A tale of two cities: Part 5, Very difficult to persuade businesses to set up shop

April 17, 2015 | Annexation, Bankruptcy, Chicago, Cities, Detroit, Finance, Housing, Infrastructure, Municipal bankruptcy, Real estate taxes, Speculation, Urbanization, US News, Zoning | No comments 110 views

[Continued from yesterday’s Part 4 and the preceding Part 1, Part 2, and Part 3.]

By: David A. Smith

“— in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

Charles Dickens, A Tale of Two Cities

As we’ve seen so far, somewhere between 1945 and 1965, Chicago lost its value-proposition mojo:

austin_powers_mojo

Extracted just before

The expansion mojo vanished first in the city’s inability to make a case that outlying unincorporated areas should join into the expanding city, despite compelling geographic and infrastructure logic; second from its uber-urbanization, whereby the city’s growth are has compressed back to its original core, the Loop District around the Chicago River and Lake Michigan, where it is far more profitable to create white-collar job space in the sky than to pioneer blue-collar ground-level jobs in the periphery.

Sources referenced in this post

Reuters (February 27, 2015; gray-blue font)

National Journal (March 28, 2015; black font, main source)

Encyclopedia of Chicago’s History; Georgia sepia)

Previous AHI blog posts on related subjects

June 5, 2013: A grand unified theory of municipal insolvency (2 parts)

September 13, 2013: Next up, Chicago (3 parts)

September 25, 2013, Decline and fall of the Roamin’ Empire (5 parts)

December 4, 2013: A fool and his bond market are soon parted (2 parts)

December 31, 2013: Sub-cities? (2 parts)

January 6, 2014: Out of the muck? Jefferson County (5 parts)

January 5, 2015: Doublethink pension funding (10 parts)

A century ago, Chicago’s growth (and its economic-development business case) derived from hard-asset infrastructure – roads, railways, and especially its water/ sewer systems.  Today’s new Chicago economy doesn’t need that old infrastructure, and it doesn’t need (or want) the outer boroughs:

The city’s key industries, primarily centered in and around the Loop, are financial services, tourism, transportation, logistics, health care, and education.

With the decline of manufacturing, the outer boroughs, as one might dub the nineteenth-century annexations, no longer have a business model and no longer generate net profit for the infrastructure maintenance. 

robert_taylor_building_22

2005: The last remaining building in Robert Taylor Homes, Building 22

I suspect the business model for the outer boroughs was already failing even fifty years ago when Chicago built its enormous public housing estates – among them Robert Taylor Homes (with more than 4,000 apartments), Cabrini Green (3,607 apartments, demolished 2011), Henry Horner Homes (built 1957, demolished 2008), Harold Ickes Homes (demolished 2011)

robert_taylor_aerial_partial_demolition

Robert Taylor Homes fro0m the air, after several buildings had been demolished

Ironically, the decline of American northern urban manufacturing coincided with the Great Migration of blacks from the south to the north.

great_migrations

Northern, urban, and black: the Great Migration

However it happened, the jobs that today’s Chicagoans’ parents and grandparents immigrated to work no longer exist, though the mayor has taken actions to create jobs:

Emanuel has also made some effort to secure investments in the South and West Sides. He got Method, a company that makes cleaning products, to build a small factory on the far South Side that will create about 100 jobs.

south_side_soapbox

The South Side Soapbox, expected to open in April, 2015

That’s important less for the jobs than for the demonstrated commitment to the South Side.

And with tax breaks, he induced upscale Whole Foods to put a store in Englewood, which, like many African-American neighborhoods, lacked grocery stores. Still, it’s unclear how much these small-scale investments, coupled with the city’s educational initiatives, can really do to ameliorate the gap between the South and West Sides and the rest of the city.

For the city as a whole, the goal should be jobs as a whole, and it will be easier to create them where they are already plentiful:

In March 2012, a report of the city’s main planning group warned that “the demand for low-skilled workers continues to decrease” and that “in the years ahead, the demand for high-skilled employees will increase twice as fast the demand for lower-skilled workers.” It also predicted growing demand for “jobs that require mid-skilled workers,” but these are generally workers who at least have associate degrees from community colleges. The upshot is that those without high school degrees, or with only high school degrees, will increasingly be unable to find jobs –

Hence the mayor’s emphasis on education, including free community colleges.

– and it will be very difficult to persuade businesses, almost all of which now require some familiarity with computer technology, to set up shop in Chicago’s poor neighborhoods.

Okay, but that’s worse than a scale problem, that’s a death sentence for some neighborhoods.

One of Garcia’s criticisms of Emanuel is that he has focused on economic development downtown, rather than in the poorer neighborhoods. Emanuel has responded by saying that it’s “a false choice to pit one part of the city against another. No great city does not have a thriving central city that supports jobs where all parts of the city go to.” 

Mayor Emanuel is right: while some cities – Sao Paulo and Los Angeles come to mind – have multiple downtowns, every city must have at least one job-generating magnet neighborhood.  Chicago’s job center, like that of New Orleans, has always been where the city was founded, where the land was best and the water most accessible.  In Chicago, that means the Loop.

rahm_el_roosevelt

Remember, you can take the El between your home and the Loop

It’s also true that he has squandered tax breaks intended for blighted areas –

Squandered?  Or used to lever private capital:

– on luxury hotels, high rises, and an arena for DePaul’s basketball team in the South and West Loop –

To keep major employers in the city, to attract new ones:

– all while luring Yelp and Motorola Mobility to downtown Chicago –

To increase tourism:

– and putting money into McCormick Place and Navy Pier, two key tourist destinations.

And maybe to keep richer boroughs happy to remain in Chicago?

emanuel_chicago_flag

Bingo; that’s politics 101

Meanwhile, despite the mayor’s efforts, Chicago kept spending as if revenues were plentiful, with the result that Chicago has been following Detroit’s downward slope, as I wrote two and a quarter years ago in A fool and his bond market (December 4, 2013; forest green font):

In Next up: Chicago, I spent three posts (Part 1, Part 2, and Part 3) documenting how the Windy City was following Detroit into certain municipal insolvency, and presented the prevaricating evasions offered by Chicago’s former chief auditor (now under indictment);

 

Last year, now-retiring City Comptroller Amer Ahmad argued that the city’s debt load was not “troubling” because, “We still have a very strong bond rating.”

 

amer_ahmad

Indicted? Me?

 

Too bad for him, Mr. Ahmad (who since that quote was indicted for money laundering, conspiracy, wire fraud, and more) no longer has that explanation.  As reported in Investors’ Business Daily (November 13, 2013), an unlikely guardian of integrity has emerged:

 

As Chicago’s public pension costs mount, the municipal bond market is starting to penalize the city for its inability to grapple with the problem.

 

Finally somebody is.  And somebody has to, because the system of governance used in running large American cities is not up to the financial and economic business the cities run.  Here are some tidbits:

 

The City of Chicago, with a population of 2,715,000, has an annual budget of $8.75 billion.  It employs 47,000 people, 90% of whom are unionized and covered by collective bargaining agreements, and pays them $3.25 billion annually in wages and benefits (page 22), meaning they average $70,000 apiece in total compensation; and it has at least $18 billion in general obligation bonds.  To put those numbers in context, Chicago:

 

1. Employs 1 out of 57 city residents.  With a typical household being 2½ people, that means 1 employee for every 24 city households.  That is a lot of employees.

 

chicago_teachers_strike_02

When they’re working, that is

 

2. Spends roughly $3,225 per capita, equivalent to $8,000 per household.  With the median sales price of a Chicago home at roughly $225,000, if the full revenue were provided by real estate taxes (it isn’t), that would be 3.75% of assessed value, a huge tax rate. 

Faced with an under-performing private sector and an over-extended public sector, mayor Emanuel tackled the costs:

In April 2014, Emanuel finally put forth a comprehensive strategy for reducing the deficits on two of the city’s main pension plans. He sought to increase city workers’ contributions and reduce the benefits paid out to retirees, while increasing the taxpayer contribution by raising property taxes. Everyone had to make sacrifices, he argued.

By Illinois law, he had to seek approval from the state government for any modification of the benefit or contributor formulas.  Then-Governor Pat Quinn, facing reelection, refused to approve a property-tax hike –

Why Governor Quinn vetoed a city’s property tax increase can be explained less by policy than by politics, especially, because if Chicago politics is rotten, Illinois politics is equally rotten.  Mr. Quinn became governor on the impeachment (and eventual conviction on public corruption charges, for attempting to sell the about-to-be-vacated U S Senate seat held by Barack Obama when he was elected president) of his governor and former running mate, Rod Blagojevich.

pat_quinn

You didn’t pay enough for me not to veto it

– and Emanuel had to compromise on a bill that kept the benefit cuts and increases in worker contributions but limited revenue increases to a telephone tax.  

Through his actions, Mayor Emanuel has shown that he understands what is at stake in a way that I suspect few Chicagoans do.  The cuts must be retained at any cost, and if that forces desperate taxes, so be it.

He supplemented this telephone tax with various fees and fines – including those from expanded use of red-light and speeding cameras – that have proved exceedingly unpopular.

If voter backlash forces the mayor to back off on these charges, then he can say, Where do you want me to get the savings from?

Complicating matters further, some unions, citing a state constitutional provision that prohibits benefit cuts without the beneficiaries’ approval, got the deal thrown out in a lower court. It is now being considered by the Illinois Supreme Court, and it is very possible that it will completely collapse.

While this post won’t be about the legal ramifications – I’m not qualified and speculation is moot, as the judges will decide one way or another soon enough – it’s worth sufficient exposition so that you understand it, because the issue is a critical and representative hinge for many cities in similar straits.

doors_durin_gandalf

I no longer remember how to open the economy’s hinges

[Continued next week in Part 6.]

 

A tale of two cities: Part 4, Either illegal or impossible

April 16, 2015 | Annexation, Bankruptcy, Chicago, Cities, Detroit, Finance, Housing, Infrastructure, Municipal bankruptcy, Real estate taxes, Speculation, Urbanization, US News, Zoning | No comments 142 views

[Continued from yesterday’s Part 3 and the preceding Part 1 and Part 2.]

By: David A. Smith

“… we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way …”

Charles Dickens, A Tale of Two Cities

By the end of yesterday’s post, we had established that the value proposition or business case for expanding Chicago was powerful from its founding (1837) through at least the end of World War II, but had disappeared by the 1950s when natural additions like Rosemont took extraordinary steps not to be assimilated.

locutus

I am Chicago, of Borg … you will be assimilated

With Rosemont’s and Naperville’s rejections of incorporation, Chicago’s boundaries have remained unchanged for half a century, and that invites the next question, a grimly logical one.

Sources referenced in this post

Reuters (February 27, 2015; gray-blue font)

National Journal (March 28, 2015; black font, main source)

Encyclopedia of Chicago’s History; Georgia sepia)

locutus_sleep

Time to put me to sleep, Mr. Data

4. Governance: Has Chicago outgrown mayoral government?

In multiple posts dealing with bankrupt cities (especially San Bernardino and Detroit), we’ve seen a pattern recur: the city becomes insolvent because benefits (health and especially pensions) to public employees rise ever faster than the city’s ability to pay for them (except in the world of doublethink pension-fund accounting), and the city government is incapable of resisting the public-choice/ political-vaporware doublethink cabal, even when confronted with egregious political theft in broad daylight like ‘thirteenth-month’ giveaways. 

At the same time, the pension bill itself increased due to a greater life span among retirees and benefit increases granted to public employees.

With my eyes closed, I predict this to be the thirteenth-month gimmick (that seems to have been epidemic) or something similar to what Detroit did.

By the end of 2012, the assets in the city’s funds amounted to just 36% of their liabilities.

Yikes!

yikes_hobbes

There won’t be any left for my generation, will there?

Many Chicago-area public-employee pension funds are woefully undercapitalized, and Tolstoy was wrong; each underfunded municipal public-employee pension fund is underfunded in the same dreary ways.

karenin_anna

My dear, we’ve played this scene over and over, usually with better actors

Chicago’s finances are already sagging under an unfunded pension liability Moody’s has pegged at $32 billion and that is equal to eight times the city’s operating revenue.

Though I pledged in this post not to be outraged, that figure is appalling.  If you, dear reader, owed debts equal to 8x your annual income – not your net savings, mind you, but you full income, you’d have your credit cards cut up before your eyes, your property seized, and you’d be running for the nearest bankruptcy court.

cut_up_credit_cards

Okay, Chicago, that’s enough, we’re cutting you off

Nor is this statistic any more cheerful:

The city has a $300 million structural deficit in its $3.53 billion operating budget and is required by an Illinois law to boost the 2016 contribution to its police and fire pension funds by $550 million.

Thus Chicago is already running 8%negative cash flow (300/3,530), in a year it’s slated to jump to a 24% deficit ((300+550/3,530). 

One may reasonably conclude that the pension-fund doublethinkers will always triumph over mayors, even one as smart and bare-knuckled as Rahm Emanuel, because not only must he deal with many decades of overspending, when a city becomes as large and diverse as Chicago’s, no one person can be the approved mayor of all the Chicagos:

If you drive through the predominantly African-American neighborhoods on Chicago’s far South and West Sides, it’s difficult not to be struck by the sheer desolation. While much of the city—including Pilsen, a Mexican-American area where Garcia grew up—teems with life and commerce, swathes of the South and West Sides seem bereft of hope.

pilsen_chicago

Bienvenidos!

Garbage is strewn on empty lots, stores are boarded up, and streets are deserted in daytime. In West Englewood, for instance, from 2008 to 2012, a third of households were below poverty, unemployment among those ages 16 and older was 34.7%, and 30% lacked high school diplomas.

west_englewood

Eddie’s Food Mart, West Englewood

west_englewood_shooting

Four people shot at 55th and Ashland

In Riverdale, 61.4% of households were below poverty, 25.4% were unemployed, and a quarter lacked a high school diploma.

According to the Census Bureau, overall African-American unemployment in Chicago in 2013 was 25%, considerably higher than the African-American unemployment rates in America’s other four largest cities.

First elected in April, 2011 facing a Chicago whose finances were out of whack, the new mayor opted to buy time – at a high price:

Emanuel also opted for a dodgy bond strategy used earlier by Daley called “scoop and toss”: He sold new city bonds with high interest rates so that he could buy the principal of bonds that were coming due and use the difference to make up the deficit.

scoop_and_toss

Not illegal if they let you get away with it

As far as I’m concerned, scoop and toss should be made illegal in every state, because if not illegal, it is hugely tempting, in roughly the way heroin is tempting – immediate feel-good in exchange for permanent addiction:

scoop_toss_puerto_rico

Mayor Emanuel is smart enough and tough enough to know that he was mortgaging the future at usurious rates, so what did he use the political time for?

Emanuel’s response to this problem has primarily been to try to improve Chicago’s schools.

A good investment, but one with a longer term payback versus short-term political strife: a city-wide and nasty teachers’ strike.  Still, the mayor made gains, though it’s a testament to city dysfunctionality that they were so small:

He got the school board, which he controls, to lengthen the school day and year, and institute all-day kindergarten. 

The school board also shut down 49 underused and low-performing elementary schools, and sought to transfer those who were displaced—12,000 predominantly low-income African-American students—to better-performing schools. While this move was initially justified on financial grounds, it was also part of a broader strategy to improve student achievement.

Naturally, those in whose wards the schools were closed accused the mayor of racism, fueling what would become Mr. Garcia’s challenge as he emerged as the Teachers’ Union’s candidate.

The results were mixed: According to a University of Chicago study, 93% of the students transferred from third-tier to second- or first-tier schools, but only the 21% who attended first-tier schools showed significant scholastic improvement.

It’s a further sad commentary on municipal politics that if one in five students show ‘significant’ improvement (whatever that means), that’s considered a mixed result.  How about the value of moving them to better schools, reversing spatial discrimination?

paul_green_roosevelt

R U illegal, impossible, or both?

Garcia, meanwhile, has proposed measures that, in Paul Green’s words, are “either illegal or impossible.” He has said he wants to impose a graduated state income tax, which is illegal under the state constitution and would require a constitutional amendment passed by a three-fifths vote in the state Legislature.

Obviously, Mr. Garcia’s campaign was total political vaporware, designed only to get him elected so he could reverse Mayor Emanuel’s cost-cutting reforms. 

Garcia has also said he opposes reducing pension benefits, which would put the onus of resolving the crisis entirely on taxpayers. In short, if there is a viable alternative to Emanuel’s approach, Garcia is not airing it.

Though he may have averted his consciousness from the awareness, Mr. Garcia was less a real candidate and more the personification of those who wanted anybody-but-Rahm, at least for the primary, if only to discourage the mayor from even more belt-tightening.  And that he was the voters’ consensus for the best alternative to a mayor whom they elected but who actions they now dislike strongly suggests that Chicago will find no better municipal executives this side of bankruptcy.

emanuel_garcia

On to the debates, Chuy?

5. Economics and finance: What is the business case for a mega-Chicago?

Chicago’s expansion was fueled by economic growth, mainly manufacturing and distribution, that depended on using established and extending infrastructure. 

Many suburbs were unable to provide all the services their residents demanded. There were two common problems.

 First, many suburbs were unable to borrow money for improvements because they were already at their debt limit (typically 5% of their assessed valuation).  Second, to be cost-effective, the new technologies required populations much larger than most suburbs were likely to have.

For communities with manufacturing or distribution businesses, connecting to the grid could mean becoming part of the city, or it could mean joining a non-city ‘infrastructure club’

An alternative to annexation was the formation of a special governmental body. The Sanitary District Enabling Act of 1889 permitted the creation of a special district over an area benefited by a common sewage-disposal strategy.

Municipalities within such a district would be responsible for collecting sewage, but the Sanitary District would be responsible for disposing of it.

And the MWRD paid immediate dividend: among its first actions, the MWRD reversed the flow of the Chicago River so that sewage flowed not into Lake Michigan but instead into the Des Plaines River, there to flow into the Illinois River, Mississippi River, and eventually the Gulf of Mexico.

mwrd_chicago_seal

The alternative to a city: a quasi-public corporation

The act also required municipalities with direct access to Lake Michigan to supply water to adjacent municipalities at reasonable cost. The Sanitary District created an alternative to annexation for residents of suburbs adjacent to Chicago.

The result was an ‘adverse selection’ of annexation into Chicago, with the higher-income suburbs (Evanston, Oak Park, Blue Island) remaining independent, and the lower-income ones adding to expanding Chicago.

The southern suburb of Blue Island voted against joining Chicago in 1915, although its neighbor to the north, Morgan Park, had joined the year before. Blue Island’s assertion of its right to Sanitary District water helped it to preserve its independence.

[Remarkably, this dynamic – adverse selection defining who’s a customer of which water/ sewer system – would later be replicated in Jefferson County, Alabama, contributing to that system’s insolvency and its eventual bankruptcy. – Ed.]

jeffco_bankruptcy_signs

These two outcomes are a package

[Continued tomorrow in Part 5.]

A tale of two cities: Part 3, Either change the constitution or discover oil

April 15, 2015 | Annexation, Bankruptcy, Chicago, Cities, Detroit, Finance, Housing, Infrastructure, Municipal bankruptcy, Real estate taxes, Speculation, Urbanization, US News, Zoning | No comments 198 views

[Continued from yesterday’s Part 2 and the preceding Part 1.]

By: David A. Smith

“… it was the spring of hope, it was the winter of despair …”

Charles Dickens, A Tale of Two Cities

When I started this post by asking the question, Is Chicago too big to survive, or should it break up into smaller cities?, that led to exploring just how and why Chicago grew, and as we’ve seen up to now, more than many American cities Chicago was consciously created and consciously expanded, always with civic economics at the forefront, and most of that civic economics driven by transportation and distribution.

chicago_annexation

An expansionist empire, on the march for more than a century

Sources referenced in this post

Reuters (February 27, 2015; gray-blue font)

National Journal (March 28, 2015; black font, main source)

Encyclopedia of Chicago’s History; Georgia sepia)

Previous AHI blog posts on related subjects

June 5, 2013: A grand unified theory of municipal insolvency (2 parts)

September 13, 2013: Next up, Chicago (3 parts)

September 25, 2013, Decline and fall of the Roamin’ Empire (5 parts)

December 4, 2013: A fool and his bond market are soon parted (2 parts)

December 31, 2013: Sub-cities? (2 parts)

January 6, 2014: Out of the muck? Jefferson County (5 parts)

January 5, 2015: Doublethink pension funding (10 parts)

But vis-a vis its neighbors, annexation by Chicago first appeared a boon (Gilded Age, late 1880s), then a bane (Great Migration, 1950s), so whereas lower-middle-income communities (e.g. Austin) were pleased to be enfolded by Chicago, upper-middle-income suburbs like Oak Park and Evanston resisted – and then newer upper-middle-income peripheral communities like Rosemont aggressively expanded themselves to reach indigestibilty.

rosemont_water_tower

Try swallowing that, Chicago

Rosemont, in fact, exists as a legal entity for the sole purpose of not being Chicago.  Take a look at its shape and location:

rosemont_borders

An Interstate interchange and a strip of commercial uses

Immediately to Rosemont’s west is the massive footprint of O’Hare Airport, and when one exits from O’Hare, any rout other than Mannheim Road (US 45) takes one through Rosemont, which in turn is bounded to the east by the Des Plaines River and a greensward (Chevalier Woods); what’s left for the village of Rosemont is spectacular access (I-294, north to Milwaukee, and I-90, the Kennedy Expressway which runs east into downtown Chicago), a natural hotel/ office CBD, and better-than-neighboring residential areas.

Rosemont is geographic and political proof that between 1875 and 1955, Chicago’s urban value proposition inverted; it’s no longer desirable to join the Windy City Club.

join_or_die

A business case in 1775 and 1875 … but not in 1975

Instead, annexation competitions (for instance, between Aurora and Naperville) have continued in Chicago’s western suburbs up to the present day:

In the last quarter of the twentieth century, Naperville pursued a vigorous program of annexation to capture increasing tax revenues from its booming neighbors. Annexation today is considered feasible for combined areas in the 50,000 to 100,000 population range.

Even today, Naperville invites unincorporated townships or land plots to join Naperville via annexation.  Throughout all these annexations, the proposition has been that annexation adds value both for annexed unincorporated land and for the annexing city:

A larger jurisdiction, the result of annexation, was expected to reduce the cost of providing existing services and provide tax revenues to pay for additional ones.

That proposition held for (say) 75 years.  By the late 1960s it was under stress, though even in Detroit it would take another five decades for the stress to prove insupportable. 

decline_and_fall_detroit

And if [candidate Jesus Chuy Garcia] means manufacturing on a scale that Chicago once enjoyed, the long-term trends in the local economy are running against such a strategy.

Those jobs have long since gone to China and India.

As one head of an economic-development organization in a minority neighborhood told me, hopes of reviving manufacturing on a large scale are a “pipe dream.”

opium_pipe_babe

It’s unreal … but it feels so good

If manufacturing cannot sustain Chicago’s economy, and if distribution is increasingly dematerialized (point to point rather than warehouses and distribution centers), can Chicago sustain the level of infrastructure its citizens expect?

3. Services and infrastructure: Can Chicago deliver to its inhabitants?

Even as it grapples with this extreme [income] gap, Chicago is suffering from a severe fiscal crisis.

Worse, or at least more imminent, than the fiscal crisis is the capital-markets crisis, where Chicago is on the verge of being permanently parted from the bond markets:

Chicago drew closer to a fiscal free fall on Friday [February 27, 2015] with a rating downgrade from Moody’s Investors Service that could trigger the immediate termination of four interest-rate swap agreements, costing the city about $58 million and raising the prospect of more broken swaps contracts.

The downgrade to Baa2, just two steps above junk, and a warning the rating could fall further still, means the third-biggest U.S. city could face even higher costs in the future if banks choose to terminate other interest-rate hedges against fluctuations in interest rates.

The banks will either terminate the swaps or charge large cash premiums not to do so.  Either way, very bad for Chicago.

All told, Chicago holds swaps contracts covering $2.67 billion in debt, according to a disclosure late last year.

As with so many other US cities, the crisis is largely self-made, over many years and decades of over-optimism coupled with public-choice theory.

Like plenty of other municipalities, Chicago lacks the revenue to pay its bills, particularly its pension obligations to city workers. According to a 2013 Pew report, 61 other U.S. cities face similar difficulties, but Chicago’s situation is one of the worst. “Voters must realize we are facing the greatest economic crisis since the Great Depression,” says Roosevelt University’s Paul Green, the doyen of Chicago political experts. “If something doesn’t happen, the city is beyond the abyss.”

If Chicago were a bank, resolution would be straightforward and swift, even if painful: the portfolio would be divided into performing loans (the ‘good bank’) and non-performing (the ‘bad bank’).

rbs_bad_bank

And we’ve had plenty of bad banks lately

For a city (as for a country) the problem is more challenging; if it’s predominantly a financial issue, then the overlevered debt is written down or rescheduled.  But, if the problem is operational – the enterprise called the city is unable to make its cash inflows match its cash outflows – then the economically rational analog would be to renounce the unprofitable neighborhoods.  Give them back. 

no_returns

But can you do that?

Pre-bankruptcy Detroit did this, though not by design, and as a result Detroit’s population decline concentrated in a few neighborhoods that the unhappy city must now gradually un-build its excess and useless houses and turn the land back into parks.

Although this isn’t far from what the ECB has sought to impose on Greece and Spain, and is possible politically mainly because Mario Draghi and his colleagues are not elected; in America, in Chicago, for a mayor to announce such a strategy would be political suicide, 

Many of Chicago’s black residents are the descendants of those who came from the South in the 1940s to work in the city’s factories, but most of Chicago’s large factories have shut down or moved over the last 40 years.

Spatial segregation by income (and by its corollary and frequent cause, race) would be challenged judicially, especially by Rahm Emanuel’s former boss:

emanuel_obama

“Boss, I’m going back to Chicago, I’m going to run for mayor, and then I’m going to cut off the black neighborhoods.”

“If you do, Rahm, you’re dead to me.”

As if the socioeconomic gap wasn’t hard enough to solve on its own, it’s made even more difficult by the local government’s terrible fiscal condition.  Chicago’s finances, like those of some other city governments, have suffered from the boom-bust cycle of the past twenty years.

I don’t recall Chicago’s economy ever ‘booming’ in the last twenty years.

The city grew complacent during the boom, failing to set aside funds for the future, and then didn’t take the necessary corrective steps when the economy faltered. The blame largely belongs to [Richard M.] Daley, Emanuel’s predecessor, who lavished money on civic projects and doled out funds to appease aldermen without raising taxes.

Nor did Mayor Daley improve the pension fund; if anything, he made the pension deficits much, much harder to solve.

richard_m_daley

I’ve got friends and I’ve got enemies; which are you?

The heart of Chicago’s current fiscal woes is its pension system. The city’s public workers, including teachers, do not receive Social Security. Instead, they get pensions from the city.

The government pays for these pensions through funds that consist of employees’ and taxpayers’ contributions and what Chicago earns on investments from these contributions. According to University of Chicago public-policy expert Michael Belsky, investment earnings have generally accounted for two-thirds of the total funds.

michael_belsky

Do not ask for whom the Belsky tolls: it tolls shortfalls

Private pension funds are usually required to maintain assets equal to 100% of their total liabilities, measured as what would be required to pay benefits to existing workers and retirees; but because cities and states can count on being able to tax to cover their obligations, rating agencies and regulators believe their assets need to cover only about 80% of their total liabilities.

Rating agencies ‘believe’ this?  Or doublethinked their way to rationalizing?

[I remain astonished that no rating agency has been litigated into bankruptcy. – Ed.]

While the Illinois Constitution clearly states pension benefits cannot be impaired or diminished, the state doesn’t have the money to make good on that promise.

As I’ve discussed before (in the context of Detroit and Michigan’s constitution), such arguments should fall on Federal supremacy grounds:

Seton Hall law professor Stephen Lubben neatly dispatches several of the more common ones:

 

First is the argument that Michigan’s Constitution prohibits modification of the pensions, and thus prohibits a Chapter 9 filing, where they might be modified.

 

What Michigan’s Constitution actually provides is that pension benefits “shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” By calling the benefits a contract, the state’s Constitution invokes the federal Constitution, which has a Contracts Clause that prohibits the states from passing any law impairing contracts. The same kind of provision also appears in Article I, Section 10 of the Michigan Constitution.

 

But the Bankruptcy Code is federal, enacted under the Bankruptcy Clause of the Constitution, and not subject to the Contracts Clause. And, of course, the laws under the federal Constitution override conflicting state laws, including the state Constitution.

That’s the practical posture adopted by “the doyen of Chicago political experts”, Paul Green, who commented (2013):

“How can you be constitutional and pay the bills?” Green asked. “We have to either change the constitution or discover oil.”

While the Illinois language is better for the pensioners than was Michigan’s, I still think it must fail, but having dismantled such reasoning in many previous posts, I’m not going to be outraged about it here. 

sofa_outrage

Been there, done that

Yet the incapacity of city government to deal with runaway pensions by any means short of insolvency invites the next question in this post.

[Continued tomorrow in Part 4.]

 

 

A tale of two cities: Part 2, Most suburbs looked to Chicago

April 14, 2015 | Annexation, Bankruptcy, Chicago, Cities, Detroit, Finance, Housing, Infrastructure, Municipal bankruptcy, Real estate taxes, Speculation, Urbanization, US News, Zoning | No comments 127 views

[Continued from yesterday’s Part 1.]

By: David A. Smith

“… it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness …”

Charles Dickens, A Tale of Two Cities

As we saw in yesterday’s Part 1, once one takes as a given what many are foolishly denying – namely, the certainty that Chicago will go bankrupt in the next few years, following Detroit into and eventually out of bankruptcy – it invites the next big question: could Chicago break up or fragment, the way the USSR or Yugoslavia or the Austro-Hungarian Empire fragmented, out of failure of integrative synergy?  For that matter, should Chicago dissolve into constituent pieces, like some merger or conglobulation gone awry, and if so, how and via what precedent? 

Sources referenced in this post

Reuters (February 27, 2015; gray-blue font)

National Journal (March 28, 2015; black font, main source)

Encyclopedia of Chicago’s History; Georgia sepia)

That, in turn, made me ask a question I’d never considered – where did mega-Chicago come from?

city_hall_1837

Chicago’s very first city business was conducted in leased space in the Saloon Building at the southeast corner of Lake and Clark Streets.”

It started, as we saw yesterday, as a small grid settlement based on an infrastructure-node economic argument: connecting the Mississippi River System to the Great Lakes.  With that, commerce boomed.

city_hall_1842

“By 1842, the Saloon Building lease had expired, and city business was conducted in a building owned by the Widow Chapman, at the corner of LaSalle and Randolph Streets.”

With its installed urban core, and its huge infrastructure advantages (the Illinois, Michigan, and Chicago River canal system), Chicago became the natural northern railroad junction (with St. Louis, Memphis, and New Orleans strung south along the Mississippi), and with that, the city grew and grew on farming and manufacturing:

chicago_1860s

By the late 1860s, the city had quadrupled in size

These boundaries moved outward via a series of referendums until the city encompassed just over 185 square miles by the end of the century. At first, these annexations were the result of legislative acts, but, beginning in 1889, they were the result of elections.

Chicago’s geographic expansion was driven by infrastructure and municipal finance, as I discovered in this chapter by David Cutler and Grant Miller, Water, Water Everywhere: Municipal Finance and Water Supply in American Cities:

Following financial difficulties during the depression of 1837 and a series of state defaults around 1840, the landscape of local public finance changed radically. Many state legislatures amended their constitutions to prohibit state borrowing for costly canals, turnpikes, railroads, and other improvements.

Although that was 175 years ago, it remains relevant today to remind us of private-infrastructure projects for economic development (say, Harrisburg’s treatment plant) sometimes being the gift that keeps on costing.

As states were increasingly constrained by pay-as-you-go financing, municipal debt arose to fill the gap between what could be afforded and what was thought to be needed. (Not until after World War I were many state constitutional restrictions on debt officially relaxed.)

A large share of municipal debt during this period was for railroad construction. This era of expansion peaked in the late 1860s and early 1870s. Between 1868 and 1873, the net bonded debt of New York tripled; between 1867 and 1873 the bonded debt of Chicago also tripled. (Griffith 1974).

chicago_annexations

Chicago’s expansion, in 48 annexations from 1830 to 1930

Just as in the 1990s REITs grew by levering their favorable access to capital to buy/ absorb other REITs, nineteenth-century Chicago used is network advantages (the established water system) and access to capital to give its abutting localities a great option:

Over the following two decades, Chicago, like many American cities, experienced numerous annexations.  That annexation indicates why some suburbs elected to relinquish their autonomy, and others retained theirs.

it_takes_two

We have to be moving in harmony

Clearly some suburbs were too small, too poor, too debt-ridden to continue as autonomous municipalities, but others, such as Hyde Park, could have remained independent.

In fact, Hyde Park spent 28 years as an independent township, from 1861 to 1889.

Along with the other North Shore suburbs, Evanston was annexed to the Sanitary District in 1903.

Although a later section of this post will discuss the Metropolitan Water Reclamation District of Greater Chicago (MWRD), for now it’s worth observing that the MWRD was a nineteenth-century quasi-governmental entity invented and evolved even as cities were expanding:

MWRD is a special-purpose district, chartered to operate in northern Illinois since 1889. Although its name may imply otherwise, it is not a part of the City of Chicago’s local government, but an independent agency of state government with an elected Board of Commissioners. MWRDGC’s main purpose is the reclamation and treatment of wastewater and flood water abatement in Cook County to protect the health and safety of citizens and of area waterways.

It’s instructive that the emergence of modern cities owes so much to the need to supply those cities with clean water and the associated need to create large-scale public finance to fund the infrastructure. That question decided the choices made by a series of townships”

In a complicated series of votes, a majority of Cicero voters compelled Austin to join Chicago (1899), Oak Park detached itself from Cicero (1901), and then Oak Park repeatedly voted down its own annexation to Chicago.

As Frank Lloyd Wright (active in Oak Park at precisely this time) and thousands after him will attest, Oak Park is glad it was never annexed into Chicago.  And it’s quite likely (I didn’t bother to check) that even in 1889, Oak Park’s socioeconomic position was better than its neighbors to the east (such as Austin or the Cicero), so it wanted to maintain fiscal and political independence.  Here’s a lesson that the Greeks and the Irish would undoubtedly like to have known sixteen years ago.

In 1889, however, most suburbs looked to Chicago, not to the Sanitary District, as the supplier of sanitary services.

hull_house_1889

Jane Addams’s Hull House, founded in 1889

Annexation took two to tango: the towns absolutely wanted to join Chicago, but Chicago had to want to add the towns:

city_hall_1885

“1885 – It wasn’t officially called The Boondoggle, but this city hall took much longer to build than expected; it cost more than planned, and it was out of date, overcrowded, and poorly suited to its use by the time it was completed. Plans for a more functional building were begun almost immediately.

The largest single annexation followed an election on June 29, 1889, when Chicago gained 125 square miles and 225,000 people. It became the (then) largest city in the United States in area and passed Philadelphia to become second in population.

state_street_chicago_1880s

Chicago, State Street, 1880s

Back then cities had to go out because, lacking elevators, they could not go up.

Evidently, in the nineteenth century, urbanization and incorporation were a disruptive governance model akin to the disruptive business models that Amazon, Facebook, Apple and others are racing to capture, based on a beliefs that all network effects are positive, all scale economies are evergreen, and all projections are achieved.  It seems to have been a race like the REIT race of the mid-90’s and the dot-com race of the early Aughties – get to minimum acceptable scale, or be absorbed. 

Suburban annexation activity continued into the twentieth century, but it was relatively minor within Chicago. The village of Niles Center (Skokie) increased its size tenfold with a series of annexations between 1924 and 1926.

In fact, the pattern of annexation-for-infrastructure swept the nation in the Gilded Age (not coincidentally, the great age of railroad expansion and the development of streetcar suburbs), such as in Boston:

brighton_1870s

Disruptive transit: Brighton streetcar, 1870s

In the 1868-73 period five communities – Roxbury, Dorchester, Charlestown, Brighton, and West Roxbury – opted to merge with the city, thereby increasing Boston’s area fivefold and adding some 108,000 new residents to its population.

I find it immensely pleasing, in a general-theory-of-urbanization way, that the annexation movement – which I discovered only in writing this post – was driven by real estate development and infrastructure network-effect scaling benefits.  I likewise find it satisfying that the decisions about annexation hinged on self-interest, including a counter-movement by the richer enclaves; and in 1873, Brookline rejected Boston’s offer of annexation:

crabgrass_frontier

King of the wild back yard?

On Tuesday October 7, 1873, under the heavy propaganda of the anti-annexationists and a fairly disorganized annexationist force, the electorate voted to keep Brookline  independent by a wide margin (70% No).  Simultaneously [Boston voted 81% Yes], but the measure failed without Brookline’s consent.

 

As Kenneth T. Jackson points out in his book Crabgrass Frontier, “the first really significant defeat for the consolidation movement came when Brookline spurned Boston.” This was, according to Jackson, the starting point for a massive suburbanization campaign that swept the United States and greatly influenced the American way of life. “After Brookline spurned Boston,” Jackson says, “virtually every other Eastern and Middle Western city was rebuffed by wealthy and independent suburbs-Chicago by Oak Park and Evanston, Rochester, NY by Brighton and Irondequoit, and the city of Oakland by Piedmont. […] And, as the suburban trend gained momentum, state legislators became increasingly reluctant to override the wishes of the voters concerned.”

Boston_annexations_1880

Brookline stood like a rock against the incoming tide of expanding Boston

As Allston-Brighton historian Dr. William P. Marchione, President of the Brighton-Allston Historical Society, puts it:

Brookline’s rejection of annexation took the wind out of a seemingly irresistible consolidation movement. Boston would, in fact, absorb no more towns for nearly forty years, until 1912, when Hyde Park became the last suburb to approve a merger.

Meadowy Milton likewise resisted annexation, with consequences we experience to this day. But few cities and towns stood independent; most joined the growing streetcar cities:

The rapid growth of urban populations and technology in the late nineteenth century increased public demand for urban services.

Annexation, it appears, has always been a response to socially disruptive transportation networks created by technological advances.  In 1942-43, Douglas Aircraft and the War Department built a giant airport, Orchard Field Airport, on the Illinois plains west of Chicago, next to an assembly line turning out C-54 transports; a few years after the war ended, the city of Chicago realized it needed an expansion of Chicago’s downtown airport, Midway, in 1955 decided that would be the (by then renamed) O’Hare, and in a bold move, annexed the entire area, together with a shoestring annexation of streets to connect the polyp to the rest of Chicago.  This prompted an immediate self-defense reaction from the intervening Rosemont, which feared being engulfed:

rosemont_1956

Vaccinating ourselves against Chicago’s infections since 1956

The village of Rosemont treated annexation as a tool for creating a city. Incorporated as an area of about 84 acres in 1956, it swiftly began to annex adjacent areas so that it could become a viable municipality.

For Rosemont, annexation and city incorporation represented Chicago-takeover antibodies – and they worked, with intriguing consequences for the urban land uses out that way, as anyone knows who’s ever either taken the el in from O’Hare to Chicago or dropped off in Rosemont at one of the many convention hotels dotting the arterial roads leading to and from the El stops. 

rosemont_el_stop

The Rosemont El stop is classy, to encourage you to take the El here

[Continued tomorrow in Part 3.]

 

A tale of two cities: Part 1, The epicenter of America’s transportation system

April 13, 2015 | Annexation, Bankruptcy, Chicago, Cities, Detroit, Finance, Housing, Infrastructure, Municipal bankruptcy, Real estate taxes, Speculation, Urbanization, US News, Zoning | No comments 231 views

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness …”

Charles Dickens, A Tale of Two Cities

By: David A. Smith

Within a year, two at the most, Chicago will be the next ‘biggest US municipal bankruptcy ever,’ overtaking Detroit for that dubious honor.

chicago_deficit

Yes, that’s bankruptcy looming

While no one else has written this yet, with no power comes no responsibility, so I will (and have).

friendly_neighborhood_spderman

Courtesy of your friendly neighborhood Bloggerman

Chicago’s slide is the subject matter of a broadly useful article in National Journal (March 28, 2015), and in its pursuit of the political-news angle, the story misses a larger question: Has Chicago become too large to be sustainable?

Sources referenced in this post

National Journal (March 28, 2015; black font, main source)

Encyclopedia of Chicago’s History; Georgia sepia)

Previous AHI blog posts on related subjects

June 5, 2013: A grand unified theory of municipal insolvency (2 parts)

September 13, 2013: Next up, Chicago (3 parts)

September 25, 2013, Decline and fall of the Roamin’ Empire (5 parts)

December 4, 2013: A fool and his bond market are soon parted (2 parts)

December 31, 2013: Sub-cities? (2 parts)

January 6, 2014: Out of the muck? Jefferson County (5 parts)

January 5, 2015: Doublethink pension funding (10 parts)

That question asks another, one it’s taken me two years to formulate: Should Chicago’s bankruptcy be the occasion for the city’s breakup into smaller municipalities?

1. The situation: Is Chicago really desperate?

courbet_despere_1843

I’m desperate to sell this painting

[In the] April 7 runoff against county official Jesus “Chuy” Garcia, Rahm Emanuel is probably going to be reelected mayor of Chicago –

He was, though the modest victory (56% to 44%) shows that four-ninths of Chicago’s voters have no clue how desperate their city’s situation is.

chuy_poster

How many symbols can you count in this picture?

– but it won’t have been a pretty road to get there. He failed to garner a majority in the first round of voting, back in February – a rebuke, of sorts, from voters, who had four years ago given him 55% of the first-round vote.

Along with scapegoating, shooting the messenger is an old political pastime.

shoot_messenger

Perhaps more than any other major city in America, Chicago is facing a truly grave set of problems—problems that are essentially more extreme versions of the challenges confronting city governments across the country.

Thus the real issue surfaces: what could anybody do?

The quandaries begin with Chicago’s dramatic social divide. To an even greater extent than is the case in, say, New York or Philadelphia, Chicago has become two entirely separate cities.

In fact, Chicago contains within itself many more than two cities, but for the time being, let’s use the binary: Rich, poor.

rich_poor

Which one has the penny?

One is a bustling metropolis that includes the Loop, Michigan Avenue’s Magnificent Mile, and the Gold Coast, as well as the city’s well-to-do, working-class, and upwardly mobile immigrant neighborhoods.

chicago_gold_coast

The old Chicago, now grown large and rich

That Gold Coast happens to be most of the original 1837 Chicago, plus the affluent northward growth.

The other Chicago consists of impoverished neighborhoods on the far South and West Sides, primarily populated by African-Americans. These places have remained beyond the reach of the city’s recovery from the Great Recession.

South-side and West-side Chicago have never been economically strong, and just as New Orleans’ 2005 catastrophe (Hurricane Katrina) redivided the city along the lines of both geography and economy, the fallout from Chicago’s long-declining manufacturing base and long-corrupt political machines hit the poorer and worse-located neighborhoods hardest. 

[Now re-elected Mayor] Emanuel [] will have no choice but to try [to make the city viable].

Unsurprisingly, the National Journal’s perspective – politics, short-term thinking – blinds it to the larger question that I previously raised an answered: Can Chicago be made viable without bankruptcy?  Answer: No.

no_hand

Thanks for your optimism

If the gaping holes in Chicago’s social and fiscal fabric can somehow be mended, the city will have created a powerful blueprint that other large urban centers could in theory follow. And if they can’t be fixed? 

They can’t.

Then Chicago may end up serving as a cautionary tale about the grim political and economic fate awaiting other U.S. cities that put off or wish away their problems.

Chicago is already a cautionary tale – because unlike Detroit, which relied on the automotive industry to the exclusion of everything else, Chicago has a diverse economy, including major financial centers, a tremendous natural position as a distribution powerhouse, the world’s busiest airport, from which you can fly non-stop basically anywhere in the world, and enough cultural and activity diversity to be a tourist destination.  Despite all of this, somehow Chicago has so botched its urban model that bankruptcy is inescapable … and even bankruptcy may not be enough, as the pension funds are protected by a contested (and if upheld, suicidal) clause in the Illinois state constitution:

[For the last several years, Chicago’s] pension funds [have been using] their assets to pay off immediate benefits. That meant the total funds were being steadily reduced, which meant the investment income was also going down.

As I’ve already dismantled doublethink pension fund management at length (10 parts), I’ll touch on it only lightly in this essay; for now it’s enough to know that Chicago’s pension fund situation is fiscally worse than Detroit’s.

The pension funds were in a death spiral—and they still are.

Bankruptcy is inescapable – but should it be less like a Chapter 11 corporate reorganization and more like a Chapter 7 corporate liquidation and asset sale?  When Chicago goes bankrupt, should it break up?

breakup_text

Should we begin the end?

2. History: Why was Chicago assembled?

Unlike the East Coast cities – Boston, New York, Philadelphia – Chicago was consciously founded; not settled by Europeans until the 1780s, then properly established in the 1830s out of a real estate bubble based on speculation of its potential as a distribution center:

chicago_58_blocks_1830

America’s own ‘Panama Canal’?  Chicago in 1830

The high cost of moving goods meant that areas close to waterways were particularly valuable as commercial space, which is the backdrop for the great Chicago land convulsion of the 1830s.  [It] was vitally connected with the deep currents of America’s economic development. 

The Erie Canal, which had opened in 1825 gave Chicago access to the East Coast, meaning that “even by 1831 it was found that goods could be brought from New York to St. Louis by way of Chicago one-third cheaper than by New Orleans” (Hoyt, 1933).

In 1835, the State of Illinois had committed itself to digging the Illinois and Michigan Canal which promised to eventually (it would take until 1848) give Chicago access to the Mississippi River System. With these two canals, Chicago would sit at the epicenter of America’s transportation network.

illinois_michigan_canal

America’s isthmus?

With the anticipated connection from the Mississippi River through Chicago to Lake Michigan, Chicago was poised to be an intra-American ‘Panama Canal’ whereby goods could be floated from America’s heartland to the world, and vice versa.  The speculative bubble burst with a credit crunch, the Panic of 1837.

panic_1837_color

“I have no money, and cannot get any work.”

“My dear, cannot you contrive to get some food for the children?  I don’t care for myself.”

Whereupon, if I deduce correctly, the town of Chicago expanded and became the City of Chicago, so as to create the revenue streams to maintain basic city services.

At its founding in 1837, the city of Chicago encompassed little more than 10 square miles. It was bounded on the east by Lake Michigan, on the south by 22nd Street, on the west by Wood Street, on the north by North Avenue. East of LaSalle Street, the northern boundary extended to Center Street.

chicago_1837

Chicago, 1837 (blue shading shows the 1837 expansion)

Real estate bubbles are seldom entirely wrong (just ask Flagler), they are merely overhyped and premature.  And so it proved with Chicago, which like Las Vegas went from concept to city to bust to boom in a series of multi-decade cycles.

[Continued tomorrow in Part 2.]