Reform has been kicked down the road
President Barack Obama’s first major legislative achievement, the American Recovery and Reinvestment Act (ARRA) of 2009, was a $787 billion stimulus package. Much of the public debate focused on whether the package was large enough or too large. Far less attention was paid to how ARRA quietly reshaped incentives for cities, including Chicago, by muting the fiscal pressures that normally force reform.
Beyond its headline spending totals, ARRA included a broad set of federal handouts and relief measures aimed directly and indirectly at municipalities nationwide. The most consequential of these for local governments was the creation of Build America Bonds (BABs), a new class of taxable municipal bonds subsidized by the federal government. Under the program, Washington reimbursed issuers for 35 percent of their interest costs. At the time, this subsidy made BABs cheaper, on a net basis, than traditional tax-exempt municipal bonds, particularly for long-term capital projects.
BABs were promoted as a pragmatic solution to frozen credit markets. By issuing taxable debt, cities could access a broader and deeper pool of investors, including pension funds and foreign buyers, while still enjoying lower effective borrowing costs. In practice, however, BABs also softened the budgetary discipline that traditionally accompanies municipal borrowing. By artificially suppressing debt service costs, the program reduced the urgency to scrutinize capital spending decisions, project prioritization, and long-term liabilities. For Chicago, the direct fiscal impact of BABs was modest. It was measured in tens of millions of dollars over time, but the precedent was significant. Federal policy had stepped in to dampen a core market signal that normally constrains local government behavior.
ARRA’s reach extended well beyond municipal bond markets. The legislation included a wide swath of formula grants and stabilization funds designed to plug state and local budget gaps, particularly in education and essential public services. These funds helped avoid layoffs of teachers, and other municipal employees. ARRA also included substantial direct aid to households through expanded unemployment insurance and increased food stamps or as they are more commonly called today, Supplemental Nutrition Assistance Program (SNAP) benefits, which boosted consumption and softened the recession’s impact on vulnerable populations.
Chicago benefited materially from this web of support. Public schools received additional funding that helped stabilize staffing and programming. No need for belt tightening here. Health care cost pressures were eased indirectly as state and federal programs absorbed a greater share of the burden, particularly through enhanced Medicaid matching funds. Perhaps most importantly, the City’s own budget was stabilized because Illinois and Cook County, both responsible for major health and social service obligations, were temporarily relieved by federal dollars. While Chicago did not receive an explicit municipal bailout, the fiscal stress that might otherwise have forced immediate corrective action was blunted.
Two deeper consequences followed, both uncomfortable and rarely discussed at the time. First, a larger share of Chicago’s population became increasingly dependent on federal handouts. Emergency measures intended to be temporary lingered longer than anticipated, subtly reshaping expectations about the role of government support. Second, for some individuals, the urgency to reenter the workforce diminished. This was neither universal nor necessarily irrational given labor market conditions, but it nonetheless reduced labor-force participation since the handouts lasted longer than the crisis did. Fewer people working meant fewer people paying taxes, even as the City’s underlying cost structure, driven by pensions, payroll, and debt continued to expand.
As expansive as the Obama-era interventions were, they pale in comparison to what followed a decade later during the COVID-19 pandemic. Yet the period between the expiration of BABs and the onset of COVID is critical to understanding Chicago’s present predicament. During that decade, there were no major federal municipal handouts. There were no interest rate subsidies, no general operating backstops, and no pension relief. Federal involvement was largely limited to project-specific, conditional programs such as transportation grants, infrastructure loans, and housing assistance that could not be used to mask operating deficits or address unfunded liabilities. Since money is fungible those funds did mask those problems through the back door.
For Chicago, this interlude was painful but clarifying. Pension contributions rose sharply as statutory funding ramps accelerated. Reliance on property taxes, fees, and other locally imposed revenues increased. Credit ratings deteriorated in the absence of any federal offset or guarantee. Structural deficits accumulated quietly year after year, often obscured by short-term fixes and optimistic revenue projections. These pressures were not the result of sudden shocks; they were the predictable outcome of decades of deferred decisions and political avoidance.
Uncomfortable as this period was, it imposed a degree of fiscal discipline. When revenue growth is constrained and external rescue is absent, choices become unavoidable. Either costs must be restrained, benefits restructured, or taxes raised. Reform, however unpleasant, tends to occur only when pressure is allowed to build. By the late 2010s Chicago was approaching such an inflection point, with its fiscal challenges increasingly difficult to ignore. That is how things should be, but politicians love nothing as much as they like a crisis.
Then came COVID. The pandemic triggered an unprecedented federal response that fundamentally altered the trajectory of municipal finance. Through the CARES Act, the American Rescue Plan Act (ARPA), FEMA reimbursements, and a host of public health grants, nearly $4 billion flowed directly to the City of Chicago. Roughly $2.4 billion of the total functioned as highly fungible, balance-sheet support, money that could be used, directly or indirectly, to replace lost local revenue and sustain general operations.
This flood of cash fundamentally altered incentives. One-time federal money was used to support recurring costs. Payrolls were maintained, service levels preserved, and pension contributions met. It was not because underlying liabilities were reduced, but because federal dollars covered other obligations. Difficult decisions about spending levels, labor contracts, and long-term affordability were postponed once again. The immediate crisis was addressed, but the structural problems remained untouched.
This dynamic represents a textbook case of moral hazard. When governments are insulated from the consequences of their own cost structures, the incentive to reform diminishes. COVID relief severed the feedback loop that normally forces adjustment. The aid did not pay down debt, restructure pensions, or slow the growth of long-term obligations. It bought time, and little more.
When that time expired, the underlying reality reemerged. Revenues normalized as the economy recovered. Federal aid wound down. Costs, however, did not fall. The structural gap returned abruptly, creating the impression of a sudden fiscal crisis. What Chicago faces today is the delayed recognition of problems that were merely masked, not solved.
Chicago’s experience illustrates a broader lesson about federal intervention and local governance. Federal aid can stabilize systems during genuine emergencies, and in some cases it must. But stabilization is not the same as reform. Each bailout that postpones adjustment makes the next reckoning more severe, as costs grow and political tolerance for change diminishes. Reform has not been defeated. It has simply been deferred and kicked further down the road, once again.
America’s latest bout of inflation in 40 years occurred when government spending far out-stripped the tax revenue that rolled in. The government normally sells bonds to cover the difference. If interest rates are too high, the Federal Reserve can buy the bonds. This is what created the inflationary spiral most recently. Printing money, or to be less charitable, counterfeiting, will do that. There may be some future administration with a compliant Congress that will abide.
That could be another reason why reform is not an urgent issue. Talk about the H-Bomb of moral hazard.
