No one should begrudge Mayor Brandon Johnson wanting to use a municipal bond to finance badly needed infrastructure projects, such as road and bridge repair and equipment like fire trucks and police cars. In fact, there is probably no more appropriate financial instrument to use — long-dated general obligation, or GO, municipal bonds whose terms correspond to the combined average lifespan of the infrastructure assets make eminent sense. However, when it comes to the cost of a conventional municipal bond compared with that of a “structured” bond that has been put forth, what is in Chicago’s best financial interests is called into question. We also need to be assured that the bond proceeds will be used only for appropriate purposes.
Yes, as one of the largest municipal bonds ever issued by the city, the $830 million size is daunting. And this $830 million issuance would be added to the outstanding debt already issued by the city during the past 25 years, the sum total of which at last reporting was $29.2 billion (not including pension liabilities, which adds another $36 billion). How does this compare with other major cities across the U.S.? Of the 10 largest U.S. cities, Chicago’s debt ratio — total debt as a percentage of total liabilities — is second-worst at $156%, trailing only New York’s. Similarly, Chicago has long routinely ranked among the worst in the nation in debt load per capita. These and other measures should be fully considered in the decision of alders on whether to issue new debt and, if so, how much. Without doing so, the city risks adding to the recent record of downgrades from the ratings agencies and impels that any new infrastructure debt minimizes additional costs over the long run.
So about that matter of cost. A standard, 30-year GO municipal bond should cost the city about 5% in terms of the coupon rate. Spread over 30 years, this equates to $781 million in total interest paid on the proposed $830 million to be borrowed. Principal and interest are repaid to investors every six months. In and of itself, this is not untoward. A homeowner borrowing $350,000 with a 5% 30-year mortgage will pay $326,395 in interest over that term.
However, the city is proposing a “structured” bond reminiscent of what the junk bond market used to do 20 years ago, whereby no principal is paid, in this case for the first 20 years of the bond, with no payments at all for the first two years. The result is drastically higher interest costs. In the case of the structured bond scheduled for a City Council vote this Wednesday, the interest is $1.175 billion as compared to $781 million for the conventional municipal bond — a substantial difference of $395 million more paid by Chicago taxpayers. And that’s assuming the structured bond could even be issued at 5%. Market sources tell us that the deferred payback of principal would cost the city at least half of a percentage point higher in interest. The incremental differential in interest paid as compared to the conventional bond just got a lot bigger — $395 million for the extra half-percentage point alone. The Johnson administration has noted that aspects of this structured approach have been used in the past. To the extent that’s true, it should be seen as a factor City Hall needs to avoid in today’s fiscal fix. The road forward will require shedding problematic past practices like this.
So here are some suggestions for Johnson to consider.
First, size the bond correctly by making sure that only immediately necessary infrastructure projects are being financed. The Government Finance Officers Association counsels that in times of fiscal constraint, infrastructure investments should continue, but only to the degree critically and immediately necessary. That means specifying and tiering by necessity and priority from among a long menu of possible projects now being discussed. That would also address another concern. The current proposal leaves the door open to possible non-infrastructure uses. One unusual provision in the current proposal appears to allow for, among other things, the potential use of bond proceeds to assist the Chicago Public Schools in making a long-disputed pension reimbursement payment before the city must close the fiscal 2024 books at the end of March. To the extent open doors like this exist, they need to be sealed shut. Such measures would likely lead to a smaller bond issue and a more favorable rate.
Second, drop the structured aspect of the bond issue in favor of a conventional 30-year bond. That would mean steady-stream payments rather than the current proposal of a two-year upfront payment holiday, interest-only payments for 20 years and huge balloon payments and a higher total taxpayer burden for our children and grandchildren. Simply put, this balanced approach, more responsive to the city’s fiscal challenges, would lower the amount of new debt, maintain critical infrastructure investment and save the city and taxpayers a huge amount of money.
Joe Ferguson is the president of the Civic Federation of Chicago. Dana Levenson was the city’s chief financial officer from 2004 to 2007.
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