By: Mark Glennon*
Most readers’ eyes surely will glaze over a piece in The Bond Buyer today —
Why Puerto Rico Highways Ruling Has Wide Ramifications. But have no doubt it’s a matter that will be paramount, sooner or later, for Chicago and many other Illinois municipalities, and perhaps for the state itself.
In the Puerto Rico case, a U.S. bankruptcy judge basically invalidated a lien — a mortgage — securing bondholders with public assets. Here in Illinois, the municipal bond industry has been quietly putting language into Illinois statutes to try to avoid the same result. If successful, for municipalities that go bankrupt, those efforts would be disastrous for taxpayers and government services. An assetless bankruptcy would result, meaning there’s nothing to work with and no hope of a fresh start.
In the near term, however, borrowing costs may increase as a result of the ruling. That’s because bond buyers today aren’t focusing much on general creditworthiness. Instead, they are looking at what assets are mortgaged to secure the bonds and whether the mortgage will hold up legally in bankruptcy. The ruling might make them feel less secure.
We’ve written about this issue in articles linked here, here, here, here and here.
The muni bond industry has mostly had its way in the Illinois General Assembly. Mercifully, however, Gov. Rauner vetoed its most recent attempt to overcome the issue in a bill for the RTA and CTA.
The muni bond industry and Wall Street are acutely aware of the issue, though the Illinois press is asleep.
“Without a doubt … this is a victory for the Oversight Board’s continuous effort to destroy all bondholder liens in Puerto Rico,” said one attorney about the Puerto Rico ruling.
That’s what Illinois and its broke municipalities should be positioning themselves for. Instead, we’re doing the opposite — turning over public assets to bondholders to secure more borrowing.
Chicago, in particular, is moving towards using its new statutory authority to convey ownership of future income to bondholders for additional borrowing, as described here in an earlier Bond Buyer article.
UPDATE 9/15/17: Be aware that the Puerto Rico ruling was only on a motion for a preliminary injunction. A full ruling on the merits is yet to come. Legislation recently passed in Illinois providing for transfer of ownership of future income, on which Chicago intends to rely for that upcoming bond offering, presumably was drafted to avoid the result in the Puerto Rico ruling — that is, to ensure the bondholders win. For those interested in the legal details of the decision, linked here is a piece by Chapman & Cutler about it.
–Mark Glennon is founder of Wirepoints. Opinions expressed are his own.
Ted joined Tom Miller of WJPF to talk about Illinois’ highest-in-the-nation property taxes, why lawmakers don’t want to touch the tax’s cost drivers, just how much Illinoisans’ tax burden has grown over the decades, why Gov. Pritzker failed to meet his promise to reform property taxes, and more.
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Is there any collateral left after the hurricane? Is there any economy to pay anybody? Federal disaster aid priority will likely be for infrastructure, food and housing. I think Puerto Rico will test the issue of what expenses do we pay when there’s not enough money to pay all that’s been promised. The same issue will soon be tested in Illinois based on a scenario that is similar, only lacking a natural disaster to force the issue. My prediction is that in both places there will be allocation of resources based on human needs alone, and bondholders and pension millionaires… Read more »
In the long run, I don’t see how the bondholders win. Yes, their lawyers are creating inventive ways to “lien up” and insulate future revenue flows in a bankruptcy proceeding. but in any kind of insolvency or bankruptcy proceeding with pensions involved the political pressures will be enormous to protect pension beneficiaries (although one would hope that those with the most generous benefits will be made to take a haircut). The threat of having pensioners become wards of the state (meaning some government will pay for it somewhere) will loom significant. In this respect the bondholders are as delusional as… Read more »
I think your instincts are sound but keep in mind that secured debt is really protected in bankruptcy. It has a constitutional underpinning as a property interest. Still, the pressure will be fierce to undo it for the reasons you say.
From the Joe Rogan podcast: Peter Schiff discusses the benefits of living in Puerto Rico
https://m.youtube.com/watch?v=Ss2cQqr5abI
Don’t kid yourself. The physical assets of most municipalities are usually specialized and, although carried on books at historical cost, aren’t worth much on the market. Bondholders best bet is the stream of revenue that an on-going municipality can produce and keeping that stream going is the best way for them to get the debts serviced. Take it into bankruptcy and hope to get the assets is a fool’s errand.
I don’t blame the bond investors as no one lend to Chicago or Illinois without such clauses. The corrupt Democrat Mobster politicians are to blame. The unions don’t want a fresh start, they would rather have a death spiral to try and save their pensions.
Right, bondholders are doing the rational thing you would expect. I formerly did lots of work as a lawyer for lenders facing insolvencies and that’s what you do — you “collaber up” everything you can with liens to secure your loans. The problem is that bondholders are the only ones who understand the game. Nobody is representing the public and taxpayers on the other side.
I warned taxpayers and the legislators. Too many fail to understand.
Yes, you did Rep. Ives. You alone. And that’s because you work incessantly watching what goes through the General Assembly, and are among the very, very few there who understand these things.