CHICAGO - When Chicago in 2004 received a $1.8 billion windfall from its groundbreaking 99-year lease to a private consortium of its Skyway toll bridge, the city committed $500 million to establish its first-ever reserve. That move shored up the city's then-shaky credit and led to a round of upgrades.

The reserve was set up as the city teetered on the brink of a downgrade, due in large part to its narrow cash balance - at the time its only fiscal cushion. The balance had fallen dramatically from a high of $180 million in 1998 to a low of $13 million in 2002. In the fall of 2004, the city estimated a narrow $19 million ending balance for the year. It also was grappling with a $220 million deficit in its preliminary budget.

It wasn't just the city's creation of the account to bolster what has grown to a $3 billion corporate fund and $5.9 billion all-funds budget that helped the city win a round of upgrades over the next year and a half. It was also Mayor Richard Daley and his finance team's pledge to rating agency analysts to leave the pot untouched even in times of fiscal turmoil.

Moody's Investors Service waited more than a year to upgrade the city's GO credit a notch to Aa3. "We waited to see if they would show the fiscal discipline to cut spending and raise taxes and fees, and they did, to balance the 2005 budget," said Moody's analyst Edward "Ted" Damutz.

Last week when Chicago's chief financial officer Paul Volpe announced a whopping $420 million deficit in the 2008 and 2009 budgets, he unlocked the doors to the reserve when he left it on the table as an option in efforts to erase the city's budgetary red ink by fall when the 2009 budget is introduced to the City Council.

While Damutz noted that the use of the reserve appears to be "on the far end of the table" after conversations with the city, he observed: "The reserve hasn't been on the table before ... They are inching closer and closer and that's a concern. They are going to have to be very disciplined and creative in filling such a large gap without touching the reserve."

Others who follow the city's finances echo his concerns and are urging the city to look elsewhere to shore up its budget.

"Our upgrade of the general obligation credit to AA-minus was founded on the existence of the reserve and as long as that stays intact in substantial form" the credit remains sturdy, said Standard & Poor's analyst John Kenward.

"We strongly believe the city shouldn't tap the Skyway reserve - that would be an ill-advised, one-time maneuver," said Lise Valentine, research director at the business-funded government watchdog group the Civic Federation of Chicago.

Such a move would not only jeopardize the city's credit rating on $6 billion of GOs but also limit its future financial flexibility and widen the city's growing structural budget imbalance as its revenue streams have failed to keep pace with rising costs, she added. The federation is urging the city to cut personnel costs - which make up 80% of the corporate fund - by cutting positions and restructuring pension and health care benefits. The federation is also urging city council members to forgo pay raises - an unaffordable luxury given the deficit, Valentine said.

Fitch Ratings analyst Melanie Shaker said any use of the reserve wouldn't automatically trigger a downgrade, but she said the existence of the reserve is all the more important to the city's AA credit given its narrow cash balance.

"We would have to evaluate any plan they put together and at this point they have said they are looking at a number of options," she said. "If they were to clean it out, that would be a serious sign of financial weakening. It's the only real liquidity they have. They have been adamant in the past about leaving it whole."

City officials put off their traditional July release of preliminary budget numbers for the next year in anticipation of the latest revenue numbers and Volpe last week presented a grim picture of both revenues and costs.

"The preliminary estimates reflect the impact of the recession on two annual budgets - we've had slow revenues and greater than expected expenses in 2008, and we expect weaker revenues in 2009, even as we shoulder increases in wage, benefit, and pension costs," he said.

A dip in the expected level of revenues and higher expenses this year for snow removal, fuel, and energy are contributing to what is now expected to be a $141 million shortfall in the current corporate budget. No improvement is expected in the near term, resulting in a roughly $280 million hole to plug in 2009.

The city exceeded a snow collection budget of $18.5 million by $6.5 million and has exceeded its fuel budget of $29.4 million by $7.6 million.

Revenues collected so far this year are down from previous estimates by 3.4%, or about $40 million. Some are doing better than expected, including taxes on utilities, hotels, and amusements. But others are struggling, including taxes on cigarettes, real estate transactions, vehicle fuel, and bottled water, in addition to other revenue streams such as the sale of city-owned land and building permits. Overall, revenues are expected to fall about $107 million below those collected in 2007.

Between January and July, real estate tax collections were $35 million below projections. The city estimates a total $55 million reduction in budgeted revenues from the tax for the year. The once-flush revenue stream generated $242 million at its peak in 2006 when the Chicago real estate market was still booming. Sales taxes are a trouble spot too, with collections falling flat this year and now on pace to fall about $18.1 million short for the year from previous estimates.

In further evidence of the city's fiscal struggles, the city's unreserved ending cash balance for 2007 will be just $4.6 million once its audit is completed, down from an earlier projection of $15.5 million and the lowest in recent memory.

Volpe last week left all options - with the exception of a property tax increase - on the table. He did stress the importance of maintaining the city's sturdy credit ratings and his hopes to avoid the use of the reserve, but it still remains on the table.

Daley's 2008 budget raised property taxes by 10% to generate $83.4 million - the most politically controversial and unpopular piece of $275 million in tax and fee increases sought to erase a $218 million deficit in the preliminary budget.

Daley has already undertaken several management steps to help rein in spending that will benefit the 2008 and 2009 budgets, including ordering a hiring freeze, a 3% across-the-board cut on non-personnel costs, a suspension of most overtime, and a suspension on non-critical out-of-town travel.

A significant round of layoffs appears inevitable and City Council members and labor leaders are bracing for such an announcement, reporting that they have been told at least 1,000 positions will be cut to help balance the budget. Labor leaders and some council members have raised the specter of using the reserve, suggesting that it was created for times of fiscal struggle like now.

Some have suggested just a small piece be tapped as part of a larger diverse package of measures to balance the budget. Analysts and the Civic Federation frowned on such a move, saying that sets a dangerous precedent that does nothing to solve the city's structural budget problems.

Damutz said even a more minor move on the city's part to speed up the use of its $375 million annuity created with Skyway proceeds would concern him. The agency viewed the creation of the annuity to be drawn down in equal amounts over eight years to fund various programs as a means for the city to wean itself from the infusion of Skyway funds and move towards structural balance.

Shaker agreed that any acceleration in the use of the annuity funds would be viewed negatively because of the longer term impact on the budget's structural imbalance.

Whether several proposed lease transactions can help relieve the budgetary strain remains to be seen. The city is currently reviewing bids from teams interested in leasing Midway Airport, which some believe could raise $3 billion, and from teams interested in bidding on a lease to operate the city's parking meters. The Midway lease proceeds are committed to repaying Midway bonds, funding neighborhood infrastructure projects, and reducing the city's $9 billion in unfunded pension liabilities.

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