Moody’s Investor Service just lowered the city of Chicago’s credit rating to junk-bond status.
First of all, what does this mean?
It means that, in Moody’s opinion, the bonds issued by the city of Chicago are more likely to default, so much so, that they are below an investment-grade credit rating. The Moody’s Baa2 rating prevents financial fiduciaries from investing in these bonds because they are too risky. So institutions will have to sell their bonds and it will now be far more difficult and expensive for Chicago to sell bonds in the future.
How did this happen?
When government credit ratings are impaired, it typically means structural spending (ongoing financial commitments) are growing far beyond their ability to tax. In Chicago, and the state of Illinois, their credit ratings are impaired because government employee pension obligations are continually being underfunded. What triggered the latest credit-rating decline was the Illinois Supreme Court’s recent decision to uphold the state law forbidding benefits that had been earned from being reduced.
The state of Illinois has the greatest unfunded state pension in the country and the city of Chicago has a $20 billion deficit for its four pension plans. The Illinois Supreme Court’s ruling will make it more difficult to reduce any government pension liabilities, so these unfunded liabilities will continue to grow. These unfunded liabilities are already unsustainable so some form of restructuring will have to occur as government services are slowly reduced from a lack of funding.
What should happen?
It is easy to actuarially map-out pension obligations. To be continually funded, these obligations must remain at an affordable and sustainable financial level. This is financial literacy 101 and must always be done before any financial commitments are made. Whether it is a household, company, or government, you cannot escape basic financial literacy. In my opinion, sooner or later, government employee retirement plans will be forced to transition toward private retirement plans, which means mostly self-funded accounts with some contribution from the employer. Until this happens, cities and states, like Chicago and the state of Illinois, will stumble along with unsustainable debts that will consume an increasing amount of their budgets until they go bankrupt; just like Detroit.