For bankruptcy to work, a city must have enough to work with. It is unclear if Chicago does
A not uncommon remark around Chicago is that municipal bankruptcy is the city's ultimate escape hatch, or even that it is inevitable: Just file under Chapter 9 of the federal Bankruptcy Code, restructure the debts, reduce pension obligations, and give the city a fresh start.
But that won’t necessarily work, even assuming Illinois first authorized Chicago to file, as federal law requires. A successful bankruptcy requires a credible plan for the future and enough available revenue, disposable assets, and politically acceptable savings to make the plan work. In other words, a city must have enough to work with. It is not clear that Chicago does.
In corporate bankruptcy, businesses can close unprofitable operations or liquidate entirely as a last resort. A city has no such luxury for police and fire protection, roads and other essential services. Those services must continue during and after bankruptcy, and the municipality must present a credible plan for doing so.
But Detroit showed that it can be done, right?
Not so fast. Detroit's bankruptcy worked reasonably well, but Detroit had several advantages Chicago might not have.
Here are the main obstacles Chicago would face and why its situation differs from Detroit's:
First, beginning in 2017, Chicago transferred ownership of its current and future share of certain sales tax revenue to the Sales Tax Securitization Corporation, which issues bonds backed by that revenue. The structure was deliberately designed to isolate the transferred revenue from a city bankruptcy. Whether every feature would survive a future court challenge isn’t certain, but the city isn’t likely to recover the sold tax revenue.
Detroit, by contrast, benefited from an extraordinary asset and settlement. The city owned the Detroit Institute of Arts collection, which turned out to have surprising value. The state, foundations, the museum, and private donors committed roughly $816 million through the "Grand Bargain," supporting the pension settlement and transferring the museum to an independent nonprofit. Chicago has no such art or other assets lying around.
Second, pensions are Chicago’s biggest financial problem -- far bigger than bonded debt -- making Chicago’s pension hole too big to fix simply by cutting benefits. The city’s four pensions have combined unfunded liability of $36 billion. They have just 28 percent of the assets on hand needed to pay for benefits already earned, a catastrophically low number and worse by far than any major city or state in America.
Bankruptcy would allow the city to cut pension benefits despite the state’s constitution pension protection clause. However, benefit cuts anywhere near what would be needed to restore the pensions to health would be unconscionable and create a humanitarian nightmare. They will need more funding.
Detroit’s pension problem was far less severe, being over 70 percent funded when it entered bankruptcy, though estimates on that varied. Pensions were reduced, though rather moderately. General retirees had pension checks cut by 4.5 percent and COLAs were eliminated. Police and fire retirees kept their base pensions but had their COLAs cut from 2.25 percent to one percent. Comparable cuts would leave Chicago still in a pension crisis.
Last but not least, who would control a bankruptcy on behalf of Chicago? If the same political establishment ran the bankruptcy, you could expect results no better than the failures that bankrupted the city in the first place.
The answer, ideally, would lie in the appointment of a good emergency manager. Emergency managers can be authorized by the state to act on behalf of a city during the bankruptcy and make a host of key decisions. This includes the sole power to submit any reorganization plan for court approval.
Detroit was blessed with an exceptionally capable emergency manager for its bankruptcy, Kevyn Orr, who was appointed by the State of Michigan.
Would the Illinois super-majority in Springfield appoint a similarly talented, hard-nosed restructuring expert willing if necessary to challenge public-sector unions, reduce payroll, renegotiate contracts, sell nonessential assets, and impose genuine operating reforms? Or would they select a politically acceptable insider whose main objective would be protecting the same special interests and constituencies that now dominate city and state government? Perhaps it would appoint no emergency manager at all.
Answer that question with all appropriate cynicism.
One potential bright spot in a Chicago bankruptcy is cancellation of the city’s infamous parking meter deal, which could return hundreds of millions of dollars in revenue to the city. It wasn’t a sale of the parking meters. The deal terms are in a document self-described as a “concession agreement,” and it would probably be characterized as an “executory contract” in bankruptcy. That means, in bankruptcy, there’s a good chance it could be cancelled by the city. Details are here.
No bottom line can be given on whether it would ever be sensible for Chicago to file. That call would have to be made by experienced, practicing bankruptcy experts with a full schedule of assets, liabilities, revenues, contracts, and liens. They would also have to assess myriad legal questions: whether encumbrances on city assets could be challenged, whether the sales tax securitization would hold, whether the parking meter agreement could be rejected and at what cost, and much more. That is true of any bankruptcy.
Suffice it to say that anybody counting on bankruptcy as a panacea for Chicago's fiscal challenges is misguided.
One further point: Uncertainty about whether bankruptcy would work for Chicago does not mean Illinois should continue to refuse to authorize the option. Over half the states authorize Chapter 9 filings, although many impose conditions or limit which municipalities may file. Illinois should join them. The option can inject fiscal discipline and give a distressed city leverage to negotiate with creditors.
Those reasons and more are laid out in testimony I gave with a colleague before an Illinois House committee and in an interview with Jamie Sprayregen, a nationally prominent restructuring lawyer.
Mark Glennon is founder of Wirepoints.
