Would You Date Chicago?
Over the past decade I’ve dealt with a lot of teen angst. My three kids range from 19 years old to 24, so there have been thousands of stories – some first hand and some from their friends – about romantic relationships and friend drama.
Like any good parent, I jumped into such conversations in the early years, eager to share my wisdom and save the young souls from heartache. And, like most parents, I found myself roundly ignored until the relationship in question ended in flames.
Such things have thousands of unique details, but typically come back to the same basic principle. A person who has acted badly in the past is most likely to repeat that behavior in the future. They don’t change, no matter what they tell you. And no, you’re not different in their world, you’re simply next.
That’s a hard lesson. We all want to think that we’re special, and that when someone makes us a promise, they will keep it. When they don’t, even if they’ve broken promises to countless others before us, we’re hurt.
We should approach investments the same way, considering what company executives and business leaders have said and done in the past. With that as a guide, I’m guessing no one would buy the new bonds that the city of Chicago is about to peddle.
The city has a problem. Well, it has a lot of problems, including homicide and drug use. But I’m referring to fiscal issues, where civic leaders have overpromised city funds and underdelivered on securing the necessary bucks.
For over a decade their fallback position was to shortchange the pension system for city workers and teachers, leaving gaping holes of unfunded liabilities. To catch up, the city has squeezed more property tax blood from homeowners while requiring higher contributions from teachers and city workers.
It’s still not enough. The city runs a nine-figure deficit every year, and if it doesn’t meet ever-higher funding targets for the pensions, those retirement schemes will blow up.
To keep all the balls in the air, the city sells lots of bonds. As you might imagine, rating agencies don’t think too highly of these offerings, rating them somewhere between “Don’t sell them to your grandmother,” and, “At least they aren’t Detroit… yet.”
Because Chicago has shown a penchant for financial shenanigans, they pay higher rates of interest on their bonds. But now they have a new schtick. The city has carved out its sales tax revenue, some $ 660 million per year, and will issue bonds backed by that stream of income.
Suddenly the rating agencies are all smiles. They give the new bonds an AA rating, closer to that of the U.S. government than Venezuela.
But does the Windy City deserve it?
The rating only counts if the city stands by its word, using the sales tax dollars to pay the new bonds first, and then transferring what’s left to the general budget. And what about all the current bondholders, who (correctly) believed that the sales tax dollars were part of the funds available to pay off their bonds?
Now that the sales tax dollars are siphoned off, existing bondholders have to rely on a smaller pot of money from an already questionable borrower. If that sounds bad, it’s because it is.
City officials will quickly point out that the new bond dollars, issued at a low interest rate, will be used to pay off old, high interest rate debt, thereby saving the city money.
That’s true. Today.
What happens tomorrow? The city remains mired in pension debt, and even with the newfound savings will run a budget deficit for the foreseeable future.
It’s not hard to see a time when the city decides it must issue even more bonds, eventually overloading the fiscal boat, capsizing the entire system. Then all the players will find themselves in court, arguing over the dregs of the corpse, deciding who gets the juicy parts and who’s left with the burnt edges.
As investors in Detroit already know, and those who own Puerto Rico debt – both general obligation bonds and sales tax “COFINA” bonds – are finding out, once you get to financial divorce court, the books are already cooked. And you, the investor, were on the menu.
Whatever’s leftover goes to the friends and cohorts of the political players, namely the unions and civil service organizations. All the promises on paper mean nothing.
The best way to avoid this painful and expensive breakup is to never get involved in the first place, which is a piece of advice that’s easy to say and hard to do, even long after we’ve left our teenage years behind.
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