Brexit and Chicago’s potential bankruptcy

Pension funds aren’t immune to the volatility of the stock market. Even before Brexit, Moody’s warned that low investment returns are already putting Chicago’s pension funds at risk. A major stock market correction or another recession just might put Chicago and CPS over the edge if their already-underfunded pension systems collapse.

Chicagoans might think the fallout of Brexit – Britain’s exit from the European Union – means little to them. After all, that mess is an ocean away, and how much of an effect can European politics have on the Windy City?

But Brexit is likely to affect Chicago much more than even some European cities. That’s because Chicago and its public school system, the nation’s third-largest, are already at the brink of bankruptcy. Moody’s Investors Service already rates both the city’s and Chicago Public Schools’, or CPS’, debt as junk, meaning the city faces a very real possibility of bankruptcy.

A major stock market correction or another recession just might put Chicago and CPS over the edge if their already-underfunded pension systems collapse.

The stock market’s 600-point sell-off after the Brexit news, combined with negative interest rates across the world, is a reminder that a recession may not be far away.

Like 401(k)s, pension funds rely on investments to grow, meaning Chicago’s pension funds aren’t immune to the volatility of the stock market. And even before Brexit, Moody’s warned that low investment returns have been putting Chicago’s pension funds at risk. Those funds depend heavily on getting high investment returns – 7.5 to 8 percent annually – to make good on their pension promises.

But with a combined $35 billion shortfall in their investment portfolio (including the CPS teachers fund) and sub-par returns, the risk of bankruptcy is increasing.

On top of that, in 2015 the four city funds and the teachers fund earned significantly less than their investment targets, resulting in even bigger pension shortfalls. The municipal fund had investment returns of just 1.8 percent, while the fire fund returned just 0.4 percent. The police and laborers funds actually lost money on their investments.

That means Chicago’s pension funds, in particular those for fire and police, are moving closer toward bankruptcy. Those two funds have just a quarter of the funds they need today to ensure they can cut pension checks in the future. In the private sector, those funds would have been shut down and deemed bankrupt long ago.

The problem with Chicago’s pension plans, and those at the state level as well, is that taxpayers have to make up for any shortfalls in the pension systems. Already, that shortfall for Chicago exceeds $35 billion, or $34,000 per household. And because many city households don’t have the income to handle such a burden, future tax bills will fall heavily on those Chicagoans who can pay.

Chicago officials can’t afford to continue stalling on reforms to the city’s pension funds. The post-Brexit 600-point sell-off is a reminder of just how tenuous Chicago’s future is.

It behooves Chicago politicians, as well as government-worker unions and their members, to bargain for a deal – an opening for reform introduced in the recent Illinois Supreme Court ruling – that finally brings an end to the broken pension systems. That deal should preserve already-earned benefits but move to a 401(k)-style plan for benefits going forward. Government and union officials can look to major reforms across the country, as well as the 401(k)-style plan that currently exists for state-university workers, as models for reform.

If not, Chicago and CPS will continue careening toward insolvency, and that will hurt everybody. Taxpayers will be forced to pay billions more to prop up a failed system. Pensioners will see major cuts to their pensions. Bondholders will take big hits and halt future lending to Chicago. Core government services will be slashed, which will hurt the most vulnerable residents. And those who can escape will, leaving the burden for even fewer people to pay.

Brexit’s real impact on the markets and the global economy won’t be known for some time. But given that Chicago is already at the precipice of bankruptcy, its leaders should see the initial response to Brexit as a wake-up call for major reform.