Pension Obligation Bonds – Both Sides of the Ledger
Recently, the City's Chief Financial Officer, Carole Brown, proposed the City sell up to $10 Billion in so-called “pension obligation bonds (POBs).” If approved, it would be the largest such bond issuance in history.
– If successful, taxpayers would save the difference between the annual payment for the bond and the pension payment savings. According to the CFO, this could amount to up to $200 million a year in pension payments and reduce pressure to raise some revenue.
What is a Pension Obligation Bond?
CFO Brown proposes the proceeds of the $10 Billion bond be placed into the pension plans to lower the overall long-term debt from $28 to $18 billion. This immediate funding of part of the pension obligation, would lower the cost of the City's annual pension payments, at least in the short term. The logic is to lower city payments to 5.25% interest on the bonds from our current 7% interest on the outstanding liability. In the best case, this accumulated savings could amount to $6 Billion by 2055, according to the CFO.
On the cost side - Chicago would repay the bonds with interest; the bonds would be secured by an as yet undisclosed dedicated revenue stream and, the pension plans would have to earn more than 5.25% on the money contributed.
The Risks of Issuing Bonds – Can We Afford the Downside?
Center for Tax and Budget Accountability
cautions “Chicago may find itself in an even worse hole a few years down the line” if Chicago does not use
of the proceeds to fund the “unfunded liability.” Moreover, if city "saves" $200 million a year, it isn’t “found money,” just a reduction in a large overdue bill.
With interest rates climbing and the market at an all-time high, bonds are cheaper right now, But, if the markets tank and the pension plans lose money over time, as in past recessions, the interest we will owe on the $10 billion debt could, in the long run, be more expensive than it is today.
History of Public Offering Bonds (POBs)
Center for Retirement Research
study shows a wide range of outcomes – from a +1.5% return to a - 2.6% return for bonds issued close to the peak in the markets. A POB issued by the CTA in June 2008 failed. The
State of Illinois Auditor
analyzed that CTA only had a 50% likelihood of earning 7.7%. As it turned out, CTA paid 6.8% to sell the bonds, and after the market fell 45%, CTA kept the funds in 2% money markets for some time.
. According to the
CTA's pension plan
the amount of contributions to be paid by the CTA, with respect to debt service on bonds issued for contribution to the Plan, is treated as a credit against the amount of required contribution." This means that the CTA contributes less to the pension plan and instead pays off the bondholders.
Pew Foundation study
predicts “If an invested bond lost… 20 percent in a single year in an economic downturn…it would be extremely hard for a state to get back on track and access the expected proceeds.”
Will bonds “solve the pension problem?”
No. Chicago must dedicate resources over the next five years to be able to afford the full state law required contribution which will begin in 2023. If successful, the bonds would reduce the amount needed.
What is the dedicated revenue to pay this new debt service?
If the markets fall within the first few years of the bonds’ issuance, how will we raise money to cover the debt service and make the required contributions?
What is the difference between the anticipated savings this will generate and the cost of the debt service?
Will all the pension bonds revenue be contributed to the pension funds?
When do the bonds mature?
Can we guarantee the bonds won’t be refinanced to evade paying our pension liability?
: Is the potential
for short term savings and a long term 1% to 1.75% return worth the risk of a falling market that could drain city finances even more? As we receive answers to these questions, we will report back.
Finally, if taxpayers support this approach, then our energy should redouble to push for a constitutional way to reduce the pension liability – especially the so-called “Cost of Living” increases. The Mayor’s economic team’s first attempt to moderate benefits was ruled unconstitutional. The “consideration” model, offered by Senate President Cullerton, should go back on the table. Some legislators favor a constitutional convention to consider many issues including pension obligations. It is important to note that Chicago is prohibited under Illinois law from declaring bankruptcy.
Please let me know what you think of this idea by
or calling the office.