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By: Mark Glennon*

When the possibility of Congress authorizing bankruptcy for insolvent states was last discussed a couple years ago, most of Illinois’ media and political establishment either ignored or ridiculed it with words like “dangerous,” “silly,” and “unconstitutional.”

The discussion is returning and this time it will be informed and rational, if Friday’s New York Times article is an indication.

The spark for the new round of discussion is Puerto Rico’s full reorganization plan, recently proposed in its bankruptcy-like proceeding under a federal law called PROMESA, which Congress authorized in 2016.

“If the plan survives the challenges ahead, it could be a model for how struggling states deal with their financial problems in the future,” says the Times, referencing Illinois and New Jersey in particular.

Those in Illinois who scoff at talk of bankruptcy, particularly public pensioners, should read the Times piece with an open mind. They may find much to their liking, especially if they understand the chaotic alternative Illinois faces if it does not find another orderly way to address its rapidly deepening insolvency.

Yes, pensions would be cut under the Puerto Rico plan. As the Times reports, the new restructuring plan would reduce the island’s $54.5 billion pension obligation to $45 billion. However, cuts would be made on a sliding scale. The biggest pensions would be reduced by, at most, 8.5 percent, and the smallest pensions would not be cut at all.

Illinois, too, needs some kind of progressive or means-tested pension reform. Many pensions here are very excessive, but smaller ones need more protection. Federal legislation can permit or even mandate differential treatment.

But bondholders would bear a far bigger burden to give Puerto Rico a fresh start under the plan. It would trim the island’s bond obligations to $41 billion from $75 billion — a 45 percent reduction. That, too, is an average, with cuts to bonds ranging from 64 to 93 cents on the dollar. Others could risk getting nothing at all, according to the Times.

Puerto Rico retirees would also get legal assurances of future funding under the plan. “The result,” according to the Times, “is retirees get a better deal than almost any other creditor group: at least 91.5 cents on the dollar.” Most Illinois pensioner who truly knows our numbers would take that deal and run because, as things stand, one way or another, those with the larger pensions will be lucky to get 60 cents on the dollar in the long run.

In total, Puerto Rico’s plan would cut $129 billion in debts to about $86 billion — a reduction of 33 percent, NYT calculates.

How did they conclude that was the right amount? That is, how did they balance the need for debt reduction against the need to maintain competitive levels of taxation and services while still giving the island a fresh start?

On that, the federally-appointed oversight board, which proposed the plan, took a sensible approach. From the Times article:

First, the board looked at the debt burdens of America’s 10 most indebted states, calculated the average, and pared back Puerto Rico’s debt to an amount less than that. Then it began pushing for changes meant to make the government perform more efficiently, rebuild the public trust and encourage businesses to grow and hire.

Could Congress pass legislation for states comparable to PROMESA for Puerto Rico? There’s no constitutional obstacle, notwithstanding claims to the contrary by some opponents. “The constitutionality of bankruptcy-for-states is beyond serious dispute, according to David Skeel, a law professor at the University of Pennsylvania and member of Puerto Rico’s oversight board. The key is that bankruptcy would be entirely voluntary for any state, which eliminates any concerns about federal intrusion on state sovereignty.

Would Congress ever do so?  In 2017, there was enough interest in Congress to prompt then-Governor Bruce Rauner to predict that such legislation would be passed that year. He obviously overestimated Congressional interest in the subject, and interest abated in 2018 when Democrats, who are more opposed to the idea, took control of the House.

However, action is probably just a matter of time. It would likely take a state controlled by Democrats telling Washington it needs bankruptcy-for-states. Illinois and New Jersey may be the worst off, but Connecticut, Massachusetts, California and Kentucky are not far behind.

The real fight would then about what form bankruptcy-for-states would take. It needn’t be identical to PROMESA nor similar to Chapter 9 of the federal Bankruptcy Code, which is for municipalities but not states. Issues about priorities among bondholders, pensioners and other creditors, as well as many other matters, could be addressed by Congress in its legislation.

If you still think the concept of bankruptcy-for-states is far-fetched, be aware that those with the most financial expertise and skin in the game think otherwise. That’s the municipal bond industry. They saw the risk to their wallets back in 2016. Knowing that PROMESA could set a precedent that would jeopardize outstanding bonds, they fought hard to defeat it in Congress and ran a national ad campaign in opposition.

The author of the New York Times piece, interestingly, is Mary Williams Walsh, who has long been following state financial and pension issues in Illinois and elsewhere. You may recall her 2015 article, “Bad Math and a Coming Public Pension Crisis,” about the efforts of Jim Palermo and others here in Illinois to expose the work of an actuary for many Illinois pensions, Timothy W. Sharpe. That work, and probably her article, resulted in Sharpe’s suspension by the American Academy of Actuaries from membership for two years.

When we wrote about bankruptcy-for-states in 2017 we quoted Arthur Schopenhauer: “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”

Hopefully, we’ve now at least passed through that first stage.

That’s not to say we endorse bankruptcy for Illinois or any other state. We do think, however, the topic warrants consideration. It would depend on the specifics and the details of the legislation. It would also depend on whether Illinois pursues the drastic reforms it needs in some other manner. However, the only alternative that would allow for real pension reform in Illinois is an amendment to our constitutional pension protection clause, which our political establishment has ruled out. And if equity requires sacrifices from other creditors, only bankruptcy can do it.

*Mark Glennon is founder of Wirepoints.

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Poor Taxpayer

U Haul is the only answer that will work.

Bob out of here

The pension funds should invest in U Haul, because they will make a killing over the next few years as more and more people flee. I moved out of state 2 years ago, was checking apartments in a small suburb, and rental agent told me I was the third person she had seen THAT DAY from Chicago.

Andrew Szakmary

There are some relevant stats that were left out of this article, so I will include them here. Since its peak in 2004, by 2018, Puerto Rico’s population decreased by 14.9%. Over the same 2004-2018 period, Illinois’ population grew by 1.2%; yes, the state’s population has declined recently, but since the peak in 2013 the total decline is 1.2%. Per capita GDP tells a similar story: Puerto Rico’s actually declined between 2004 and 2018, while Illinois’ increased 12.2%. Yes, the increase in Illinois may lag many other states, but it is positive. I should also note that in terms of… Read more »

s and p 500

NY Times had another article about how even in Europe it is very difficult to resist the pressure to underestimate how much pensions really cost.

https://www.nytimes.com/2014/10/12/business/no-smoke-no-mirrors-the-dutch-pension-plan.html

Astonished

And so it begins. A bull market for bonds began in 1981. Since then, owning bonds was a capital gains money machine. Bonds, like stocks, are intangible assets. The market for intangible assets does not conform to Econ 101 supply/demand price models; as prices rise (in a bull market), the quantity demanded rises also. This dynamic has run for 38 straight years, resulting in a veritable OCEAN of debt being filled (the on-budget $22 trillion national debt is a snowflake on the tip of the worldwide iceberg of IOU’s.) We LONG AGO passed the point where debts (promises of future… Read more »

Astonished

We’re all facing a sea change. Pensions (public and private) all hold debt. Bonds are the backbone of the world’s wealth today. Bonds are the capital held by banks. When it becomes inescapably obvious that most of those obligations cannot be met, the inevitable result should be a deflation in the amount of wealth never before encountered. We all will get a haircut, possibly a buzz cut. I think it is the size of the cataclysm now baked into the cake that fuels an inability to face the music. The deck of this ship is washing with sea water but… Read more »

world with end

On the possibility of IL eventually declaring bankruptcy, how would it likely be handled? Would there be the same percent reduction applied to all pensions? Would retiree health care benefits be reduced? They should. Who the heck doesn’t pay a health care premium in retirement? On a related note, I’m concerned that unless the cuts are deep, the people thinking of moving out of state shouldn’t unpack their bags. For example, a 30 percent cut in pensions while keeping the three percent annually compounded increases and free health care for retirees, and inappropriately high salaries for state employees such as… Read more »

Astonished

The solution to this will not be deliberately chosen because too many people stand to lose too much for the process to play out coherently. The resolution will come spontaneously, painfully for those most vulnerable. If history is any guide, those with closest ties to the political levers will find means of skinning the rest of us still. In the aftermath of the Revolutionary War, the script issued by the Continental Congress was worthless. A clever con artist traveled around, buying it all up for a tiny fraction of face value, then later went to Congress and his political benefactors… Read more »

Astonished

The 3% COLA is insane. Nothing on Earth exhibits permanent, compound (exponential) growth. The fact that everyone now thinks that we can all have exponential 3, 5, 7, 8, (etc) percent growth is evidence that (1) people don’t understand math and (2) we’ve lived in a bubble where the impossible appeared (for a time) possible. What will happen when this Debt Fantasy burns down? If the 1930’s were any guide, it will result in a deflationary depression. The odds of even maintaining a fixed-price pension in that environment look low. I’d rather see some kind of inflation/deflation pension adjustment, such… Read more »

David

Bankruptcy is the only option for Illinois, it should however require NO bailout from the feds. It should also NOT be means tested for pensions. Those who worked hard and saved their money versus buying a boat and snorted coke on the weekends should not be penalized for saving for their retirements. No-one getting a state pension even at 50% will be in the welfare line, if they don’t like it just give them what they paid in with interest and they WILL be in the welfare line.

Astonished

Means-testing is robbing the prudent by perverting the meaning of “fairness.” But Orwell was far from first to notice that con artists first warp the meaning of words to lie to your face. However, six-figure pensions are an abomination. No one’s work in the public sector justifies what amounts to millions of dollars in deferred income (pension) payments. NO ONE. A pension should be CAPPED at what supports a modest living standard. If a police chief, a school superintendent or a parks and recreation manager wants to drive luxury cars and live in luxury homes as a retiree, they should… Read more »

Cass Andra

I applaud the Orwell Observation. By political or judicial fiat pensions have been cleverly characterized as Deferred Compensation and then anointed Contract Rights. [Judicial fiat and legislative fiat aren’t that different.] Granted that the these “elevations” were in response to prior judicial decisions that public pensions were mere gratuities. But there IS something circular or charade-like having legal consequences follow from labels given to arrangements with the intent of changing the rights and expectations of the parties. Curse my lack of political correctness, but it’s a bit like transforming every unwelcome advance into a rape. Or taking the names of… Read more »

DOUG

Illinois should lose its Statehood Status and be relegated to a US Territory like Puerto Rico. The corrupt Illinois Mafia political machine will never voluntary file for BK, screw 95% of the taxpayers, they will go “Scorched Earth Death Spiral” before cutting anything that’s theirs. The only question is how bad does it get before Feds step? The voters of Illinois are too stupid to vote the Democrats out of office.

Rick

Bankruptcy for states would give states some defense against the predatory bond market and rating agencies who together seem to operate under the assumption that our taxes can be raised forever. It was always needed for this reason even though all the arguments for it now are due to the impending doom. If a market knows that they can squeeze a state past the breaking point with the cycle of improved rating awards for ever higher taxes and give-away’s, they will think twice. Right now without bankruptcy there is no defined “breaking point” for a state, so the bond markets… Read more »

Erik

Whenever I start to feel hopeful about a state bankruptcy option I remind myself that a state cannot be involuntarily forced into bankruptcy, they must ask for it. Given the depth of incompetence and corruption displayed by our elected leaders I don’t expect them to request a bankruptcy option until Illinois is nothing more than a hollowed-out husk on a state.

Bob Out of here

If the bondholders of the sales tax secured receipts get 93 cents on the dollar, that does not sound good for the city and/or state, since they seem to have used securitization as collateral for the last few years. Also notice pensioners don’t seem to be taking a particularly big haircut.
Ted, what reduction in pension benefits be enough for IL? I don’t think retirees in PR are making near the 6 figure pensions so common in IL.

DantheMan

If Illinois ever did file for bankruptcy, I have 2 concerns. First, who would manage the state finances during and afterwards? For obvious reasons, it better not be the liberal politicians that created the mess. Second, if taxes remain at current levels the exodus would likely continue, thus causing all the revenue estimates for coming out of bankruptcy to be too low.

Jeff

Personally, I think the bankrupt State should have to relinquish their sovereignty for a period of time, say 15 years and revert back to a Territory. The Feds could assign a governor, financial boards, etc. to manage things.

Seems like there needs to be some real consequences.

Tom Paine's Ghost

I like that idea. Since the most financially incompetent states tend to be run by Democrats the loss of 2 Democrat senators, loss of a majority of Democrat representatives, loss of voting for President and the loss of the Blue electoral college votes ought to kick some moral hazard into the criminal politicians running this state and into the moronic voters that keep electing them.