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By: Ted Dabrowki and John Klingner

Illinois’ brutal political campaigns may have distracted attention from the reality of the state’s crumbling finances, but an upcoming $500 million bond borrowing by the state will remind investors and Illinoisans alike how little has improved.

Both Moody’s and S&P recently affirmed Illinois’ one-notch-above-junk rating in preparation for the state’s upcoming bond.

And Moody’s continues to maintain a negative outlook on Illinois’ rating. That means a downgrade by the agency is more likely than an upgrade in the next year.

The reasons for the rating agencies’ pessimism are obvious. It’s not just what lawmakers have failed to do, it’s what lawmakers continue to do that’s dragging the state down.

The state continues to operate at a deficit despite nearly $5 billion in new taxes in 2018. And the shortfalls aren’t being compensated with spending reforms. Instead, the state continues to primarily use interfund sweeps to make the general budget balance. And the agencies don’t expect any big reforms this year – not with a stalemate that might ensue during this campaign season.

Bond investors are demanding a heavy price from Illinois for the increased risk they are being asked to take.

According to Municipal Market Data, Illinois will pay yearly interest rates that are 2.1 percentage points higher than the states with the best credit ratings – states that include Indiana, Iowa and Missouri. By comparison, states like Connecticut and New Jersey, states with severe pension crises, only pay about 0.85 percentage points more than the best-rated states. Illinois and its taxpayers are being heavily penalized for the state’s fiscal and governance mess.

The impasse script

Fitch, which still has Illinois two notches above junk, has warned what it would take to issue another downgrade. It reads like a script right out of Illinois’ impasse playbook:

“The rating will be lowered if the state (1) returns to a pattern of deferring payments for near-term budget balancing and materially increases the accounts payable balance. Specific risks include spending (2) above the level assumed in the budget, a significantly (3) slower revenue growth environment, as well as the (4) re-emergence of a political stalemate that negatively affects fiscal operations.” (numbers in parentheses ours)

Illinoisans should have very little confidence that lawmakers will avoid the pitfalls mentioned above. Let’s take each of Fitch’s points one-by-one:

  1. Deferred payments

Illinois politicians have been deferring payments for more than 15 years. The state hasn’t had a truly balanced budget since 2001 and every year since then, lawmakers have engaged in a series of accounting gimmicks to keep the state “balanced” under the constitution – usually by borrowing or pushing off payments into the next year.

That’s led to a steady growth in the state’s unpaid bills, which reached as high as $9 billion in 2013, three years before the recent budget impasse even began. At the impasse’s peak, unpaid bills hit a high of $16.7 billion.

Today, the backlog is back below $10 billion, but don’t let that number fool you. It’s only lower because the state borrowed $6 billion from the bond market to pay down some of the bills. In the end, the state increased its mortgage to pay down the credit card.

  1. Spending above the budget

It’s hard for lawmakers to avoid “spending above the level assumed in the budget” when they’ve been doing it for years and they continue to do so.

Wirepoints previously wrote on Illinois lawmakers’ inability to keep spending under control. The FY 2018 budget was on track to spend $1.7 billion more than expected – even though lawmakers had $5 billion in new tax hike dollars to work with.

The state has found ways to whittle that shortfall down via some fundsweeps and higher tax revenue growth, but a shortfall continues to exist. “Total Fiscal Year 2018 General funds expenditures are estimated to exceed Fiscal Year 2018 General funds base revenues by approximately 590 million,” according to the state’s official bond offering.

And that $5 billion won’t mean 2019’s budget is balanced either – it could be up to $3 billion out of balance. In fact, the latest predictions of the governor’s budget office have Illinois in deficit spending for the next 5 years.

  1. Slower revenue growth environment

The only positive thing to say – and it’s not related to anything state lawmakers have done – is that thanks to national growth, the stock market and the reductions in regulations, Illinois tax revenues may do better than expected.

  1. Re-emergence of a political stalemate

You’d think that none of the politicians in Springfield would want a repeat of the budget impasse. But the opposite is true. It’s an election year, so lawmakers are unlikely to reach deals that benefit the state or its residents. They’re more focused on scoring political points than on fixing anything. Neither Madigan nor Rauner will want to give the other a “success” for the campaign trail. And each side will blame the other as Illinois teeters on the brink.

So dysfunction will reign and a stopgap budget is likely, unless some Republicans break from Rauner like they did with the last budget. But everything’s up in the air. As state officials warn investors in the bond offering document, “There can be no assurance that a general funds budget will be enacted for fiscal 2019 or in future fiscal years.”

2019 is 2016 all over again

In 2017, Illinois politicians sold a record, permanent tax hike on its residents as the only way for the state to avoid ruin. Illinois was just one notch away from a junk rating and no state had ever received that designation.

One year later, with Illinoisans $5 billion poorer as a result of the tax hike, Illinois is still at the precipice.

The crisis is the fault of Illinois politicians. They’ve been given plenty of warning signals – 21 downgrades by the big three rating firms over the past decade – yet refuse to change the way they and the state operate.

“The state’s credit outlook is negative, based on our expectation of continued growth in the state’s unfunded pension liabilities, the state’s difficulties in implementing a balanced budget that will allow further reduction of its bill backlog, and elevated vulnerability to national economic downturns or other external factors,” the Moody’s report on the state’s bond offering said.

To reverse that trend, Illinois needs massive reforms that change from the way Illinois politicians do budgets, dole out retirements, control local governments manage labor rules and handle education finance.

If there’s not a major reversal, prepare for a downgrade – and the plunge to junk.

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Mr. Common Sense

Start lobbying your federal reps on allowing States to file bankruptcy.

It’s Illinois’s only chance for survival.

That’s looking inevitable. However, don’t look for anybody to even talk about it before the November election. That discussion will resume afterwards. It won’t be just Illinois, either.

Dave

You make it sound like bankruptcy is painless. It costs anybody who has savings accounts in possible loss of principal and certainly reductions in interest payments. It hurts retirees who hold Illinois bonds or mutual funds which hold Illinois bonds. And it hurts everybody in Illinois whose government going forward will have to pay userous rates if they can borrow at all. Illinois only chance for survival is financial reform. That only comes with a change in politics in the state and that only comes from incredibly stupid voters becoming suddenly intelligent. Which is impossible.

Respectfully disagree. The purpose of bankruptcy is to try to deal with those pains you describe, which are inevitable, in some orderly, rational way. If successful, it does not hurt credit going forward, it improves it. And I say again I am not endorsing it for the state or any municipality. I am saying the option needs to be there and it should be considered case-by-case to see if it would work. It’s a horrible option and the real question is whether it’s avoidable.

jim palermo

Mark, maybe you can remind your readers of how states might get around the constitutional prohibition on bankruptcy of how Puerto Rico’s financial distress is heading us in that direction?

Illinois Entrepreneur

I read in Crain’s today that Rep. Welch is now trying to pass a bill that will eventually lead to the privatization of collections and auditing with private “bounty” hunters against businesses. We know where this is going. This is essentially going to become the “red light cameras,” but for businesses. An overzealous firm will be demanding volumes of supporting information from all retailers in their zeal to collect a 50% commission from businesses…or they can settle for a smaller amount and get it over with. I point this out because Illinois will continue to demand more from its ATM… Read more »

Rick

The rating agencies know how to read the numbers but they can’t recognize a ponzi scheme. But every ponzi scheme still has books that look legitimate, that’s why people and rating agencies fall for these schemes.

Your ideas are great but unwanted by leaders because 1) Illinois is, at its core, a bastion of corrupt, incompetent, political and immoral leaders. The voices that speak up are small and ignored. The markets love high-interest bonds. Those who could create change won’t speak up – so they are part of the problem – including business, institutional, political. media, religious leaders. All have become ethically neutral. Shame on our leaders.

Illinois Entrepreneur

You are right on the money.

Rick

Moody’s is not the taxpayers friend, they typically “reward” Illinois with better ratings the more Illinois screws over the taxpayers. There is no macro economic or political or rating force in play that is on the taxpayers side in Illinois, all incentives are to have us pay for this Ponzi scheme. And these rating agencies will keep the Ponzi scheme going strong by rewarding our alcoholic state with another beer.