I have a side interest in public pension plans so the news from Chicago over the last few days (that Illinois is struggling to deal with one of this country’s most underfunded (as a %) pension plans NY Times article and that Chicago debt was downgraded to junk Chicago Sun Times article) was not a surprise, but a wake-up call/reminder that underlying financial trends may have long-term secondary consequences. In the end, for Chicago to place debt going forward, it would seem that either pension benefits have to be cut, other budget line items reduced, or revenue raised (as Chicago, unlike the US Government, can’t print currency).
Now even if only one of the three categories could solve Chicago’s fiscal woes (and I doubt that), I’m not going to suggest which is more likely, or “right”. I would highlight to readers here that revenue increases are often associated with higher taxes, and that taxing things (or activities) that are captive are often viewed attractively by those charged with raising revenue. That leads me to a concern about home prices in the CHI index over time. (After all, wage earners, companies, and shoppers can move to avoid personal income, corporate and sales taxes).
Now I don’t often express market views, and clearly what’s taking place in Illinois is not unique (California has similar pension issues and both LAX and LAV are dealing with potentially crushing water issues). However CHI may reach a level (similar to upstate NY) where real estate taxes become a higher cost to homeowners than their mortgage! The combination of a 4% mortgage (on 80 LTV) plus 4% tax rates (on 80% assessed values?) might present of formidable headwind against the ~15% gains implied by CHIX17 prices.
I would imagine that much of the CHI index gains (as with other regions that experienced distress) over the last few years has been a function of the % distressed being sold at deep discounts dropping. Gary Lucido’s Getting Real blog is great source for following the CHI real estate story. This graph to the right is from his blog and is shown here to illustrate how far the “% distressed sales” have fallen. Can it fall much further, and if not, might the absence of that tailwind show up in lower HPA?
Finally, while the Chicago/Illinois problems are well known, forward CHI prices reflect higher % gains that the CUS index. The three Northeast regions (BOS, NYM and WDC) are all priced at levels consistent with slower gains by Nov 2016 than the CUS index. What makes CHI unique among “winter” cities?
As market maker I’m happy to foster trades that would allow someone to sell CHI outright (or on spread vs. CUS) or to allow CHI bulls (pun intended) to express even more positive views.
Please feel free to contact me (email@example.com) if you have any questions about this blog or hedging home prices in general. In addition, I encourage you to follow Gary’s blog.