$10 Billion Bond Borrowing Plan
Mayor Rahm Emanuel has proposed that the city issue $10 billion in municipal bonds to reduce the pension debt.
Currently, the city pays roughly 7.5% Interest on Pension Bonds. The goal would be to issue bonds with interest rates lower than 5%. Theoretically, this would enable the city to amortize existing Pension Bonds and thereby reduce the cost of interest related to the obligation to contribute to Pension funds.
This is risky because the city's ability to pay off the new bond would depend on the investment performance of the Pension fund and the stability of the stock market over an extended period of time. In the event of a recession, the city could possibly end up in worse fiscal condition.
The Emanuel administration insists the city would benefit from the issuance of these new bonds at a lower interest rate than it currently pays for existing Pension Bonds. In theory, this Interest Rate Arbitrage would enable the city to use those new bonds to pay off the existing higher interest rate bonds.
Theoretically, if that $10 Billion was used to faithfully reduce the city's unfunded pension liability, and the city continued to make its pension obligation payments on schedule, this action could help Chicago avoid future tax hikes.
From an outward appearance perspective, this borrowing maneuver might be good for outgoing Mayor Emanuel. In the short term, he could claim he saved the taxpayers money. However, it could be horrible for the new mayor who would be saddled with repayment of this new Emanuel Administration debt, no matter what happens with the economy.
Financially, this $10 Billion mega-transaction could be a big windfall for Rahm's favorite Bond house or any other that might benefit from the commissions related to the issuance of this Bond.
There is the potential for a conflict of interest because among the people advising Rahm to issue the Pension Obligation Bond, are those financial agents who could potentially benefit from the deal.
Because the negatives seem to outweigh the positives, outgoing mayor Rahm Emanuel should refrain from issuing the proposed $10 Billion Pension Bond.