Finance

Chicago's Money Problems

November 6, 2013

By Jason Grotto, Heather Gillers and Patricia Callahan

A reckless pattern of borrowing by Chicago leaders has undermined the city's future by ignoring the most basic tenets of municipal finance and piling billions of dollars of debt onto the shoulders of future generations, a Chicago Tribune investigation has found. Chicago officials abused a powerful financial tool intended to build for the future _ issuance of bonds backed by property taxes _ as they spent nearly $10 billion in 13 years with few restrictions and virtually no oversight.

The Tribune's unprecedented examination of city finances reveals that Chicago built mountains of long-term debt from thousands of problematic short-term purchases including software that was soon obsolete, spare parts for vehicles and items you might find on a weekend shopping list: trash bins, flowers, even bags for dog waste.

It's equivalent to taking out a 30-year mortgage to buy a car and making your children _ or grandchildren _ pay it off, with interest.

Hundreds of millions more went to push off upcoming bond payments by refinancing old debts. The delay tactic, nicknamed "scoop and toss," often wound up costing taxpayers more money.

That left relatively little cash for bricks-and-mortar projects and other tangible improvements that will still be around when the loans are fully paid off decades later.

"All you're doing is saddling some future unknown taxpayer with responsibility for something that's already been used up," said Ben Watkins, Florida's director of bond finance and chair of the debt committee for the Government Finance Officers Association.

General obligation bonds are intended to help governments achieve lasting public works, such as libraries and bridges, that are too costly to pay for all at once. But records show Chicago's city leaders exploited a loophole in federal tax law and pushed the boundaries of Internal Revenue Service rules that prohibit using this type of borrowing for day-to-day expenses.

City officials became so reliant on bond money that they even turned to it to cover retroactive pay and pension contributions. It also has been used to pay for mistakes, including cases of racial discrimination and police brutality that resulted in expensive legal judgments and settlements.

Most of Chicago's debt woes can be traced to the long reign of former Mayor Richard M. Daley, but the borrowing he relied on so heavily has continued under Rahm Emanuel as his administration gropes for ways to deal with the financial problems it inherited.

When the Tribune analyzed $9.8 billion in proceeds from general obligation bonds issued from 2000 to 2012, it found that nearly half of the money went to paper over growing budget problems. Among the findings:

  • City officials used about $3 billion to settle one-time legal expenses, cover closing costs on the bonds, pay off short-term bank loans and buy vehicles and other relatively short-lived equipment.
  • Even more money went to refinance old bonds. That's smart if it saves money. But the city put $1.8 billion toward deals that will end up costing taxpayers millions more in the long run by racking up years of extra interest payments.
  • Less than a third of the total borrowing, $3.2 billion, went to capital improvements that might benefit future generations. Even in this category, the newspaper found hundreds of millions of dollars in questionable spending on short-lived items.

In many suburbs, officials who want to issue bonds to build schools or swimming pools must provide detailed spending plans and put their proposals to a popular vote. Referendums also are held in Philadelphia, Los Angeles and other major U.S. cities.

But Illinois law allows Chicago to borrow billions without asking residents' permission or providing much information about how the money is spent.

There is no limit on the city's general obligation debt, and the sole check and balance is the City Council, a body that rarely pushes back on major mayoral decisions. Since 2007, aldermen have authorized $7.6 billion in general obligation bond issuances without a single dissenting vote. And each year they get millions in bond proceeds to dole out for projects in their wards.

When the city does reveal its spending plans to the public, the information often turns out to be inaccurate or misleading. Spot-checks by the Tribune found many projects came in grossly over budget and years late, which often led to more borrowing.

The dependence on bond money has created a massive debt burden even as the city wrestles with chronic deficits and a pension crisis. Chicago's outstanding debt on general obligation bonds has quadrupled during the past 18 years, reaching $7.2 billion last year. With interest, that amount nearly doubles.

Sixty-three percent of all property taxes went to debt payments last year, the highest percentage since at least 1996.

Municipalities across the country are struggling, but Chicago has more general obligation debt per capita than any of the 10 largest U.S. cities except New York, according to an analysis of those cities' financial statements. It even has more than Detroit, which recently filed for bankruptcy.

When told of the Tribune's findings, Joseph Harris, a former auditor general for Detroit, said Chicago's robust tax base and wide range of industries should insulate it from a Motor City-style meltdown. But borrowing for short-term expenses is particularly dangerous, he said, because it obscures the city's financial problems while also making them worse.

"It's like a cancer," he said. "You may not know that you have this affliction until all of a sudden you've got a tumor the size of a grapefruit in your intestine."

The billions in bonds issued under Daley allowed him to cut ribbons, plant trees and hand out large contracts _ helping him become the longest-serving mayor in Chicago history.

The Tribune provided the former mayor details on its analysis. But Daley declined repeated requests for interviews and instead issued a statement.

"As mayor, I believed my job was to address the immediate needs of the city and its residents while anticipating the needs of the future. ... As a result, Chicago now has world-class stature, the foundation on which new opportunities and success are built," he wrote.

Current city officials don't dispute the Tribune's analysis. "There's no question that Mayor Emanuel inherited extraordinary financial problems," a city spokeswoman said in a statement.

In an interview, Lois Scott, the city's chief financial officer, said: "The legacy liabilities of the city are significant. People talk about it with respect to pensions, but debt is part of that legacy as well. It is not sustainable. And we need to address it."

The administration, she said, has been working to rein in spending and cut smarter deals when it borrows.

Yet little has been done to limit the borrowing since Emanuel took office in 2011. Just like Daley, Emanuel has used bond money for short-term budget relief.

Scott, a longtime broker and financial adviser who worked on Chicago bond deals before joining Emanuel's team in 2011, said the city can't afford to tackle all of its financial problems at once. Raising taxes would threaten economic growth, she said.

Instead, the administration is using bond money to buy time, hoping that future growth will help pull Chicago out of the doldrums.

"It is a tool to be used to address financial challenges from time to time," Scott said. "Debt is a way to reallocate burdens and opportunities across generations."

___

New public buildings open with ribbon-cuttings and photo ops, but there is no fanfare when the city issues bonds. In fact, the city provides little information to the public about this complicated yet crucial civic act _ and those details often turn out to be wildly inaccurate.

To track the city's borrowing and spending, the Tribune extracted details on 49 general obligation bond deals, then filed requests under the Freedom of Information Act for records on expenditures. The city did not provide the spending data until the Tribune hired outside lawyers to press for the information.

Reporters put thousands of records into a database and used it to identify short-term expenditures like equipment purchases, legal costs and payments on bank loans used to cover pension costs and other expenses.

In one equipment purchase, city officials in 2003 used proceeds from recently issued bonds to buy $700,000 worth of Palm Pilot software, which powered hand-held organizers that were precursors to smartphones.

The software was obsolete within a few years. But the city wasn't due to make its first principal payment until 2011. By that time, taxpayers had already paid $250,000 in interest on the purchase, raising the ultimate price to nearly $1 million _ not including fees paid to issue the bonds.

Such added costs are the reason most experts say long-term borrowing should be reserved for projects that are intended to last. Depending on how bonds are structured, interest payments can double the cost of items paid for with bond proceeds; paying the brokers, banks and attorneys who execute the deals adds millions more.

But that didn't stop the city from spending $1.1 billion in bond proceeds on software, books, trash cans and other equipment since 2000.

The city in 2005 bought $21 million worth of spare parts for its fleet of cars, dump trucks, street sweepers and other vehicles. Accounting documents filed at the time said the parts would last three years, but paying off the bonds used to cover them will take at least 12 years and increase the total cost to $30 million.

The cost of library books and other materials bought with bond money in 2011 by the Emanuel administration will have nearly doubled by the time the first principal payment is due in 2032, a decade after city accounting documents say the books will reach the end of their usable life.

"From a policy standpoint it doesn't make any sense because you want to match the useful life of (what you pay for); otherwise you are having future generations pay off something that they didn't even get to use," said former Highland Park Mayor Michael Belsky, who teaches at the University of Chicago's Harris School of Public Policy and managed the public finance group at the Fitch Ratings agency.

Chicago leaders even used bond proceeds to make interest payments on the bonds themselves, a practice finance experts say is usually reserved for projects that generate revenue, such as a stadium. Interest paid with borrowed money _ known as capitalized interest _ helps cover debt payments during construction until money from the project starts to flow.

But in Chicago, officials have borrowed more than $450 million since 2000 to make interest payments on projects that generate little or no income. Instead they've used capitalized interest to kick costs down the road.

___

During the past 13 years, city officials have done more than use bond money imprudently. A review of tax documents and interviews with city officials suggest that common borrowing and spending practices during the Daley years are questionable under the federal tax code.

When Chicago issues tax-exempt bonds, it benefits from low interest rates that amount to a federal subsidy. That's because the U.S. government loses out on the taxes that investors who buy the bonds otherwise would pay on their returns.

City officials vow to follow arcane and often convoluted IRS rules on how bond money can be spent. If violations are ever found, the IRS can require the city to pay significant penalties and interest.

Those rules generally prohibit spending proceeds on day-to-day expenses. Yet a review of expenditures under Daley shows that tax-exempt bond money covered more than $37 million in maintenance costs. The largest was in 2004, when the Daley administration spent nearly $7 million on landscaping maintenance for street medians.

The city used an additional $110 million in tax-exempt bond proceeds to pay off short-term bank loans in 2005, 2008 and 2009.

Those loans provided cash for immediate needs, including retroactive pension contributions that normally come from operating revenue.

Using tax-exempt bonds that way is so problematic that Emanuel administration officials say they don't do it. To avoid IRS scrutiny, they said, the city borrows for operating expenses through taxable bonds, which have no restrictions.

Daley, in his statement, didn't directly address tax law issues, but he said: "Having worked our way through the toughest economic time in recent history, we sought to make major improvements, following the rules but unable to predict the future."

Another troubling legacy of city borrowing is the $1 billion in bond money that the Daley and Emanuel administrations have used to pay for legal judgments and settlements. The practice not only forces future generations to pay a huge price for the city's misdeeds but also could be an abuse of the tax code.

Federal law prohibits issuers of tax-exempt municipal bonds from using proceeds for legal costs. But by exploiting an exception for "extraordinary expenses," the city was able to pay off nearly $400 million in judgments and settlements with tax-exempt bonds.

The tax code reserves that exception for "nonrecurring" items, but the Daley administration used the provision every year from 2000 to 2005.

In 2002, for example, the city used tax-exempt bonds to pay an arbitration award involving the Fraternal Order of Police. Rank-and-file officers had rejected a city contract offer in 2001, but an arbitrator ruled in favor of the city's wage proposal a year later.

The deal included raises of 2 to 4 percent a year, to be applied retroactively. In bond documents, city officials deemed the back pay the city owed an extraordinary expense and paid $164 million of it with tax-exempt bonds.

The city ultimately will need to pay bondholders $280 million to cover the loan.

"That's not typically why cities borrow money," said Michael Pagano, dean of the University of Illinois at Chicago's College of Urban Planning and Public Affairs. "They usually borrow money to build roads and school buildings and city halls."

Bonds also ended up covering the $28 million a jury awarded to Joseph Regalado in 1999. The jury found that, years earlier, a Chicago police officer had beaten him in the back of the head and neck with a blunt object, which ripped apart an artery and cut off the blood supply to his brain. The injuries left Regalado unable to walk, talk or care for himself.

The judgment won't be paid off until 2019 at the earliest; by then, the total cost will have grown to $53 million.

City officials eventually switched to paying judgments with taxable bonds, which are even more costly in the long run.

Emanuel's finance team brought back the extraordinary-expense exception last year. About $54 million from a tax-exempt bond helped cover a legal judgment awarded to African-Americans who were denied a chance to become firefighters by a 1990s entrance exam that favored white applicants. An additional $8 million in tax-exempt bond money went to pay legal fees related to the case, records show.

By using bond money, the city created an irony for many of those awarded damages, as their future property taxes will help pay interest on the debt. In 2033, when the city starts paying down the $54 million, interest will have more than doubled the total cost.

Randolph Bradshaw, one of about 6,000 plaintiffs in the case, was surprised to hear that the settlement will cost the city interest for years to come.

"I'm a taxpayer," said Bradshaw, a corrections officer at Cook County Jail. "It's ridiculous, constantly paying for somebody else's mistake."

(Chicago Tribune reporter Alex Richards contributed to this report.)

(c)2013 Chicago Tribune

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