By: Mark Glennon*
The fiscal crisis in Harvey, Illinois may be exceptional, thanks to its particularly acute history of graft, mismanagement and economic problems, but rest assured it’s being closely watched by everybody interested in Illinois’ struggling municipalities — not just residents but pensioners and bondholders in particular.
Money flowing from the state to Illinois towns and cities is critical for most of them. Harvey last month became the first Illinois municipality to face “intercept” of that money to fund pensions. The law provides that any municipal pension that doesn’t get its required annual contribution from the municipality that sponsors it may request the state comptroller to seize any state money due to the municipality and deposit it into the shorted pension.
The consequences for residents and bondholders are potentially devastating for some communities. Harvey responded by laying off about half its public safety employees.
Harvey went to court to try to halt the intercept and a free-for-all fight for the money ensued between bondholders, the city, its police pension and its firefighter pension.
Comptroller Susana Mendoza delivered to the litigants a key letter last week that her office provided to us, linked here, outlining her position and her intention to complete a $2.3 million intercept. It’s important for two reasons.
First, the comptroller exempted a bit of the disputed money from the intercept — $279,000 of home rule municipal sales taxes that are specifically to be used for holders city hotel-motel revenue bonds.
Second, and more importantly, she directed the intercept in favor of the pension that was first to make its request, which was the police pension. The firefighter pension had made its intercept request second. While the priority issue was not discussed in the letter, implicitly that means the first intercept request wins.
However, the court immediately blocked distribution of the funds. A further hearing is scheduled for this Monday, the the primary issue apparently being the battle between the two pension funds.
Legally, it appears that the comptroller had it right. Taxes destined for revenue bonds aren’t state money subject to the intercept. Instead, they are dedicated from the outset to debt service on a specific project. (They are usually held in trust for that purpose, though I have not seen the documentation for the Harvey project.)
It also appears correct that the first pension to ask gets the state money. The comptroller has no discretion and is bound to administer the law. As the statute (40 ILCS 5/3-125) is written, it appears the pension that first properly certifies its request should indeed prevail.
We’ll have to wait to see if the court agrees that first-to-ask-wins, but if that becomes the rule going forward, trustees of pensions that can demand an intercept will face increasing pressure to do so. They have a fiduciary duty to look out for the pension, not bondholders, taxpayers or residents.
And there are lots of pension trustees facing that issue. A Wirepoints Special Report found about 200 municipalities that could face a pension intercept based on inadequate funding for 2016, which is the most recent data we have and the earliest year subject to the intercept law.
That’s why Moody’s today issued a statement saying Harvey developments are “credit negative” for all Illinois municipalities. “The comptroller’s response has important implications for other municipalities in the State of Illinois struggling to provide services and pay pensions because it clearly prioritizes underfunded pensions over municipal services,” said Moody’s. Their statement is discussed in a Bond Buyer article today linked here.
So much for the battle between pensions and bondholders. What about taxpayers and residents needing services?
The city has been trying to negotiate some kind of broad settlement that would preserve at least some of the funding for itself, but I’ve seen nothing reported that, legally, it can stand on. The law is the law. As we’ve been saying repeatedly, this is an inevitable fight over the bones between pensions and bondholders. They’re who Springfield wrote the law to protect, and they’re the only ones playing the hardball game of insolvency smartly. Taxpayers and service recipients be damned.
It’s happening, as we like to say. Harvey is only the first.
UPDATE 5/31/18 The next court hearing, that was scheduled for today, was postponed to Monday in light of ongoing settlement efforts.
*Mark Glennon is founder and executive editor of Wirepoints. Opinions expressed are his own.