The case for asset transfers in Chicago and beyond
An asset transfer that links a revenue-producing asset to public pension funds may provide long-term solutions for governments — like Chicago— struggling under the weight of poorly funded systems.
It's a common practice in the private sector that entails depositing an income producing asset owned by the government into a pension fund. An asset transfer does not require going into debt — as Chicago is currently contemplating — and for a local government like Chicago it would use an existing publicly owned asset that was previously valued at carrying cost.
The transfer enables the asset to be accounted using its higher market value to boost funding ratios. Admittedly valuing public assets is not easy in that there isn't a ready market for public assets. That said there have been numerous privatizations of public assets and public private partnerships across the country to arrive at a reasonable value — notwithstanding parking meters.
An additional benefit is that the asset remains in the public domain, which is not always the case with privatizations. Another positive is that public assets are often essential purpose monopolies such as water and electric systems. This provides stable asset values and predictable income streams for pensions as opposed to the vagaries of the market.
Any excess cash flow can be used to offset the annual pension expense after the asset is operated, maintained, and pays its debts. According to a Stanford University white paper published in 2017, an asset transfer was successfully done in Queensland, Australia, with the Queensland Motorway. In this case the pension fund received the motorway asset at a value of $3.1 billion. Driven (no pun intended) by its fiduciary duty to maximize the value of assets, the fund made improvements through more efficient operations, adding lanes and new roads. The fund sold the asset three years later for $7.1 billion.
Recently the State of New Jersey had its lottery system independently valued at $13.5 billion. The system was contributed to its state pension funds, bringing the funding ratio from 44.7% to 58.7%. With cash flows from the lottery, pension payments were increased from $1.86 billion to $2.51 billion. While this increased payment will help pay down the liability the state was able to reduce payments from its general fund by $1.5 billion, helping to mitigate the crowding out effect.
As Chicago Mayor Rahm Emanuel's administration explores issuing $10 billion in bonds with the idea of increasing pension funding levels to 53% funded from the current 26.5%, I would suggest that the administration may be looking at the wrong side of the balance sheet to solve its pension problems and should consider the asset transfer model.
The city's liability is pegged at $28 billion and requires payments of close to $1.0 billion per state requirements. These payments are expected to rise to $2.1 billion in 2023. Numbers of this magnitude serve to crowd out dollars for essential services such as police, fire and infrastructure.
I do not fault the mayor for looking for solutions. In contrast to most elected officials across the country, he has been willing to start tackling the issue of legacy costs with recent increases in the property tax, a water and sewer surcharge, and an increase in 911 fees, all aimed at increasing required payments to shore up the pension funds.
That said, a $10 billion dollar pension bond is not a panacea and has many attendant risks. The idea is that the proceeds of the bond issue will be deposited into the funds thereby reducing the liability. This deposit, in turn, results in a lower payment. The annual pension expense covers payments to retirees, the funding of recently accrued benefits by active employees and paying down of the unfunded liability.
Underlying all this is the assumption that the cost of borrowing $10 billion will be about 5.25% and the earnings on pension assets will be a blended 7% for the four funds. However, this 7% is not guaranteed, as demonstrated by the fact that funds across the country have seen their pension burden increase as a result of investment returns on assets coming in well under the assumed rate of return. If that is the case in Chicago, taxpayers will be on the hook. In the worst case this may create a moral hazard where the fund reaches for returns through riskier investments.
Rather than using property taxes, the City is contemplating using sources of revenue transferred from the state such as the local distribution share of the sales tax, the personal property replacement tax and the motor fuel tax (the last is problematic in light of the lock box amendment which constitutionally requires this source to be used exclusively for transportation purposes). The problem with this is that these sources of revenue are deposited into the corporate fund to support basic services. In effect this becomes another source of crowding out.
I suggest that rather than going into further debt to shore up pensions that instead the City explore inventorying its income producing assets and consider contributing these to the pension fund. For example, the water and sewer system and or Midway Airport to name a few.
In fact, non-income producing assets such as undeveloped land can be contributed and then monetized in the future through leasing or sale for development. I realize that there will be many hurdles such as protecting any existing bondholders and complying with federal regulations. But those hurdles are worth exploring if we want the City to get out from under these large legacy liabilities and be able to have a fiscally sustainable government. At a minimum if the pension bonds were proffered as a way to "start the conversation," as stated by mayoral adviser Michael Sacks. then I would add asset transfers to that conversation.