CHICAGO — Corporations are moving in, and housing prices are looking better across the region. There has been a slight uptick in population. But a crushing problem lurks beneath the signs of economic recovery in Chicago: one of the most poorly funded pension systems among the nation's major cities. Its plight threatens to upend the finances of President Obama's hometown, now run by his former chief of staff, Rahm Emanuel.
The pension fund for retired Chicago teachers stands at risk of collapse. The city's four funds for other retired city workers are short by $19.5 billion. At least one of the funds is in peril of running out of money in less than a decade. And starting in 2015, the city will be required by the state to make far larger contributions to the funds, which could leave it hundreds of millions of dollars in the red — as much as it would cost to pay 4,300 police officers to patrol the streets for a year.
"This is kind of the dark cloud that's coming ever closer," Mr. Emanuel said in a recent interview, adding that he had no intention of raising his city's property taxes by as much as 150 percent — the price tag, he says, that it might take to pay such bills. "That's unacceptable."
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Illinois lawmakers, who make key financing and benefit choices for Chicago's pension system, have wrestled for months without agreement on the politically troublesome matter of cutting the benefits of public sector retirees to save money. And last month, Moody's Investors Service downgraded Chicago's rating by an unexpected three notches as part of a broad reassessment of how pensions are affecting the financial strength of cities. That "super downgrade," in the parlance of the bond market, left Chicago, the nation's third-largest city, with a lower rating than 90 percent of Moody's public finance ratings.
The financial woes of Detroit, which last month became the nation's largest city to file for bankruptcy protection, dwarf the financial issues here. But as Detroit makes its way through the federal court system, other cities, including Chicago, are wrestling with overwhelming pension liabilities that threaten to undermine their capacity to provide municipal services and secure their futures.
The pension system in Charleston, W.Va., is so depleted that retirees are being paid straight from the city budget, something experts say is unsustainable. School districts across Pennsylvania, including Philadelphia's, are stumbling as required contributions to a state-run teachers' pension system rise and education money from the state drops. Even prosperous San Jose, Calif., has a pension problem, leading residents last year to vote to slow the rate at which city workers build up their benefits.
Among the nation's five largest cities, Chicago has put aside the smallest portion of its looming pension obligations, according to a study issued this year by the Pew Charitable Trusts. Its plans were funded at 36 percent by the end of 2012, city documents say. Federal regulators would step in if a corporate pension fund sank to that level, but they have no authority over public pensions.
Chicago's troubles, experts say, were years in the making. They are the result of city contributions under a state-authorized formula that failed to accumulate nearly enough money, two economic downturns in the 2000s that led to heavy investment losses, and an impasse in the State Capitol despite urgent calls to cut costs of the state's own pension system. Illinois, which has the most underfunded state pension system in the nation, controls Chicago's benefit and funding levels.
In Springfield, which, like Chicago, is controlled by Democrats, leaders have clashed over how best to cut costs of the plans — a notion that pits the lawmakers against labor unions, which have traditionally been allies.
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By last week, top Democratic leaders in the legislature sued Gov. Pat Quinn, a fellow Democrat, after he announced he was withholding lawmakers' paychecks until they come up with a plan to fix the state's pension crisis. "That was a drastic step but obviously a necessary one," Mr. Quinn said, describing the pension crisis as "the biggest, most important economic challenge we'll ever have."
State leaders have argued over the meaning of a state constitutional provision protecting government pensions in Illinois, and, in private conversations, over the potential political fallout from unions if benefits are cut. But Mr. Emanuel has openly called for increasing retirement ages, raising workers' contributions toward their own pensions and temporarily freezing inflation adjustments now paid to retirees, all of which amount, union leaders say, to benefit cuts.
Public sector union leaders have been enraged by Mr. Emanuel, who was at the helm in 2012 during this city's first teachers' strike in 25 years and who has announced plans to phase out city health care coverage by 2017 for some city retirees. A change in pension benefits could affect more than 70,000 people who worked as Chicago police officers, teachers, firefighters and others, and who now receive average annual benefits ranging from about $34,000 for a general-services retiree to $78,000 for a former teacher with 30 years of service.
Some labor leaders say the city, not the state, is ultimately responsible, arguing that Chicago leaders long ago should have begun planning how to pay for pensions promised to its workers, regardless of insufficient state contribution formulas.
"The city failed to fund this all along, and now Mayor Emanuel has made it clear he is going after the hard-working men and women on the Chicago Police Department to make up for that," said Michael K. Shields, president of the Fraternal Order of Police, who described Mr. Emanuel, simply, as anti-labor. "He's trying to stiff us out of our pay."
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All sorts of political battles are emerging from the pension crisis. Candidates from both parties are seeking Mr. Quinn's job next year, many of them citing the state's inability to untangle the pension woes as reason to toss out those holding office. William M. Daley, another former chief of staff for President Obama and now a Democratic candidate for governor, said in an interview, "Anyone who thinks that this is just a problem on paper, those are the same people who looked at Detroit 20 years ago and said, 'Don't worry about it, we can handle it.' "
Mr. Emanuel has made clear his plans to seek a second term as mayor in 2015, and no major challenger has emerged so far. But the city's looming pension debt — and the bills that will balloon by election year — may carry political fallout from unions as well as ordinary Chicagoans.
"Voters don't care about pensions as an abstract issue," said Dick Simpson, a former Chicago alderman and political scientist. "What they care about are the effects over the next two years of having to cut services or raise taxes to pay for this."
Over all, experts say Chicago's financial health has improved since the recession; city revenues are growing again and the population, which fell during the decade after 2000, has grown modestly since 2010. The city's general budget fund faces a potential shortfall of $339 million in 2014, but city officials say that gap is lower than initially expected and manageable.
Circumstances grow far more complicated a year later, when state law will require Chicago to pay significantly more — $1 billion a year — into the city's pension funds, to make up for years of underpayments. Even sooner, the Chicago Public Schools, which draws from the same tax base, is required to find an extra $338 million for its pension fund, and more every year after that.
Unless the legislature agrees to a complete overhaul of the pension plans, Mr. Emanuel said, he will not even entertain the notion of raising Chicagoans' taxes.
"What the system needs is a hard, cold dose of honesty," Mr. Emanuel said. "I understand the anger. I totally respect it. You have every right to be angry because there were contracts voted on."
He added: "People agreed to something. But things get updated all the time."
—By Monica Davey and Mary Williams Walsh of The New York Times