NextFin News - Chicago spent more than a decade clawing its way out of a fiscal hole, earning a string of credit upgrades that restored its investment-grade standing after a 2015 junk-rating downgrade. Now, barely two years after Wall Street's last upgrade, the city is sliding back: a $130 million mid-year budget shortfall, a $1.19 billion gap projected for fiscal 2026, and fresh downgrades from two major ratings firms. The question is whether this is a cyclical stumble after the pandemic or the return of a structural deficit the city never truly fixed.
Layer 1 — The Situation: A Turnaround That Ran Out of Road
Chicago's fiscal reputation was rebuilt on a specific set of achievements. After years of deficits and the 2015 junk-rating downgrade that pushed Moody's rating to Ba1, the city posted balanced budgets, built reserves, and — starting in fiscal 2023 — began making supplemental pension payments beyond what state law required. The payoff was measurable: Moody's upgraded Chicago back to investment grade in November 2022, the first such move in seven years; Fitch lifted the city to BBB+ in October 2023 and then to A- in July 2024; the State of Illinois itself was upgraded to A2 in October 2025.
That progress is now reversing. The City Council passed a $16.6 billion budget for fiscal 2026 in late December 2025, closing a projected $1.19 billion gap — the largest in city history, rivaled only by the 2021 pandemic shortfall. Mayor Brandon Johnson neither signed nor vetoed the plan; it took effect on January 1, 2026 without his signature. Six months later, the mayor says the city is already at least $130 million short for the year because revenue measures baked into the budget over his objections never materialized.
The mechanics of the shortfall are stark. The budget counted on $89.6 million from selling the rights to collect overdue utility and red-light camera debts — no buyers responded to the city's request for proposals. It assumed $29.3 million from advertising on 3,000 light poles, city vehicles and bridge houses — no interest. An augmented reality advertising licensing program was expected to raise $6 million — no interest. Video gambling in bars and restaurants was projected at $6.8 million; state officials have issued only six licenses and the city has yet to green-light the terminals.
Meanwhile, spending keeps outrunning the plan. The Chicago Police Department spent $1.98 billion in 2025 against a $1.82 billion budget — a $162.5 million overage, the fifth straight year of overspending and part of a $600 million cumulative overrun since 2021. Overtime alone cost $285.8 million, $185.8 million over budget; through June 30, 2026, overtime had already reached $133 million. Misconduct lawsuit settlements and defense cost $131 million versus $82.5 million budgeted, and the city has spent more than $225 million resolving over 200 misconduct cases in just the first half of 2026.
The political surface is calm — the budget passed, services continue — but the underlying arithmetic has turned against the city.
Layer 2 — The Analysis
Why Chicago Broke Before It Looked Broken
The first thing to understand is that Chicago's deficit did not arrive suddenly. The city's Office of Budget and Management has projected baseline corporate-fund deficits stretching across fiscal years 2026 to 2028, with the cumulative gap ranging between $2.52 billion and $5.19 billion depending on economic conditions. The fiscal 2025 year closed in the red too, with a $146 million gap.
The deeper driver is a cost structure the city cannot easily cut. Personnel expenses and benefits account for roughly 70% of the operating budget. On top of that sits the state-mandated pension funding ramp, which requires steadily rising contributions aimed at 90% funded status over decades. The two public-safety funds were moved onto an even longer 40-year path by legislation passed in Springfield — a change that lowered near-term payments but increased the city's long-run exposure. In 2025, pension debt rose by approximately $500 million even as total contributions hit records, including a $272 million supplemental payment.
This is the core mechanism: Chicago's fixed costs grow on autopilot, while its discretionary revenue tools are limited and politically contested. When a budget gap opens, the city cannot simply trim its way out; three-quarters of the budget is effectively on rails.
The Ratings Verdict: One-Time Fixes Are Not a Plan
The ratings agencies have delivered a clear, if incremental, judgment. S&P Global downgraded Chicago's general obligation debt to BBB from BBB+ in 2025, citing the city's failure to address a persistent structural imbalance. The agency had placed the outlook on credit watch negative in November 2025. KBRA downgraded Chicago to BBB+ with a negative outlook, pointing to a deteriorating fund balance, narrowing liquidity, and an exceptionally high and rising fixed cost burden.
Yet the picture is not uniform. Fitch kept Chicago at A- after a criteria change, and S&P's outlook is now stable rather than negative. S&P director Scott Nees explained the reasoning in the agency's report:
The stable outlook reflects our expectation that the city's overall reserves and liquidity will remain strong enough to support the BBB rating through the outlook horizon, that it will continue making its advance pension payments and therefore see relative stability in pension funding levels, and that it will continue to work toward addressing the structural budget gap, likely through some combination of cost-cutting and new revenue over a multiyear period.
That conditional language — if it continues — is the hinge. The city's credit standing now depends on it sustaining a policy, advance pension payments, that its own mayor tried to cut. In his October 2025 proposal, Johnson reduced the advance pension payment from $238.6 million to $120.2 million to free up cash for the gap. The City Council restored the full payment in the final budget, but the attempt itself signaled that the supplemental-payment policy — the very lever that earned rating plaudits — is politically vulnerable.
The Political Economy: A Mayor, a Council, and a Blame Game
Chicago's budget process has historically been dominated by the mayor. Fiscal 2026 broke that pattern. For the first time in city history, the City Council drafted and passed a spending plan without the mayor's support or his finance team's involvement, rejecting Johnson's signature proposal — a per-employee tax on large firms — in a 30-18 vote on December 20, 2025.
The result is a budget that satisfies no one's theory of the case. Johnson wanted new business taxes and avoided broad property-tax increases; the Council instead layered on higher taxes for shopping bags, Uber rides, liquor, online gaming, and a small property-tax increase for the library system, plus the unprecedented sweeping of Tax Increment Financing district surpluses and $1.8 billion in new borrowing authority. About $450 million of that debt is earmarked for operating costs: $166 million for firefighter back pay under a new labor contract and $283 million for police misconduct settlements.
Six months in, both sides are blaming the other. Johnson told reporters on July 7, 2026:
There were other options. We did not need to cede to big money interests and fall back on the tired practice of balancing budgets on the backs of working people.
The Council camp fired back through Ald. Samantha Nugent's office, accusing the mayor of slow-walking implementation of the revenues and efficiencies designed to close the deficit and of seeking excuses to raise taxes and skip the remainder of the advance pension payment.
The institutional consequence is a governance vacuum. An interim report from the mayor's Financial Future Task Force laid out 89 levers for stabilizing the city's finances, with a final report due in May 2026. Task force co-chair Jim Reynolds, chairman and CEO of Loop Capital, framed the challenge plainly in the task force's interim report:
Chicago didn't develop a billion-dollar gap in a year, and we won't erase it in a week, but we can change the trajectory now. After decades in finance, I know the cost of inaction is higher than the cost of action.
Cyclical or Structural? The Call
This is not a cyclical dip. Three tests separate a cyclical shortfall from a structural one: whether the driver is temporary, whether it self-corrects, and whether the fix requires a regime change rather than a policy tweak.
Chicago fails all three. The pension ramp is written into state law and will rise regardless of the economic cycle. Personnel costs are locked in by collective-bargaining agreements and the sheer size of the workforce. Police overtime and misconduct costs have compounded for five straight years with no visible inflection. The revenue side is equally rigid: the city's most reliable growth source, the Personal Property Lease Tax, came in 11% over projection at more than $402.3 million through May 2026 — a genuine bright spot — but one tax cannot offset a billion-dollar structural gap.
The 2010s turnaround, by contrast, leaned on cyclical tailwinds that have now expired. American Rescue Plan Act funding filled pandemic holes; a strong post-COVID economy lifted receipts; and one-time supplemental pension payments bought credibility. Those were real achievements, but they were partly a favorable cycle wearing the clothes of reform. Now ARPA is gone, the cycle is normalizing, and the structural core is exposed.
The second-order implication is what should worry bondholders more than the headline deficit. Downgrades do not just signal trouble; they transmit it. A lower rating raises the city's borrowing costs on new issuance and on the $10.6 billion in outstanding debt backed by property and sales tax receipts that sat on the books at the end of 2024. Higher debt service then widens next year's gap, which invites another downgrade — a feedback loop that Detroit and several other cities know well. The Civic Federation, the nonpartisan budget watchdog, put it directly in its review of the adopted budget:
continues on the downward path with no clear plan to reverse course.
The Counter-Thesis: Chicago Has Survived Worse
The strongest case against this gloomy read is that Chicago's finances have been declared terminal before, and the city kept improving. The ratings trajectory from 2022 through 2024 was not a mirage: balanced budgets were adopted, reserves were built, and the supplemental pension payments genuinely slowed the growth of unfunded liabilities. Revenue is not collapsing — the lease tax is running 11% ahead of plan, and the city's economy and liquidity remain resilient enough that S&P kept its outlook stable. The $130 million mid-year gap, while serious, is a fraction of the $1.19 billion structural problem, not evidence of imminent insolvency.
There is also a plausible political path forward. The task force's May 2026 final report could break the mayor-council deadlock with a package of efficiencies and targeted revenues that neither side could propose alone. Illinois' own credit has strengthened — upgraded to A2 in 2025 — which lowers the state-level drag on Chicago.
This counter-thesis is credible on liquidity but weak on solvency. Reserves can absorb a shock; they cannot erase a structural deficit that grows on autopilot. And the political stalemate is not a temporary glitch — it is the predictable result of a cost structure that forces every actor to choose between raising taxes, cutting services, or borrowing for operations. Chicago chose borrowing.
Layer 3 — What to Watch
The forward picture splits cleanly by time horizon. In the short term, the question is whether the city needs mid-year layoffs or service cuts to close the $130 million gap — Johnson warned in January that he was bracing for exactly that. In the medium term, the fiscal 2027 budget, due in late 2026, will show whether the city can produce a balanced baseline without one-time TIF sweeps or operating-cost borrowing. In the long term, the test is pension reform: without a change to the state-mandated funding ramp or the 40-year public-safety plan, the fixed-cost burden keeps rising.
Three signals will tell the story. First, the task force's final report in May 2026 — whether it offers a credible, adopted roadmap or another document that gathers dust. Second, any further rating action from S&P, Fitch, KBRA, or Moody's, which would directly raise borrowing costs. Third, the fiscal 2027 budget's reliance on one-time measures: if it again leans on TIF surpluses or operating debt, the structural label is confirmed.
The falsifying signal for the structural-deficit thesis is specific: a fiscal 2027 budget that closes a recurring gap with recurring revenue and documented spending restraint, with no mid-year FY2026 cuts and no new operating-cost borrowing. If that materializes, the sliding back in narrative is wrong, and Chicago's rebound was merely paused.
Base case: the city muddles through — enough revenue holds to avoid a crisis this year, but the gap persists and borrowing costs creep higher. Upside case: the task force delivers a bipartisan package, the economy keeps outpacing projections, and Chicago stabilizes at its current ratings. Downside case: mid-year cuts arrive, another downgrade hits, and the debt-service spiral begins in earnest.
Chicago's lesson is not that reform is impossible. It is that a turnaround built on a favorable cycle and one-time payments is not the same as a fixed cost structure that has been reined in. The city dug itself out once. The hole, it turns out, was still there.
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