Statecraft Podcast Episode Summary
Episode Title: Should the Feds Bail Out Chicago?
Host: Santi Ruiz
Guest: David Schleicher
Date: November 25, 2025

Overview

This episode tackles the complexities of state and local government pensions, the mechanics—and politics—of public finance crises, and the thorny question of what the federal government should do if a major city, like Chicago, faces insolvency. Santi Ruiz interviews Yale Law Professor David Schleicher, author of In a Bad State, to break down why underfunded public pensions matter, how cities end up in fiscal trouble, and what policy choices are available when disaster looms.

1. Why Public Pensions Matter to Everyone

[00:14–02:24]

• Most younger Americans (and even many public-sector workers) rarely think about pensions, but their design shapes government budgets and services.
• David Schleicher explains pension debt: “When we say a pension system is indebted, what it means is that people who paid for teachers in 1970 didn’t save the money or pay them enough at the time, and that today we’re paying not only for our school system today, but for our older school system.” [01:47]
• Pension spending squeezes other governmental services; paying old obligations means less for today.

2. How Public Sector Pensions Work—and Why Debt Accumulates

[02:25–06:37]

• Most state/local pensions are "defined benefit" (guaranteed annual payout) rather than 401(k)-style.
• Unique U.S. history: Legal changes in mid-20th century gave pension promises the force of contracts—states must pay, no matter what.
• "California Rule": States like CA, NY, and IL guarantee both accrued AND future pension benefits for current workers.
• Pension debt is not covered by most state constitutional debt limits, making it a tempting way to conceal deficits: “...underfunding your pension system in one way or another is a way to bury your fiscal imbalances by borrowing effectively, but not borrowing that is limited or regulated through debt limits.” [05:54]

3. When the Bill Comes Due: What Happens When Governments Can’t Pay?

[06:37–12:49]

• Default by U.S. states is nearly unheard of thanks to taxing power; cities can declare bankruptcy (Chapter 9), as Detroit famously did.
• Legal requirement for bankruptcy is "insolvency"—but defining that is tricky. Courts invented “service delivery insolvency”: If public services become intolerably bad, bankruptcy may be allowed.
  • Memorable quote: “Service delivery insolvency...was a word a court just created out of cold cloth in the mid 2010s.” [11:26]
• States have sovereign immunity, so enforcing debt payment sometimes comes down to market discipline (difficulty borrowing in future), not court orders.

4. The Chicago Pension Crisis (and Why It’s So Intractable)

[12:49–28:53]

• Fictional scenario from Schleicher’s book: What if Chicago and Illinois declare “bankruptcy” and demand a federal bailout?
• Three federal responses:
  1. Bailout: Feds give money (historically: Hamilton’s assumption of state debt; NYC Fiscal Crisis).
  2. Default/Bankruptcy: Creditors and pensioners take a loss.
  3. Austerity: Massive service cuts and tax hikes.
• Moral hazard is the central problem with bailouts: "If we offer bailouts, everyone will get themselves into trouble so that they get bailouts." [16:28]
• Municipal bonds are hard to short due to tax incentives and thin credit default swap markets.
• Chicago’s Situation:
  • Four pension funds, all among the worst funded in the nation.
  • City’s pension debt exceeds that of 43 states.
  • Seven of the ten worst-funded local pension systems in the U.S. are in Illinois.
  • Over the past decades, chronic under-saving, rather than lavish pension promises, is to blame: “All it takes to have a pension crisis is to have budget deficits forever.” [23:00]
  • Pensions now squeeze all other spending: 40% of Chicago budget goes to debt and pensions. “It tightens and tightens the amount you can spend on everything else...” [24:41]
• Exit: High taxes drive out wealthy residents, but the bigger problem is lack of new, wealthy arrivals (“lack of entry”) and overall economic stagnation.

5. Political Structures & Unanimous Bad Decisions

[31:30–37:20]

• Recently, an $11 billion benefit boost for Chicago’s first responder pensions passed the Illinois Assembly unanimously—despite deepening deficits.
• Why do politicians keep making the problem worse?
  • Short-term political incentives: “Should I help out the firefighter today or should I think about the fiscal health of the state 10 or 20 years from now?” [34:13]
  • State legislators often defer to local ones, expecting reciprocal support—a “universal logroll.”
  • Even constitutional protections (the “California Rule”) for pensions cannot force prudent saving: “They thought about it, they imposed this constitutional limit, and they said, legislature, you’re going to have to follow the rules...they were wrong.” [35:04]

6. Managing Bailouts: What Should the Feds Do?

[38:34–42:13]

• No good options: “All the choices are bad. There’s austerity...there’s default...and there’s bailout, which creates moral hazard. So all three bad.” [38:34]
• Combinations tend to make the best policy:
  • E.g., in the 1970s, New York City got federal support—but only after severe austerity and governance reform.
  • Federal help can come after local pain, which reduces future moral hazard.
  • Imposing new, stricter accounting/budgeting rules should be part of any bailout.

7. Creative and Malign Budget Tricks

[42:13–45:42]

• U.S. states/cities are notorious for bizarre ways to mask debt:
  • Arizona sold its state house and leased it back.
  • Stretching out payments owed to suppliers turns them into accidental lenders.
  • Chicago and others issue special bonds (e.g., sales tax bonds) to game bankruptcy priorities.
  • Attempts to dodge defaults by creating new, debt-free legal entities (e.g., Port of Mobile).

8. Why Public (But Not Private) Pensions Are So Lax

[45:42–47:25]

• Private sector pensions, after ERISA, must be fully funded, actuarially sound, and insured.
• Public sector resisted similar rules for “states’ rights” and because defaults were rare.
• Defined benefit pensions have disappeared in the private sector but persist in government due to inertia and union power.

9. Should Public Pensions Be Passively Managed?

[47:25–53:07]

• Passive investment (e.g. index funds) would have improved Chicago returns and cut costs, but Schleicher says it’s not a simple solution.
• Potential gains from active investment exist due to long-term horizons, but abuses and underperformance are frequent.
• “On one side of these negotiations, [are] the world’s sharpest financial figures. On the other side you have well-meaning civil servants who are a little bit outmanned.” [48:49]
• Jurisdictions like Utah or Ontario seem to manage well, but it’s hard to generalize.

10. Rapid-Fire Policy Questions with David Schleicher

[53:07–65:28]

• Priority List for Federal Infrastructure: Designate the most vital projects for regulatory waivers and federal help, to cut through U.S. infrastructure “cost disease.”
  • “Congress should, when it’s approving its general transportation bill, give the Secretary of Transportation the ability to designate [the most important] super duper important, super popular projects and attach to those the reforms that might improve costs.” [54:10]
• Does Zoning Still Matter with Remote Work?
  • “It matters both more and less.” Remote work may shift demand, but exclusive suburban zoning can still drive up prices.
• Declining Cities and Land Use:
  • Zoning isn’t just a problem for growing cities—rules can block useful reuse (like tree farms or at-home businesses) in shrinking places.
• New York City Charter Reforms:
  • Changing election timing and zoning processes could unlock more housing supply—by letting broader constituencies overcome entrenched local opposition. Both systems are “democratic,” just with different results.
  • “All Mencken said democracy is the belief that the common man knows what he wants and deserves to get it good and hard. The modern political scientist’s response to this is democracy can be structured in many different ways and those things will have different outcomes.” [61:18]

Notable Quotes

• On Why Bailouts Create Trouble:
  “If we offer bailouts, everyone will get themselves into trouble so that they get bailouts.” —David Schleicher [16:28]

• On Fiscal Gimmicks:
  “The state of Arizona, to balance its budget one year, sold the state house and then made an agreement to buy it back in the future with payments every year...But it didn’t count as debt.” —David Schleicher [42:19]

• On Chicago’s Chronic Underfunding:
  “All it takes to have a pension crisis is to have budget deficits forever.” —David Schleicher [23:00]

• On Universal Logrolls and Political Inertia:
  “If you’re from Springfield, you don’t want to get in the way of what Chicago wants, because if you do that, the Chicago representatives will get in the way of what you want for Springfield.” —David Schleicher [36:11]

• On the Roots of U.S. Public Pension Dysfunction:
  “They thought about it, they imposed this constitutional limit, and they said, legislature, you’re going to have to follow the rules because you’re going to have this outsized problem in the future if you don’t. And then well, well and well.” —David Schleicher [35:04]

Takeaways

• The design and funding of public pensions aren’t just a boomer issue: they shape today’s (and tomorrow’s) public services and tax burdens.
• Chronic underfunding is usually a political and budgeting problem, not a result of extravagant benefits.
• There are no painless options when cities or states face insolvency: Someone will pay—taxpayers, bondholders, or federal taxpayers.
• The politics of bailouts, pension reform, and local governance are riddled with perverse incentives, short-termism, and policy inertia.
• The best chance for future reform is to use moments of crisis to demand stronger, more honest rules going forward—at both state/local and federal levels.

For more coverage of Chicago’s pension mess:

• Chicago Tribune
• The City That Works (newsletter)
• Work by Austin Berg
• Illinois House Bill 3657 (“jacking up the pension deficit”)

End of Summary