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By: Ted Dabrowski and John Klingner

The world’s collapsing interest rates have just made survival that much harder for Illinois’ pension funds, most of which are built on the assumption that they can earn around 7 percent on their investments. Interest rates have fallen below zero percent in Europe, while US 30-year interest rates fell below 2 percent for the first time in history. Ten-year rates here are now at 1.5 percent, also near their lowest level ever.

Low rates are particularly hard on the most underfunded pensions because those funds are forced to keep more of their money in short-term, low-yield bonds so they can cover near-term pension payouts. Low rates also hammer the smaller police and firefighter pensions around the state because they, by law, are forced to keep large parts of their investments in bonds.

Expect funding levels to continue their descent across the state.

Illinois’ pensions are just 38 percent funded. That’s the third-worst rate in the nation, just behind fellow crisis-wracked New Jersey and Kentucky. 

Chicago’s firefighter plan is just 17 percent funded while the city’s police and municipal plans are just over 20 percent funded. 

And many of Illinois’ 650 local police and fire funds are just as bad. The overall funding ratio across the state is just 55 percent, but nearly 100 of those funds have funding ratios lower than 40 percent.

Low interest rates make it that much harder for the funds to grow what little money they have left to invest. And that means Illinois’ true fiscal crisis will come sooner than later, everything else equal. 

The low funding ratios have already contributed to Illinois’ just-one-notch-above-junk credit rating – no state has been rated junk before. Chicago already has a junk rating from Moody’s, while Chicago Public Schools is already five notches into junk – two notches lower than the city of Detroit. 

Lower interest rates are likely to put even more pressure on the rating agencies to drop credit ratings in Illinois even further. That’s particularly true if US interest rates follow the path of those in Europe, as some analysts expect. There, interest rates have gone below zero, meaning investors get back less money than they actually invest. Germany’s most recent 10-year bond rate was at a negative 0.71 percent. 

Low interest rates will make things worse in Illinois for three reasons. 

First, because the funds need to set some money aside for payouts to current retirees, they can’t afford to have it all locked up in risky investments. That forces them to keep money in investments that are liquid and easy to sell – meaning bonds. The problem is, those bonds pay little and don’t keep up with how fast the plan’s pension promises have been growing. That alone makes the funding hole in the pension plans bigger.

Second, lower bond rates will tempt the plans’s managers to make even bigger investments in stocks and other risky assets. And that could spur a liquidity crisis if there is a major stock market correction.

Finally, Illinois law requires most of the 650 police and firefighter pensions around the state to invest much or most of their money in bonds. Half of those funds must invest 55 to 90 percent of their holdings in fixed income investments. With interest rates now so low, they have little hope of earning meaningful returns.

A fundamental flaw of defined benefit pensions is now fully exposed. They guarantee high benefit payouts to pensioners but they are backed by investments that are far from guaranteed. 

The gap between the two has reached absurd levels.

Read more about how interest rates and investments mean deep trouble for pensions:

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DOUG

If Chicago and/or Illinois are allowed to go BK, they should lose their municipal and statehood status. Illinois should then become a US territory like Puerto Rico.

mike Williams

Has anyone else noticed a slight shift in the nature of the comments here on Wirepoints in the last year or so? Before, when talking about teachers and other public pensions, the comments seemed to hold these pensioners in high regard and not blame them for the pension crisis. Now, these pensioners aren’t being given a free pass any more when assigning blame…. or maybe it’s my imagination.

Mike, more generally, I’ve clearly noticed a significant shift towards recognition of how bad our problems are. You can see it not just in comments here but on other sites like WTTW. People are increasingly hostile to those who ignore our problems. We also see it in our pageview numbers, that are growing extremely fast.

mike Williams

I’m glad the site is growing in popularity. I’m sure it’s an ongoing challenge to try and make stats/graphs and raw data meaningful to the general public.

Willowglen

My childhood teacher friend from my Northshore town still lives there. She retired at 3x plus what a private sector worker would make under social security, but did do at age 56 and with a 3 percent adjustment upwards each year. Low cost healthcare until Medicare, too. She relates she gets treated coldly as she goes about the well off North Shore town in Lake County. She doesn’t like it, responding she played by the rules. Although anecdotal, there’s resentment, even in a town with 3x the median income. So I think some anger towards this mandarin class is inevitable.

I see this all the time, late 50s or early 60s retired teachers spending their day playing golf or at the health club and they all have a nice car like a lexus or BMW

debtsor

There’s a retired fireman in Old Irving Park (NW side of Chicago) who parks his speedboat in front of his house. The name of the boat is ‘put it out’. The rest of us working stiffs have to pass the boat every day driving to our house while this guy stores his boat on the street.

Illinois Entrepreneur

A police detective once said, “the difference between police and firemen is that firemen actually believe they are heroes.” This comment won’t be popular with the “firemen are heroes” crowd, but I think firemen are vastly overpaid. Police and construction workers–who make far less–have inherently much more dangerous jobs without the “glory.” Because firefighting used to be much more dangerous (with much higher incidents of fire) the pay scale is wildly out of whack with modern conditions. Senior firemen are making upwards of $200,000 a year, and much of that time is spent cleaning the truck and hanging out at… Read more »

DantheMan

Perhaps our revenge is coming when some day in the not so distant future these former public servants get a letter from their union stating something like, “Despite our best efforts fighting in court, your pension is being reduced by ?? percent.” I wish I could add my own personal PS to the bottom of the letter saying, “Paybacks a bitch, isn’t it? signed an Illinois taxpayer”.

Bonnie

That seems like a very unfair comment to me. State workers are taxpayers, too. When I started working for the crappy state of Illinois 20 something years ago, I was young(er) and just needed a job to pay the bills, so could have not cared or was unaware of retirement. However, I remember something to the effect “Sign here on the dotted line and we will manage your money for you every paycheck and you will get a pension out of it someday” WHEN REALLY what it should have said was “Sign here and we will steal and mismanage your… Read more »

debtsor

Your ‘piddily’ pension, over the course of your lifetime, will be multiples of what you contributed to the system, all the while earning a higher than private sector salary, with unheard of job security, and generous state benefits.

your whining makes me dislike you even more.

mike Williams

Yeah, Yeah… it’s not my fault. I just play by the rules and did what I was told. Hmmm….where have I heard that line of thinking before.”

DantheMan

You don’t see too many comments with a negative agreement count. Currently Bonnie rates a -4. Sorry Bonnie, the rest of us aren’t buying what you’re selling. If being a public employee is as bad as you pretend, get a real job in the private sector.

MikeH

Buy the ticket, take the ride, Bonnie.

Cass Andra

The unions presumably told you to vote for Democrats so you did that and you see the developing mess. Likely it will soon hit you in the pocket. Wirepoints and others would love to resolve the mess but the unions won’t stand for it OR sit (at the table) to discuss it. Meanwhile while you are forced to continue working until an age when regular folks retire, you can take comfort in knowing that your retired union brothers and sisters are bleeding the funds dry with their lavish pensions and benefits. You seem to have a glimmering of understanding of… Read more »

DantheMan

So my dear remaining Illinois taxpayers, look at the list/graph showing the level of pension crisis by state. Wirepoints has done your homework for you. Look at the states that aren’t too far away from 100% funded (around 9 of them) and pick one. Now get up off your butts and go!!!

Jacob

For real though. I’m a Millennial who grew up in the western suburbs. All but one of my friends have left for other states. I’m joining the exodus next year, but I’d move back someday if I didn’t have to pay the second highest property taxes, highest sales tax, and a climbing income tax for potholes, violence, and the expectation of more taxes.

NB-Chicago

So, as mr t pressures the fed reseve to lower interest rates to juice the markets, he’s hurten the pension funds? But as the world economy cools with interest rates at near zero when recession hits fed’s will have no ammo to stimulate? What do you do-

Hank Scorpio

Which is why the next recession will be worst than the last — they never really fixed anything last time, just swept everything under the rug via easy money policies and bailouts. Oh, and the Fed’s balance sheet is still at $4 trillion. Buckle up folks.

NB-Chicago

us treasury bonds yields will go negative like they are in japan and Europe..almost already there. and decades of stagnation…. and streets and sans pensioner guys will still be retiring as multi-millionares at 55 in Florida.. maybe they could use a 60 something pool boy?

Freddy

I’ve stated this before in a comment. The 3% compounding was not indexed to anything. It went from 3% simple to 3% compounding regardless of market conditions. So the Fed is partly responsible as is Illinois for not having the foresight to index to at least the yearly S.S. cola’s. For example there is at least $50 billion in the TRS fund. By getting 4% interest yearly that = $2 bil which could have increased funding levels substantially over the years. In 1990 when the 3% was instituted you could get 5% in a MMF account. Chase and other banks… Read more »

Ben

“Moody’s has indentured your children, should they stay here, to massive debt.” Nope. The troubled pension systems are all going to collapse during the next recession, and the pensions will will be lowered – one way or another. There is NO WAY to pay them realistically, and so they won’t be. Bankruptcy at the very least will occur in every city in Illinois nearly, and most likely the federal government will have to allow state bankruptcy as well. Mark and Ted, I am sure you agree.

debtsor

“Bankruptcy at the very least will occur in every city in Illinois nearly, and most likely the federal government will have to allow state bankruptcy as well. ” We are a generation away from this. Cities and states will cut, cut, cut before they miss that pension payment. 20 years from now the municipalities will be barebones operations with a majority of the meager taxes recovered being paid to pensions. You already see this in many towns where the infrastructure is crumbling and the services are non-existent – but the pension payments are made every month, on time, always.

Ben

There is a limit to how long that can go on, and we are already almost there. If a recession hits these cities you mentioned in trouble will instantly go bankrupt. No one will be around in cities with high taxes and no services – that is not realistic at. The game is about over. A city with no basic services would fall until police powers. I give this five more years at most and the GA will have no choice but to start allowing cities to go bankrupt.

debtsor

That’s crazy, 5 years is crazy. My suburban town has a well funded pension, as do many others, and many down state are looking great too. It’s just the crappy suburbs, the state, and of course, Chicago. If anything, residents who don’t leave the state will eventually flood into the towns with well run pensions (because lower property taxes, better services, etc) which will mean that some places will be in excellent shape, while others will be completely insolvent. My belief is that this progressive uptopia right now is just a temporary thing and IL might be a lot ‘redder’… Read more »

Freddy

Debtsor. It is good that your town and some others pension funds may be well funded. If you are talking about police and fire remember there was some chatter about consolidating the 650 or so different funds into one. That would then reduce your towns funding ratio and increase some city’s like Harvey. That would not be fair at all. If they would each remain autonomous then administrative costs should be reduced under one umbrella. Having your town under good fiscal management and proper pension funding then having to shift money into one big pot would stink to high heaven.… Read more »

NiteCat

They call it The Combine…Rs playing both sides of the fence.

Ben

Mark and or Ted, please respond. This won’t go on another twenty years. I give it five at most. There is a limit to taxation, and there is a limit to cuts too. The pensions are toast.

Yup, probably five years at the most.

debtsor

We’ve got another generation of this mess, at least. Things will get far, far worse for the middle class before things collapse. Illinois is a progressive utopia now, there is no way this will collapse in five years. More like 20-30. We’ve got a long way to go, and taxes are still not confiscatory yet. High, certainly, but not confiscatory. And as long as the government keeps employing, the state will keep chugging along, until the eventual receivership when I’m an old man getting ready to retire, by which time, I will likely be living somewhere in the sunbelt.

Ben

Property taxes are out of control already. Illinois is already a high tax, low service dump. Taxes cannot go much higher, and services cannot be cut much. You are clueless. The next recession is game over. Mark agreed with me as well.

debtsor

“You are clueless” Come on’, we both agreed it will collapse, eventually; but our difference is over the timing. Calling me clueless is unnecessary. I didn’t insult you. My logic is that other states are bad too – and none of them have collapsed yet. We also have plenty of well funded pension and a very large business community that does not seem intent on fleeing – yet. We have some of the country’s largest insurance companies, commodities brokers, food distributiors, law firms (kirkland!), fortune 500 companies and so on. They are still here and their highly paid employees still… Read more »

Ben

Illinois is on the brink right now; Illinois can’t handle another recession mathematically. I firmly believe the next recession may actually turn into a depression because of all the unsustainable worldwide debt and the federal reserve’s limited options to battle another one. A recession alone will be enough to take down Illinois, and other states, but a depression would obviously be even worse. Without a middle class a state dies, and the middle class, as you stated, in Illinois cannot afford much as far as tax increases at this point. Property taxes are far too high already, and won’t be… Read more »

Willowglen

Debtsor – I read your comments as stating that the current rent seeking political/union class will go to the end of the earth to protect their racket. That perspective i can see as a rationale that things will fall apart later than some believe. But the numbers are so bad I can envision the productive class leaving quickly. My clients are multinationals and they move people and resources away at light speed. So I think sooner than later. By the way, I am no moral arbiter, but no thoughtful person here should be called clueless. Not only is it completely… Read more »

Ben

Also, the state will continue losing population until the pensions go bust. It is unsustainable, and insane to think it will go on for twenty more years. If there is a recession it will almost instantly collapse.

NiteCat

This will last until the new “progressive” income is passes or fails. If it passes, we’re doomed as everything in that law is indexed in one way or another. Not to mention that it gives the GA the ability to fiddle with it at will. If it fails, praying hard it should, most of the pension funds might actually have to finally declare bankruptcy. The state is technically in bankruptcy now, it just hasn’t been “pronounced” because Las Vegas East keeps buying our bonds.

Ben

Even if it passes taxes can only go so high and the pensions still collapse. People don’t seem to get that. The income tax is not going to be 20%. Most people (the majority of Illinois) are nearly tapped out now tax-wise when you equate how high property taxes are in Illinois. The pensions are doomed even if it passes, maybe just a few years later.

debtsor

My best guess is that the progressive tax rate is going north of 10% for everyone over $40,000 a year; probably in a few years time. Thats *basically* what Califnornia does and they keep chugging along. Kind of crazy but I saw tax return teh other day. Single mom, Head of household filer, one kid. a little more than $50k income. Paid $4,000 in federal tax after the child tax credits and standard deduction. Paid $4,500 in state tax. That’s crazy that a single mom pays more in state taxes than federal taxes. only in IL!

Ben

California is in much better shape than Illinois, so that comparison means zero. California has much lower property taxes, and people still want to live in California overall, unlike Illinois. More than half of Illinois residents want to leave, and that isn’t so in California. California has much better weather also. Illinois will absolutely bleed residents if it raises incomes taxes that high on people making 40,000 and above, and it will collapse even quicker. The pensions are toast in the next five years.

riverbender

Yep every year my Illinois taxes exceed my Federal taxes…that’s life in Illinois.

Rick

Nice article except where it says that the rating agencies will be pressured to lower ratings to below “just above junk”. The rating agencies are snake oil salesmen at best and Ponzi runners at worst. They will keep Illinois artificially at “just above junk” simply becUse they are paid to do so. And because they are in collision with the administration to raise taxes ad infinitum. Moody’s is the enemy of the people. Moody’s has endentured your children, should they stay here, to massive debt.

Willowglen

Excellent article. New York recovered from its financial abyss in the 70’s in large part because the ensuing 15 years had quite a bit of inflation and escalation of interest rates, a fortunate circumstance for a big debtor. I foresee low interest rates and modest inflation for some time to come. Throw into the mix that Chicago, while not a Detroit in terms of income potential, doesn’t have the economic finance engine of New York, and it is easy to be pessimistic.