Phil Cannella and co-host Joann Small educate listeners each week on The Crash Proof Retirement Show. This week’s lesson was on the risky bond environment, something creditors for the city of Chicago know all too well.
Research from Retirement Media Inc. found that Moody’s, a leading provider of credit ratings, research, and risk analysis, has downgraded the credit rating of America’s 3rd-largest city to junk-bond levels. Moody’s rating system, which grades bonds from Aaa to C, makes a distinction between investment-grade and junk level bonds between Baa and Ba, the exact fall-off that Chicago’s credit experienced.
This is just the latest setback in a series of events that has engulfed Chicago—and the state of Illinois as a whole. “What many investors and everyday Americans don’t realize is that interest rates have been down for 10 years,” said Phil Cannella. “That environment affects the bond environment.”
When interest rates moves lower, bond values increase—accordingly, bond values have been up for the past decade. However, the reverse is also true. When interest rates start to increase, bond values will be depressed.
A full decade without an increase in interest rates in unprecedented in the American economy—and as Phil Cannella pointed out, that run is most likely nearing an end sometime in 2015. “The bond industry is in a bubble right now,” Phil summarized, “and when those interest rates go up, it’ll be like a sharp pin, popping that bubble.”
In making the announcement, Moody’s said they saw a negative future outlook for Chicago’s credit, citing a recent Illinois court ruling voiding state pension reforms.
Adding to the problem were the words of Illinois Governor Bruce Rauner, who said last Wednesday that no bailout money will be coming from the state government to help Chicago. That’s because the state of Illinois is locked in what Governor Rauner calls a “terrible financial crisis” of its own.
Experts said the downgrades in credit ratings could trigger upwards of $2 billion in accelerated debt payments. But that’s going to be a big problem, because according to CNBC, the city and state are underfunded by $130 billion!
Of course, the municipal bond crisis really got started two years ago, when Detroit became the largest U.S. city to declare bankruptcy. Since then, cities such as Stockton, CA have filed for protection from bankruptcy. But a crisis in Chicago—again, the country’s third largest city—would take things to an entire new level.
“In my opinion, this could have a domino effect. These concerns could happen in city after city,” Phil Cannella summarized.