Articles

Is Chicago headed for bankruptcy? Why 'nuclear option' should be last resort

Monday, May 18, 2015 4:00 pm
by Marc J. Lane



ginza_line via Flickr
 ginza_line via Flickr

Many cities in Illinois, overwhelmed by pension debt and faced with unprecedented cuts in state aid, soon might be lobbying the General Assembly to amend the Illinois Municipal Code to allow local governments to go bankrupt, a remedy Gov. Bruce Rauner supports.

If a pending bill of Rep. Ron Sandack, R-Downers Grove, becomes law, some commentators predict that Chicago might be the nation's first big city to follow Detroit's unenviable example and seek protection under the Federal Bankruptcy Code.

Mayor Rahm Emanuel dismisses that possibility, insisting that he'll bring down the long-term costs of the city's four public pensions, reeling from $20 billion in unfunded debt, and limit the city's annual expenditures to the revenue it takes in each year.

Many are less optimistic. In addition to the daunting pension challenge, the city's taxpayer-backed bond debt amounts to a staggering $8.3 billion, partly the result of short-term management decisions that deferred principal payments and relied on debt to close budget gaps. Making matters even worse, Moody's Investors Service downgraded Chicago's bond rating to junk status after the Illinois Supreme Court held that the state's controversial pension overhaul unconstitutionally “diminished and impaired” retirement benefits for public-sector workers, a fate that Mr. Emanuel's benefit-cutting plan to ease Chicago's crippling pension problems almost certainly will face.

IN SOME CASES, A GOOD IDEA

The arguments for municipal bankruptcy have merit. Sandack's legislation empowers debt-ridden municipalities to restructure their obligations and reclaim greater control over their financial futures. Without the ability to recast their debts, some city pension funds actually might go belly-up, leaving their beneficiaries without retirement income; and taxpayers might find themselves taxed more, but served less, by cash-strapped local governments.

When a city files for bankruptcy, the horrors one might imagine don't come into play. Its assets aren't seized or sold off to pay back debts, and its creditors don't become owners or managers of its assets.

But unfettered access to the bankruptcy courts presents unique risks. With bankruptcy protection, municipalities might reprioritize their agendas to address immediate political goals at the expense of more sustainable policies. Moreover, local police and fire unions would be unfairly disadvantaged when negotiating with city officials who would have the upper hand.

Let's make bankruptcy available to struggling municipalities, but only as a last resort. Sandack's bill should be tweaked, as the Civic Federation and the Illinois Municipal League have argued persuasively, to require that a quasi-judicial state authority first see that an insolvent municipal debtor and its creditors collaborate in a good-faith effort to avoid federal intervention while solutions short of bankruptcy may still be within their reach. Bankruptcy never should be an easy answer or a substitute for political will.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf

The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems.

A SIB isn't a traditional bond where investors are guaranteed a fixed return but a contract among a government agency that agrees to pay for improved social outcomes, a private financing intermediary and private investors. SIBs shift the risk of experimenting with promising but untested intervention strategies from government to private capital markets, with public funds expended only after targeted social benefits have been achieved.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system.

The government decided which goals would be supported, but exactly how those goals would be achieved was left to the private sector. It was the investors, through a bond-issuing organization, who ultimately endorsed the allocation of investment proceeds — how much would be invested in job training, drug rehabilitation and other interventions.

If the Peterborough plan eventually shrinks recidivism rates by 7.5 percent or more, the government will repay the investors' capital and share the taxpayers' savings with them, delivering up to a 13 percent return. If the target isn't hit, the investment will have failed and the government will owe the investors nothing.

Illinois' SIB effort was spearheaded by the state's Task Force on Social Innovation, Entrepreneurship and Enterprise — the governor's think tank on social issues, which I am privileged to chair — with support from Harvard University's John F. Kennedy School of Government, the Rockefeller Foundation and the Aurora-based Dunham Fund. A request for information issued by the Office of Management and Budget on May 13 yielded responses from service providers eager not only to reduce recidivism here but also to create jobs, revitalize communities, improve public health outcomes, curb youth violence, cut high school dropout rates and alleviate poverty.

Now the governor has issued a request for proposals intended to spur better outcomes for Illinois' most at-risk youth — by increasing placement stability and reducing re-arrests for youth in the state's Department of Children and Family Services, and by improving educational achievement and living-wage employment opportunities justice-involved youth most likely to re-offend upon returning to their communities.

Kudos to Mr. Quinn for bringing SIBs to Illinois. May they soon start delivering on their promise.

- See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf
The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf

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Marc J. Lane is a Chicago-based business and tax attorney and financial adviser.

Reprinted from Marc Lane's May 18, 2015 editorial which appeared in Crain's Chicago Business. Crain Communication Inc.'s permission is gratefully acknowledged. Copyright © 2015 by Crain’s Communications Inc.


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