The Windy City has a $26.5 Billion Pension Problem

Rodney Johnson | Monday, April 07, 2014 >>

The Windy City has a $26.5 billion problem — it is short of that amount.

That’s a lot of dough for one town.

Overseers of the city’s finances haven’t kept up with their payments to the city pension funds, while the investment gurus running the funds haven’t been able to make their projected returns.

As a result, city pensions are woefully underfunded — having just 50% of their necessary funds in place.

And as if being only half funded on the pensions of your current and future retirees wasn’t enough…

Chicago will see its mandatory contributions to the pensions soar over the next three years. In 2012, the city was required to make $692 in contributions.

By 2017, this number will shoot up to $2.4 billion.

It’s hard to see where Chicago will get that kind of cash, since businesses and citizens aren’t likely to approve any tax increases.

This negative news isn’t lost on investors and analysts. Moody’s Investor Service recently downgraded the city of Chicago from A3 to Baa1 — the lowest of any big city in the U.S., with the exception of bankrupt Detroit.

Unfortunately, there’s no help to be had from the state of Illinois, since it has its own debt problems, with state pension funds holding only 45% of the assets needed to pay their obligations.

So what’s a city — or state — to do?

Clearly, they need to find new sources of revenue, since the old sources just aren’t doing the trick. As a suggestion, they could look out West.

Colorado recently legalized the recreational use of marijuana, bringing millions of users — and their dollars — out of the shadows of the black market and into the bright lights of legal commerce.

This not only removed the possibility of criminal prosecution for the possession and use of marijuana, but it also created an industry — from growing to selling — that can employ people and provide tax revenue.

Before any legal sales took place, the Rocky Mountain State estimated tax revenue could be just over $60 million in the first year.

Now that the doors are open, the estimates have moved up a bit, to $100 million in tax revenue in 2014. That’s a pretty good jump.

Clearly, $100 million in revenue to the city of Chicago, or the state of Illinois, would not provide the means to close their budget gaps or pay their pensions, but they could think a little bigger.

Consider all those corn fields that are currently used to feed the ethanol industry. If those fields were repurposed to pot, well, the sky is the limit.

Still, the pension obligations of Chicago and Illinois are huge. Maybe the two entities could renegotiate with retirees and future retirees.

Instead of being obligated to pay them in cash, they could promise the retirees cash and/or in-kind distributions, much like hedge funds do.

Then, when the fund can’t make a full payment to a retiree, it could simply send along a baggie of marijuana with the partial payment. That way, even though the retiree couldn’t pay all of his bills, at least he could feel good for a little while.

Of course, he should probably choose to buy food over paying rent, because he’ll definitely get the munchies.

While much of this is written in jest, the underlying trends are no laughing matter.

Chicago and Illinois are some of the worst examples of pension mismanagement. Even now, Chicago’s pensions assume an 8% rate of return, which is ridiculous.

There is no way that pension liabilities, as they stand today, will get paid. Taxpayers will not allow the dramatic rise in property tax rates and sales taxes that it would take to make these entities whole.

Postponing the fight for another day might be politically expedient, but it does nothing to resolve the issue.

Given that fights over money typically end up in a finger-pointing session, where bondholders are blamed, this is another factor investors need to watch out for when buying municipal bonds.

Check the pension funding of the issuer to make sure that in the next several years people are not pointing at you.


Rodney

P.S. Don’t forget Harry’s live twitter event tomorrow afternoon, from 4 p.m. to 4:45 p.m. You can follow @harrydentjr and if you have any questions about his latest book, The Demographic Cliff, use #democliff.

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.