When Debt Makes Sense

…and when it doesn’t. You borrow to time-shift consumption, i.e. so that you can consume today rather than consuming in the future. There are times when that makes sense. For example, when what you’re purchasing, e.g. a house, is likely to appreciate in value. Or when you expect your earnings to rise so that it’s easier for you to pay off the loan in the future. It helps when there are no good ways to save, e.g. when there are no good investment opportunities or when the cost of saving is too high.

It makes no sense to borrow to pay ordinary operating expenses. That’s the context of this remark from the editors of the Wall Street Journal:

This is the same sorrowful spectacle Chicago’s school system put on last year. When it failed to get a state bailout for a looming pension payment in 2015, it borrowed some $600 million. Now, unable to pay back what it already owes, the system last week did a $725 million bond sale at an 8.5% interest rate, a large premium over what other borrowers can pay. Mr. Emanuel blames Mr. Rauner’s bankruptcy talk for the premium.

8.5% is a lot of interest and we’re presently experiencing a period of historically low interest rates. The CPS is paying such high rates because its credit rating is very low, which is another way of saying that investors wonder if they’ll be paid back. My back-of-the-envelope calculation says that’s $50 million a year. That might make sense if Chicago’s revenues were expected to increase over time but that’s not the case.

Chicago’s population has declined in every decade since 1950 except for the decade from 1990 to 2000. The smart money is on Chicago’s population declining in the present decade. Fewer people means less revenue for the city and fewer people to share the debt burden. If the real incomes of the people who remain are shrinking (as I suspect to be the case—that’s hard to ferret out), more debt is being borne by fewer Chicagoans who are decreasingly able to bear it.

Chicago’s public schools serve fewer students than they did in 2000 but not only do the real per student costs continue to rise the total real costs do as well. There’s something wrong with this picture.

21 comments… add one
  • Guarneri

    For those of you for whom the CPS rate doesn’t resonate, that is, make you fall out of your chair, here is some perspective.


    “Mr. Emanuel blames Mr. Rauner’s bankruptcy talk for the premium.”

    Yeah, right. Even a guy who was just a Rolodex, and not a real bond house investment banker, knows that’s crap. I met with my wealth advisor yesterday and we were laughing (and, figuratively, crying) at the rates. Who bought those things? At least with similarly priced corporates you get an equity kicker and a deep pocket beneath you. What did they do, offer ownership units with attached rights to jugs of water from the Chicago River ??

    “That might make sense if Chicago’s revenues were expected to increase over time but that’s not the case.”

    In combination with rates like this issuance, that, my friends, is how death spirals occur.

  • PD Shaw

    Obama addressing the Illinois General Assembly in a few hours about “what we can do, together, to build a better politics — one that reflects our better selves.”

    Keep expectations restrained.

  • PD Shaw

    I assume the State is not making its normal contributions to Chicago schools due to the lack of a budget, so there is at least some reasonable ground for borrowing that shortfall.

    @Guarneri: Rauner’s timing once again is very poor. Talking about the insolvency of the CPS right before a bond sale put his fingerprints on something that didn’t need them.

  • Guarneri

    “Keep expectations restrained.”

    A nice way of saying more high minded sounding but vacuous blather.

  • ...

    If the real incomes of the people who remain are shrinking (as I suspect to be the case—that’s hard to ferret out), more debt is being borne by fewer Chicagoans who are decreasingly able to bear it.

    The real incomes of people NOT employed by the city.

    Also, how many city workers live outside the city? Giant sucking sounds: Not just for crazy billionaires any more!

  • jan

    Places like Illinois and Michigan have been democratic strongholds for years. Consequently, it has been democrats who have cultivated fiscal policies that are now coming to an unpleasant head. Nevertheless, true to their nature, dems are quick to turn the blame towards a relatively new political leader, especially if it happens to be someone with an R behind their name. Obama has been famous for this, in passing everything negative backwards to Bush, while playing forward a glossy but unrealistic view of his own administrative accomplishments.

    Politics is surreal….

  • Guarneri


    Perhaps, but I viewed it as planned timing. Part of the negotiation. The bond buying community already knows it. The public is comatose. Madigan, Emanuel, Lewis and their respective bands of merry men/women were simply put on notice that Rauner is willing to take the gloves off.

  • Guarneri

    To my knowledge, ice, Chicago city workers are still required to maintain Chicago residency.

  • Also, how many city workers live outside the city?

    As Guarneri noted above, they’re legally required to live in the city. In practice that means they all have mailboxes in the city. As to where they actually live, who knows? You’d need to physically sit outside the address they’ve given and see if they go in and out.

    Since I have personally known city workers who did not live in the city, I know for a fact that it’s done.

  • ...

    Does the Mayor and the Aldermen at least live in the city? That would probably be a good start.

  • Andy

    8.5%? Might be a good deal if Chicago is too big to fail….

  • Guarneri

    There seem to be an inordinate number in Will County.

    Andy – yes, but I wouldn’t want to underwrite on that. Plus I can get corporates at 9 plus equity.

    Many years ago I came fairly close to making a large loan to Yellow and Checker cab (one and the same) based on the aggregate value of medallions. Or said another way “based on the fix still being in.” Everyone thought it would be, forever. Didn’t make the loan. Today there are more cab companies than you can count.

    But here’s an idea. Let the Teachers pension fund load up on those bonds. How many times have we heard debt doesn’t matter because “we owe it to ourselves.” ;-o

  • TastyBits

    Surprise, surprise, surprise. Bankrupt cities and worthless borrowers, investors cannot throw money at them fast enough. Why? Because they have a pile of money that needs to transformed into a larger pile of money, and any losses must be offset by wins plus the added value.

    Stomp your feet and hold your breath. Reality is a bitch. The bonds were sold. The mortgages were lent. When money is created through lending, it comes from nobody’s pocket. It is nobody’s money, and nobody gives a rat’s ass about the down side.

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