Chicago’s triple-notch credit downgrade

Pension costs are already unraveling the state’s finances. Now it’s the city of Chicago’s turn. The city’s out-of-control pension liabilities and “accelerating budget pressures associated with those liabilities” has resulted in another credit downgrade by Moody’s Investors Service. The national credit rating agency downgraded the city’s nearly $8 billion in general obligation bonds to A3...

Pension costs are already unraveling the state’s finances. Now it’s the city of Chicago’s turn.

The city’s out-of-control pension liabilities and “accelerating budget pressures associated with those liabilities” has resulted in another credit downgrade by Moody’s Investors Service.

The national credit rating agency downgraded the city’s nearly $8 billion in general obligation bonds to A3 from Aa3. This is a triple-notch downgrade.

Chicago is now just four notches above junk-bond status – any further downgrades mean the city is likely to face problems borrowing money.

The agency made good on its April 2013 promise to evaluate state and local pension plans on more realistic assumptions. At that time, Moody’s placed 29 local governments under review – including Chicago.

The rating agency has long critiqued pension funds’ use of overly ambitious investment return targets that allow funds to understate their true pension shortfalls.

Based on the new Moody’s methodology, which uses more conservative assumptions, Chicago’s 2012 pension shortfall jumps nearly 90 percent, to $36 billion from $19 billion.

However, Chicago’s burgeoning liability is not the city’s only problem. The yearly bill to pay for those pensions is set to spike 2.5 times to $1.2 billion in 2015 from $467 million in 2014.

The increase is due largely to a law that will require significantly higher pension contributions by the city beginning in 2015. These contributions will create a “tremendous strain” on the city’s operating budget, hurting the Chicagoans that most depend on core government services such as education, health care and public safety.

Chicago’s crisis is no different from what the state is experiencing. Under new Moody’s methodology, the underfunding for the state’s five state-run funds is set to approach $200 billion.

Pensions are threatening to bring down both Chicago and the state as a whole.

It’s time for Illinois to follow the lead of the private sector. That means moving away from defined benefit plans and embracing 401(k)-style plans going forward. Today, more than 80 percent of private sector workers are covered by defined contribution plans such as 401(k)s.

States have also begun to move in that direction. Michigan converted all new state workers to 401(k)-style plans in 1997. Alaska did the same in 2006. Even Democrat-controlled Rhode Island, with the nation’s second-worst pension system, switched to defined contribution plans for existing workers in 2011.

Illinois and Chicago must modernize its retirement systems by adopting defined contribution plans, such as the ones found in House Bill 3303 and Senate Bill 2026.