a dead end? That’s what Chicago – and the state of Illinois – are about to find out.

Chicago’s immediate problem is last week’s credit downgrade by Moody’s Investors Services, which turned its debt to junk and could force the city to immediately come up with $2.2 billion to satisfy debts and other obligations.

It’s not clear how – or if – the city could come up with that money.

When big cities have had debt crises – such as Detroit’s recent problems or New York City’s epic problems in the 1970s – states typically rode to the rescue in one way or another. But Illinois, which has the lowest credit rating of any state in the nation, says it can’t help the stricken city.

The downgrade follows a recent decision by the Illinois Supreme Court, which invalidated state limits on cost-of-living adjustments to state pensioners. The limits were part of a slate of reforms signed into law in 2013 by then-Gov. Pat Quinn, a Democrat, to deal with underfunded pensions.

Moody’s said the court decision was key to its downgrade because the city has been hoping to dig out of its own financial hole by reducing cost-of-living adjustments, which typically raise the cost of pensions by close to 50 percent.

Chicago’s predicament actually has its roots in a 2003 decision by Illinois to kick the pension can down the road – by borrowing money to fund pensions rather than trying to get the benefits reduced or to stepping up payments to make them financially sound.

In the ultimate can kick, the state borrowed a whopping $10 billion – the biggest bond issue in its history – on the premise that investing the proceeds would earn more than the interest on the bonds.

Unfortunately for Illinois taxpayers, the pension funds’ investments, hurt badly by the financial market meltdown of 2008–2009, have earned less than expected.

Even worse, the state gets to deduct interest and principal on the bonds – currently some $500 million to $600 million a year – from the contributions it makes to the pension funds.

The net effect: The funds are worse rather than better off as a result of the pension bonds. Unfunded liabilities swelled from $43 billion when the bonds were sold to $86 billion by 2010, state data show.

Despite that grim history, Illinois borrowed another $7.2 billion for pensions in 2010 and 2011. By the time Quinn signed reforms in 2013, the state was in major trouble, with unfunded liabilities of nearly $100 billion – about $7,500 per resident.

Illinois isn’t alone in turning to pension bonds.

In 1997, New Jersey tried to borrow its way out of pension fund problems with debts that are still being repaid. The California city of San Bernardino sought bankruptcy protection in 2012 under the weight of its pension costs, pension obligation bonds and other debts.

“The borrowing is taking the pressure off politicians from actually facing the actual reforms that need to happen on these pension systems,” said Ted Dabrowski, vice president of policy at the Illinois Policy Institute in Chicago. “You’ve got a situation where the system is no longer sustainable, whether it’s New Jersey or Illinois.”

But Chicago and Illinois are the biggest examples of what happens when you can no longer kick the pension-cost can down the road. They are unlikely to be the last examples.

 

Photo by bitsorf via Flickr CC LIcense

Cezary Podkul is a former investment banker and reporter who has covered finance for Reuters and now ProPublica. This story was originally published at ProPublica.

As we reported last week, Gov. Chris Christie’s rhetoric about his fiscal record in New Jersey doesn’t always match what’s in his budget. Since then, we’ve found another example of Christie’s malleable math.

On multiple occasions, the GOP governor has claimed that he put more money into public employee pensions than any prior governor – Democrat or Republican. When we noticed that the numbers didn’t support the claim, the governor’s aides had a ready explanation.

It turned out they weren’t counting a $2.75 billion pension contribution that former Gov. Christine Whitman made – because the money was borrowed in a 1997 bond sale. That’s not the same, they said, as putting taxpayer money directly into pensions. Debt, after all, has to be paid back.

We duly reported that response. Except that when it comes to his budget, Christie does count the payback on the bonds – it’s tallied under “school aid” as a teacher retirement expense picked up by the state.

The bond payments highlight the enormous weight that public employee pension obligations have put on New Jersey’s chronically troubled finances.

Christie muscled a slate of pension reforms through the Democratic legislature in 2011, but it didn’t fix the problem. Now, as he prepares a possible presidential campaign, his hope for another grand pension bargain with unions is in trouble.

When it comes to New Jersey’s school aid budget, it turns out that pension payments have been the main driver of increases in recent years. Aid for classroom and other educational uses has held flat, but it hasn’t stopped Christie from declaring a victory for education.

“We are making record investments in aid to our schools, and this year again I propose to do that for a fifth straight year,” Christie in his February budget address, citing his proposal to spend $12.7 billion on school aid.

The figure includes $185 million in payments on a portion of the pension bonds. A spokesman for the New Jersey treasury said the bond payments are considered school aid because teacher pensions are an education cost. Past governors also have counted the pension bond payments the same way, so Christie isn’t alone.

Christie has complained about the bond sale under Whitman, a fellow Republican, listing it among “deadly sins of the past” committed by previous governors.

By the time New Jersey taxpayers finish paying off the debt, they will have coughed up more than $10 billion. Data from the treasurer’s office shows the interest rates on the bonds are higher than the returns the proceeds have earned since the sale, making them a money loser overall.

Some $7 billion in principal and interest remains due on the bonds, according to the treasury. Annual payments will top $500 million a year from 2022 to 2029, when the debt will finally be repaid.

Some of these bonds were expensive clunkers known in the trade as “zero-coupon” or “capital appreciation” bonds.

Instead of making regular cash interest payments, as borrowers do on a normal bond, these securities defer interest until all the debt comes due years or decades later, often at multiples of the original amounts borrowed. (The Christie administration has stopped issuing this type of debt.)

To give an example, just one $59 million chunk of those bonds came due this past February, costing the state $219 million. Terms prohibit New Jersey from refinancing even though interest is accruing at more than 7 percent a year – a rare find in today’s low interest-rate environment.

Investors are reaping the rewards. After the bonds sold back in 1997, The Bond Buyer newspaper called Whitman’s pension debt the “deal of the year” and quoted investors who called them a “beautiful piece of paper.”

Asked about the pension borrowing, Whitman said she couldn’t recall why the state opted to sell capital appreciation bonds.

Jim DiEleuterio, Whitman’s treasurer from 1997 to 1999, also said he couldn’t recall. But he still thinks the state made the best decision at the time, based on interest rates and assumed rates of return.

“I think that given the times that we were in, it was the right thing for us to do,” he said.

What about Christie’s claim that he’s contributed more to pensions than prior New Jersey governors?

As we reported earlier, including the $2.75 billion from Whitman’s bond sale that went into state pension funds, her administration contributed $3.7 billion, versus $2.2 billion so far under Christie.

Another $2 billion in promised payments would bring his total to $4.2 billion by June 2016 – without any borrowing.

 

Photo By Walter Burns [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons