Illinois-The Way Out of the Credit Mess

At the Wall Street Journal they are wondering who is next to fall.  Detroit finally pulled the trigger on bankruptcy.  Critics are blaming the politicians for flip flopping.

It was a situation they didn’t create, and bankruptcy is the only practical way out of the mess given the situation they are in.  For kicks, I checked real estate on Trulia.  Did you know you could buy a 9100 sq. foot mansion just steps from the water for $500,000?

That home in Chicago starts at $5M.

Real estate in Chicago hasn’t taken a hit yet.  Escalating taxes and crime will do that.  Right now, it’s in a holding pattern.  Prices are up, but not as much as the rest of the country.  A lot of that is due to artificially low interest rates.

However, all is not well.

Chicago is also fast approaching a day of reckoning. Chicago Public Schools last week announced 2,100 layoffs, which Mayor Rahm Emanuel blamed on a $400 million spike in pension payments. “The pension crisis is no longer around the corner,” he said. “It has arrived at our schools.”

Moody’s MCO +0.02% downgraded the city’s general-obligation bonds last week due in large part to rising retirement and debt service costs, which comprise about a third of its operating budget. Chicago plans to dump 30,000 retirees on Medicare and the ObamaCare exchanges in 2017. Yet all savings will go toward pension payments, which will triple in 2015. The mayor has warned that the bill could force a 150% spike in property taxes.

On the flip side, the mayor has tried to do something to fire the economic engine that is Chicago.  The Chicago Cubs are trying to get approval to rebuild Wrigley Field, and add a hotel/museum complex across the street in a vacant lot.  That means economic activity and jobs.

Mayor Emanuel has done a good job selling the city.  The port will get a $500M makeover.  He has been tremendously supportive of the startup community.  Chicago’s River North and West Loop are starting to fill with small companies that might make a difference someday.  There is a new project on the drawing board that looks good on paper-and might yield huge results in ten years; Chicago Next.

But, startups are risky and it really takes twenty years to build a self sustaining thriving community.  Brad Feld wrote a great book about it called Startup Communities.  If you trace the current startup community roots back, it began to coalesce in 2004-05, with a magnification in 2007, and again with 1871. We have a ways to go, but there is a lot of momentum.

The sword in the side of the local economic environment is three fold.  First, the city and county regulations are onerous. It’s almost impossible to open a small business without kissing a lot of rings.  Some regulation is necessary, but Chicago has so many that a huge opportunity cost is paid.  Many budding entrepreneurs don’t start businesses at all.

The other sort of silent killer for Chicago business is the attitude that has been ingrained into many people.  Engaging in a profit making enterprise for yourself is seen as evil.  If you are successful, all of a sudden you are supposed to share your profits with the community.   Somehow, one person is supposed to pick up 5, 10, 20 other people-when those people had no part in the success of the endeavor.

If a successful entrepreneur chooses on their own to give back-fine, it’s their choice.  But, they took massive risk in starting the business.  They should choose what to do, not their peers or government.

The last and most obvious problem is the pension and tax problem.  Pensions have to go from defined benefit to defined contribution.  Public employees are going to have to start paying more out of their salary for benefits.  City and state taxes need to be lowered to encourage economic activity.  Ideally, they would take corporate taxes to 0%, and encourage companies to move here.

Illinois ought to become a right to work state, which will create thousands of jobs. In the short term, Chicago might want to become a right to work city.

Higher taxes never bring growth.  They look good on paper-and for bond ratings agencies.  But they never work.  Illinois raised taxes, and nothing happened.

Meanwhile, Detroit residents pay the highest property and income taxes in the state. Last year its business tax doubled. About 40% of revenues go toward retirement benefits and debt, much of which was issued in the last 10 years to finance pension contributions. Payments on $1.6 billion of pension-related certificates of participation consume nearly every dollar of property tax revenue.

Investors jumped at the high yields on Detroit’s debt because they expected the city to borrow and raise taxes to the hilt to avoid default. If Motown risked defaulting, creditors bet that the state or federal government would swoop in like Superman and save the city in the nick of time.

Democrats like to joke about fissures in the Republican party.  But the financial equation is going to create fissures in the traditional Democratic party base.  Either they take them on, or the math will force bankruptcy.

This isn’t a class problem or a black/white/brown/yellow problem.  It affects us all.  I love my city.  As an individual I am powerless to get anything done.  I can vote in elections, and hope the politicians that are in power finally do the wise thing.

To me it seems like an easy choice.

 

 

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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