Chicago's credit rating downgraded: how its woes differ from Detroit's

Chicago took yet another hit from Wall Street this week when Moody’s Investors Service downgraded its credit rating, following a three-step downgrade last summer. Creditors are concerned that the city’s approximately $34 billion in combined debt and unfunded pension obligations represents a financial albatross it can’t overcome, economic analysts say.

Chicago could be now in a class by itself.

“There are lots of municipalities that have severely underfunded pensions, but the combination of Chicago’s size and the magnitude of its pension underfunding makes it an outlier. It’s arguably the biggest city to have this problem,” says Jeffrey Brown, a former White House economic adviser who is now the director of the Center for Business and Public Policy at the University of Illinois at Urbana-Champaign.

The drop this week puts Chicago’s credit rating on $7.8 billion of general-obligation debt at Baa1, three levels above junk. New York City and Los Angeles, by comparison, have ratings of Aa2, the third-highest level by Moody’s.

Indeed, Moody’s reported Tuesday that the reduction “reflects the city’s massive and growing unfunded pension liabilities, which threaten the city’s fiscal solvency absent major revenue and other budgetary adjustments adopted in the near term and sustained for years to come.”

The city, Moody’s said, has the highest level of underfunded pension debt of any rated US municipality.

Chicago is saddled with a bond debt load of $14 billion, which tripled between 2002 and 2012, and an additional $20 billion in unfunded pension obligations.

Critics say Chicago is on a slow slide toward a municipal bankruptcy, much like Detroit’s, which to date is the largest of its kind. The comparison was heightened last summer when Moody’s three-step downgrade happened the same week that the Motor City made its historic filing for Chapter 9 protections.

However, while both cities are dealing with manufacturing decline and population loss – Chicago’s population fell 7 percent over the past decade – Chicago’s economy remains far more robust. A report published last week by Standard & Poor’s said that Chicago “demonstrates more differences than similarities” to Detroit, which “ultimately underscores Chicago’s long-term viability against the backdrop of Detroit’s bankruptcy and default.”

Mr. Brown agrees. Both cities, he says, have “essentially dug a hole so deep that it is now impossible to fill through business as usual,” but Chicago remains “a more broadly economically vibrant city with a strong economic foundation and diversified economic base” in comparison with Detroit, which is traditionally anchored by a single industry: automotive.

“Detroit experienced steady decline over decades due to the auto industry and did not have the capacity to realistically find its way out of this hole other than going into bankruptcy,” Brown says.

Still, Chicago has its challenges. Bloomberg reports that the downgrade means interest rates will increase for the city, meaning it will have to pay more. This month it is issuing $405 million in general-obligation bonds – the first sale of its kind since 2012.

According to a Chicago Tribune investigation published late last year, reckless spending and continual refinancing by the Richard M. Daley administration, with little oversight, has forced current Mayor Rahm Emanuel to cut spending and look for politically unpopular sources of revenue, such as red-light and speed cameras.

Mayor Emanuel has also turned to taxable bonds, which tend to be much more expensive for the issuer than traditional tax-exempt bonds. To date, he has issued about $844 million of these bonds, which adds tens of millions of dollars in interest payments.

So far, however, the city has not raised property taxes to shore up funds.

Despite short-term measures to plug gaps, Rahm Emanuel has repeatedly said that the crisis requires immediate state reform during the General Assembly’s spring session. The city faces a $590 million bill in retirement obligations, due next year.

“While we disagree with the action taken today by Moody’s, we do agree that the city’s pension challenges will have a direct impact on its long-term financial stability without reform,” Lois Scott, Chicago’s chief financial officer, said in a statement.