Assessing the Investment Risk in Chicago's Municipal Bonds Amid Political and Fiscal Turmoil

The investment landscape for municipal bonds in Chicago has grown increasingly complex in 2025, as the city grapples with a confluence of fiscal fragility and political fragmentation. These challenges have not only eroded investor confidence but also prompted multiple credit rating agencies to revise their outlooks on Chicago's general obligation (GO) bonds to negative. For investors, understanding the interplay between governance dysfunction and financial instability is critical to evaluating the risks embedded in these securities.

Fiscal Fragility: Pension Liabilities and Budgetary Shortfalls

Chicago's fiscal health has deteriorated sharply in recent years, driven by an underfunded pension system and a reliance on non-recurring revenues. According to the 2025 Financial State of Chicago report, the city faces a $38.1 billion shortfall in obligations, with pension plans funded at just 25% of their liabilities. Unfunded pension obligations now exceed eight times the city's annual payroll, and a new Illinois state law has further inflated these liabilities by over $11 billion. This fiscal burden has forced Chicago to depend on one-time budgetary measures, such as the drawdown of pandemic-era ARPA funds, to mask recurring deficits.

Credit rating agencies have taken note. Standard & Poor's (S&P) downgraded its outlook to "negative" in November 2025, citing concerns over the city's "ongoing reliance on one-time budgetary measures" and "consecutive years of large deficits". Similarly, Fitch and Kroll assigned A- ratings to GO bonds but maintained negative outlooks, reflecting shared skepticism about the city's ability to balance pension obligations with long-term financial sustainability. Moody's, while affirming its Baa3 rating, revised its outlook to "stable" from "positive," highlighting the 2026 budget deficit and the 2027 pension liability increases as key risks.

Political Fragmentation: Governance Challenges and Fiscal Entanglements

Chicago's fiscal woes are compounded by deep-rooted political fragmentation, which has hindered coherent governance and exacerbated credit risk. The city's budget process has become a battleground for competing interests, with contentious debates over measures like the corporate head tax and cloud services tax. In 2025, a triple downgrade by major credit agencies followed a protracted budget approval process, during which City Hall and City Council clashed over the rejection of a proposed corporate head tax to address a $1 billion deficit. Such conflicts signal to investors a lack of fiscal discipline and strategic foresight.

Structural governance issues further complicate matters. Overlapping jurisdictions and responsibilities across agencies-such as the fiscal entanglement between the city and Chicago Public Schools (CPS)-have created a web of financial obligations that are difficult to untangle. Meanwhile, leadership transitions and departures of influential political figures, including the retirement of key legislators, have introduced uncertainty into policy continuity. These dynamics undermine investor confidence, as they suggest a lack of institutional resilience in managing fiscal crises.

Credit Risk Implications for Investors

The combined impact of fiscal fragility and political fragmentation is evident in the deteriorating credit metrics for Chicago's municipal bonds. The city's reliance on one-time revenues has increased from 32% of FY2025 budgets to 40% in FY2026, raising concerns about its ability to meet obligations during periods of economic stress. For instance, the Civic Federation has warned that without structural reforms-such as reducing vacant positions and repurposing ARPA funds-Chicago risks further downgrades and higher borrowing costs.

Investors must also consider the broader implications of Illinois' fiscal landscape. While the state's credit rating has improved, its own pension liabilities and the Safe Harbor law have created a ripple effect, amplifying Chicago's challenges. This interdependence underscores the systemic risks inherent in investing in Chicago's bonds, particularly for those with limited diversification.

Conclusion: Navigating the Risks

For investors, the key takeaway is clear: Chicago's municipal bonds carry elevated credit risk due to a combination of fiscal mismanagement and political dysfunction. While the city's Baa3 rating from Moody's and BBB ratings from S&P and Fitch suggest a baseline of creditworthiness, the negative outlooks signal a high probability of further downgrades. To mitigate these risks, investors should prioritize diversification and closely monitor developments in pension reform, budgetary transparency, and governance reforms.

The path forward for Chicago will require difficult choices-reducing pension liabilities, curbing reliance on one-time revenues, and fostering cross-jurisdictional collaboration. Until these challenges are addressed, the investment case for Chicago's municipal bonds remains fraught with uncertainty.