Authored by Mark Glennon via,

A March 2009 Bloomberg article told the story beautifully:

The Chicago Transit Authority retirement plan had a $1.5 billion hole in its stash of assets in 2007. At the height of a four-year bull market, it didn’t have enough cash on hand to pay its retirees through 2013, meaning it was underfunded to the tune of 62 percent.

Then the authority found an answer.

“We’ve identified the problem and a solution,” said CTA Chairman Carole Brown on April 16, 2007. The agency decided to raise money from a bond sale.

Carole Brown, Chicago’s Chief Financial Officer and Former Chicago Transit Authority Chairman.

Carole Brown is now Chicago’s Chief Financial Officer and leading the charge for the city to issue a similar pension obligation bond for a whopping $10 billion. The concept is simple: Borrow money and invest it in the stock market.

The CTA bonds were sold and $1.1 billion was deposited into the CTA pension on August 6, 2008.

Yes, August 2008. Good times. Remember? The S&P 500 proceeded to drop 45% over the next eight months.

The S&P 500, August 6, 2008 to March 1, 2009. Source: Yahoo Finance

Mercifully, because the market had already destabilized when the bonds were sold, the CTA didn’t initially put the money in the stock market. Nor did the bond sale go as planned. The CTA ended up paying bondholders more than it expected — 6.8%. In other words, the whole plan went wrong and losses ensued, as Bloomberg explained in that 2009 article:

The proceeds of the bond sale, held in a money market fund, earned 2 percent – 70 percent less than what the fund was paying for the loan….

“There is negative arbitrage,” Brown says. “It’s better than having dumped the money into the equity market.”

The stock market did come roaring back after March 2009 – the beginning of a bull market that roughly quadrupled stock prices. Whether the CTA was able to capture those returns and salvage the pension bond proceeds isn’t entirely clear, but it appears that didn’t happen. The proceeds of the bond were commingled with other assets, the pension presumably got back into the market slowly after being in cash and many other factors have been at work.

But we know for sure that neither the pension bond nor the stock market run stabilized the pension. It deteriorated badly after receiving the bond proceeds, through the bull market. At the end of 2008, after it received the bond proceeds, the pension had an unfunded liability of $636 million and was 76% funded. Today, that unfunded liability is $1.6 billion and it is 53% funded.

So, the real lesson isn’t really about market timing, though CTA’s was clearly awful. Instead, it’s that you just don’t know how pension obligation bonds will turn out. In CTA’s case, Mr. Market obliterated both its hopes on the stock market and its interest cost on the bond. Nothing worked out as expected. Smaller market disruptions can do the same on a smaller scale.

Most importantly the CTA experience tells us how dishonest it is to be making the case for pension obligation bonds through a simple comparison of expected bond rates to hoped-for stock market returns. Brown has been making that case for Chicago’s proposed bonds quite brazenly:

“We should do this because we can do it at 5.5 percent,’ then I just saved the city 2 percent. … It would change the unfunded liability and change how much more [in] future payments the city would have to make. We would be paying that debt at a rate of 5 or 6 percent versus 7.5 percent,” she says.

Ralph Martire of the public union supported Center for Tax and Budget Accountability made the same, deceitful case, pretending it’s a simple matter of comparing the interest rate on one credit card to another.

The truth probably is that the city’s real motivation for a pension obligation isn’t to get the two percent Brown claims. That would come to just $200 million per year, which would be nice, but wouldn’t really move the needle much on the pensions or on Chicago’s $8 billion budget. Instead, the bonds would be a huge gift from taxpayers to public unions, and Chicago is in the middle of a major round of new contracts negotiations with its unions.

More about Chicago’s likely real motivation’s are in out separate story linked here.

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