How financial mismanagement led Chicago to the financial bottom

How financial mismanagement led Chicago to the financial bottom

Chicago and New York are at the bottom of a new financial stability analysis, based primarily on data from the 2015 financial statements. This analysis was produced by the cities themselves and includes 116 U.S. cities with a population of over 200,000 people. Chicago's position at the bottom of the ranking is not surprising. The windy city has become an example of financial mismanagement.  Chicago is famous for its underfunded pension plans. And this is not counting the presence of thin reserves and large amounts of outstanding debt.

The city’s Municipal Employees' Annuity and Benefit Fund (MEABF)  reported $4.7 billion in assets and $ 14.7 billion in actuarially accrued liabilities at the end of 2015. This is only 33% of the funding ratio. Actuarial calculations are based on the controversial practice of discounting future benefits at the rate of 7.5 %.  This is the expected return of the Fund's portfolio. If a more conservative scenario has been used, MEABF’s liabilities will be higher and the ratio will be lower.

Since the rating is based on the financial checks of 2015, you can see the full data for the points on the website Center For Municipal Finance . Last summer, mayor Rahm Emanuel announced a plan to address the problem of underfunding for MEABF. This plan includes the increase of tariffs for water and sewerage services and increasing the contributions of employees to the system. These changes will take some time to affect Chicago's audited financial statements and their assessment of financial condition.

However, New York is only one position higher than Chicago. The expanded bull market and high property prices pumped money into the Big Apple’s coffers. Total municipal revenues rose from $60 billion in 2009 to $ 81 billion in 2015. But the city was spending money almost as fast as they came in.

At the end of fiscal year 2015, the total fund reserves of the city amounted to only 0.67% of expenses. This is significantly below the recommendations of the Government Finance Officers Association in the amount of 16.67 %. The General Fund of the city is similar to the settlement account of an individual.

New York is in debt. According to a report released by City Comptroller Scott Stringer, New York's per capita debt is far greater than that of all other major U.S. cities. And that debt is even 50 % higher than in Chicago.

But the comptroller’s report focuses only on bond debt. Government financial accounting standards require cities to report other long-term liabilities (e.g. retirement, accrued sick and vacation leave payable at retirement) and “Other Post-Employment Benefits” (or OPEB).

In 2015, the OPEB obligations of the city totaled $ 85 billion. This amount is roughly equivalent to its bonded debt.

The greater financial responsibility of OPEB is due to the size of the city's workforce and the high cost of health care in New York city. The city provides a health care pension to almost 225 000 pensioners. Another 315 000 current and separated employees can potentially qualify for future benefits. Benefits per pensioner in 2015 were over $16,000 a year (for workers who were not yet Medicare-eligible and who had dependents). The data are taken from the last Actuarial report OPEB1. 

High debt burden and insufficient reserves of the General Fund are related to the moments of financial distress. These moments are associated with the delay of the workers with dismissals, defaults of bonds and the declaration of bankruptcy. However, if New York continues to record significant revenue growth, it will be able to meet its debt obligations. It should be noted that the stock market has revived after the victory of Donald Trump in the elections. Therefore, the chances of a financial crisis in the short term seem long. However, the bear market may put the city at risk.

A similar situation was observed in 1933. New York briefly breached its obligations under municipal bonds. After the stock market crash and the Great Depression, the city's income declined amidst a number of property tax violations.  In 1975, the city faced a second financial crisis. The federal government refused to provide financial assistance. The state also announced a moratorium on some payments of city bonds. Although the default occurred during another bear market, the immediate cause of the crisis was the rise in interest rates. At the time, the city relied heavily on short-term debt. When inflation surged in the early 1970-ies, these debts have become increasingly difficult and expensive.

In addition to New York and Chicago, three other cities were rated below 40: Renault, St. Louis and Toledo. All three cities had relatively small common fund balances and a high debt burden.

One Perfect Score

At the other end of the spectrum, with a perfect score of 100, is Irvine and California. There is a constant increase in the city's reserves due to the constant growth of income. In 2015, the city’s reported more than $ 700 million of cash and investment on its balance sheet. This is more than enough to finance two years of government spending. Irvine is among the major American cities distinguished by the fact that he has no outstanding obligations on the bonds. All municipal loans in Irvine are made by special districts. These districts charge additional taxes to service the debt.

Two cities in California’s Inland Empire, Fontana and Moreno Valley, took the second and third spots. Both cities have a moderate debt burden and large total reserves.

These high-ranking cities are located within a short drive from San Bernardino, which filed for bankruptcy protection in 2012.  Their presence at the top of the list is evidence of California's economic recovery. But at the same time, it shows that sound financial management practices make a difference. Although during the Great Recession, Fontana and Moreno Valley faced with similar issues, both of these cities escaped the financial crisis.  This because officials have shown great discipline in terms of spending and borrowing. 

Keep in mind that it is not necessarily for a city to have an almost perfect score to be considered a good fiscal steward. Any score above 70 can reasonably be interpreted as a level of fiscal health sufficient to justify a triple-A credit rating. 

Bankruptcies and Delinquencies

The universe of cities that we analyzed includes three that have filed for bankruptcy since the Great Recession: Stockton and San Bernardino, which filed in 2012, and Detroit, which filed in 2013. Both Stockton and Detroit went out of bankruptcy. And San Bernardino is close to doing so. All three cities have scores in the middle of the ranking. Detroit and Stockton benefited from a court-sanctioned reduction in their debt. While San Bernardino ran a general fund surplus for a long time in bankruptcy. 

However, there were three cities that did not publish Comprehensive Annual Financial Reports for 2015 by the end of 2016. One of them, Baltimore, will publish its 2015 CARF in early 2017, which is quite late. Federal regulations require state and local governments to submit audited financial statements no later than nine months after the end of the financial year. Since Baltimore's fiscal year ends on June 30, it should have filed its CAFR 2015 no later than March 31, 2016.

To view the data of the full ranking of 116 cities, including scores you should visit the new Center for Municipal Finance website