Chicago’s Changing Financial Landscape: An Interview with the City’s CFO, Lois Scott

Lois Scott is currently serving as CFO for the City of Chicago and co-founded Scott Balice Strategies LLC, one of the largest financial advisory firms in the country. In 1997, President Bill Clinton named her a White House fellow, tasking her with helping to craft the US response to the capital funding crisis in Southeast Asia. Scott is one of the founders of Women in Public Finance, a national conference that brings together 500 people every year. She also serves on the board of several organizations, including Children’s Memorial Hospital, Leadership Greater Chicago, National Louis University, Better Government Association, North Avenue Day Nursery, City Lit Theater Company, and The Bond Club of Chicago.

In your economic forecasts for the next couple years, what national or local trends do you think will have the greatest impact on Chicago and its finances?

I tend to subscribe to the demographic theory of economics, where economic activity is driven by population trends. So if you look at the trends in the United States, after the mini-bubble of population growth at the early part of this century, we’re going to be in a period of lower population growth. I’m planning for a lower rate of inflation than during the first 20-30 years of my career. We may have to get used to a period of slower growth and less inflation and plan accordingly.

I think the second major issue that will shape our government finances going forward is that we have a 19^th– or 20^th-century tax structure overlaid on a 21^st-century economy. So we’ve got an outdated tax structure and a fairly regressive tax structure that’s not really keeping pace with the US or international economy. Those are the two major trends I foresee.

Looking at your 2015 forecast, the City’s corporate fund is projected to be almost $300 million in the hole. Does that keep you up at night?

When we took office in May of 2011, our operating budget was almost $635 million in the hole, and if you have followed government finance, gaps tend to widen over time, not narrow. We had projected a much bigger gap today than what we actually have.

We have a lot more work to be done. But if anybody had told me four years ago that within three years we would have wiped out more than half of our structural deficit, put money back into the rainy day reserves, and implemented some revenue increases to do one of the most significant infrastructure projects around the country through our water and sewer programs, I would have just kind of smiled politely. I am certainly not satisfied with where we are yet, but I am proud of how far we’ve come.

Chicago is famous for its colorful political culture and history. And your administration has inherited extensive, long-term, unfunded liabilities such as pensions. Is there a connection between the challenges that you’re facing and Chicago politics generally?

I think we inherited a large number of challenges; any government inherits strengths and weaknesses. But we have to look at the good things that preceded us as well. I think sometimes we get focused too much on our challenges, and not focused on what is going well.

We have an incredibly large and diverse economy which is roughly $575 billion gross regional product. This is probably 80 percent of the state’s gross state product and about four to five percent of the nation’s gross domestic product. So we have a very large, growing economy that ultimately will drive how we address our challenges fiscally. Sure closing a budget gap is hard, but not as hard as revving up an economy. I would take Chicago’s challenges compared to many other governments’ because of the health of our economy and the growth that we’re seeing.

Our economically sensitive revenues have all recovered to pre-recession levels, we’re number one in terms of people moving back into our city of any of the major cities, and what I see as really a major indicator of long-term economic health is the extraordinary progress we’ve made in high school graduation rates. We’ve increased the high school graduation rate already by about 10 percentage points. I would highlight the fundamental focus on education that this mayor has been particularly noted for—preschool, universal kindergarten, the range of choices for high school, and then the colleges-to-careers program he’s put in place through the community college system. I think you add all that up and there’s a tremendous amount of attention to the economy which will ultimately be the way out of our financial challenges.

With general obligation bonds the idea is that the city’s economy will strengthen as a result of the investment, and the City will be able to repay the bonds based on growth that happens in the future. Can other kinds of obligations like pensions be thought of in that way, or are they strictly an issue where costs need to be cut?

As we got more efficient at our jobs, and reduced employment overall for governments, we were investing less and less into our pension funds, just by the way the statutes worked. So our pension fund obligations are outpacing our growth in other revenues. So we have tens of thousands of people who are really dependent upon these pensions. And we have to address retirement security for those people, and be really honest about what is possible and how to fix pensions. This is why we spent so much time and care on the pension reform package that we worked on with our labor partners, passed in Springfield and the Governor signed. The benefits that people are depending on will be there, which is important because like many public sector employees, ours do not contribute to Social Security.

What generational differences are you seeing as you talk with constituents or investors about financial themes like long-term obligations, investments in people or capital, and taxation?

I think we’re seeing the birth of an era where a generation of investors — be they institutional or retail/individual investors — are looking at a scenario where the overall rates of return are going to be relatively low compared to historic levels, and they’re looking for the opportunity to do a little bit better through their investments.

If you’re going to get a low interest rate anyway, and you can put that money to work and do some social good, I think people are going to get very energized by that. I think we’re going to see more and more of the green bond phenomenon and social impact bonds.

I think the younger generation feels that the Baby Boom generation created a number of financial challenges for the generations that follow. And I think they’re confronted with that frustration and are looking to solve those challenges thinking outside the box, with social impact, with other ways of addressing them than the tools I was taught.

City bond ratings can bounce around based on economic conditions and balance sheets. Meanwhile the handful of cities that have actually reached bankruptcy are famous in part because they are so rare. Do you think cities pay too much attention to these ratings?

The role of ratings in the bond world is evolving right now. If you look at the default rate for corporate bonds versus the default rate for municipal bonds, you’ll find about 100 times greater default likelihood of a corporate bond than a municipal. So I don’t think the ratings reflect our relative likelihood of default, but rather they try to assess our credit quality relative to our peer groups. And I’m not sure that’s what they represent to their investors. So with the rise of Fitch in the past 20 years, and now Kroll in the past three or four years, I think there’s a changing role of how people are looking at the rating agencies.

During my career, ratings were very important, and then you had the rise of the bond insurance companies, which homogenized credit. Everything was AAA, so there was less need for the investors to have direct credit research and they let go of their credit research staffs. Now with the implosion of the bond insurance companies, we’re seeing a rise of credit analysis by the investors. And I would say that for each bond deal, we’ll meet with all three of our rating teams, but we will also meet with 15 to 20 investor credit teams. They ask questions that are every bit as detailed, and sometimes more informed. So I think you’re going to see some changes going on there.

Anything else you’d like to share with our readers?

I’m very excited about the passions coming from the Harris School students for this field. Because, just like I was saying about the investors wanting to have a social purpose, I think the students coming out of Harris also care. They want good careers but they also want meaning. I’m really excited to see what your student body is doing, because Harris has been around for 25 years now, but it’s only in the last few years that it seems poised to explode with talent and creativity. I couldn’t be happier that you guys are doing this. I think all of our municipal CFOs would say the same thing.

Feature photo: cc/(JHI)