Illinois Awaits Further Credit Cut After Latest Pension Flop
With handshakes, hugs and a few kisses, Illinois lawmakers left the capitol May 31 without repairing a leaking pension system that they have been saying for years must be fixed.
Now they wait to discover the consequences of inaction; Illinois, already the lowest-graded state in the nation, faces yet another credit-rating cut.
“They’ve moved another notch in the wrong direction, which justifies a bond downgrade and a slippage in bond prices,” said Richard Ciccarone, managing director at Oak Brook, Illinois-based McDonnell Investment Management LLC, which oversees $8 billion in municipal debt. “Credit erosion will continue until they show a willingness to address this problem.”
When lawmakers ended their 2012 session in January without a pension overhaul, Standard & Poor’s reduced the state to A-, four steps above junk, and said more cuts would follow if the systems weren’t improved. Another downgrade from the New York-based company would give Illinois the lowest credit rating for a state since California in 2004, and further penalize its cities, counties and school districts, which already face the highest borrowing costs among 19 states tracked by Bloomberg.
The five Illinois pension systems -- the worst-funded among U.S. states at about 43 percent -- are saddled with liabilities of almost $100 billion. Legislative attempts to fix them have come to nought. Labor and business interests have clashed while lawmakers seek solutions designed to cause the least discomfort for one constituency or another. In the meantime, the pension shortfall grows about $17 million a day.
The most recent collapse of pension-rescue efforts was the result of a standoff between the legislature’s two most powerful Democrats -- House Speaker Michael Madigan and Senate President John Cullerton, who backed competing measures.
Madigan’s bill would have required retirees to accept cuts in pension benefits, saving $187 billion over 30 years, he said. Cullerton said that approach was unconstitutional and instead proposed giving employees a choice of pension or health-care reductions that would save an estimated $50 billion.
Both houses adjourned until late October, though Democratic Governor Pat Quinn said May 31 he would call legislative leaders ``together in the coming week to forge a comprehensive pension-reform agreement.”
It’s the third time in the past year that gridlock prevented a pension resolution. The previous two failures -- in January and August -- led to S&P downgrades. S&P, Moody’s Investors Service and Fitch Ratings all have negative outlooks on the state.
Olayinka Fadahunsi, an S&P spokesman, declined to comment beyond the company’s recent reports on the state.
“I don’t think the politicians feel any pain from that,” said David Yepsen, director of the Paul Simon Public Policy Institute at Southern Illinois University Carbondale. “They know the state of Illinois will not go away, unlike a business with a low credit rating that might go out of business.”
Laurence Msall, president of the Civic Federation, a Chicago-based nonprofit that specializes in government finance, said he fears it will take “the actual collapse of one of our governments or a pension fund” to prompt lawmakers to act.
“These continued short-sighted actions end up having enormous long-term consequences,” Msall said.
Those costs may come from the higher interest rates the state and its localities pay in the $3.7 trillion municipal market. Investors demand an extra 1.4 percentage points of yield over AAAs to own 10-year bonds from Illinois issuers, data compiled by Bloomberg show. By comparison, buyers require only 1.06 percentage points more for securities in the lowest investment-grade tier.
People who intend to hold bonds to maturity should buy Illinois debt if the state’s yield penalty increases in the event of a downgrade or investor frustration, according to Matt Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors. The state still will face “above average volatility” amid questions about the pensions, he said today in a report.
S&P has said that even though it’s unusual for states to fall below the single-A tier, “lack of action on pension reform” could prompt another cut. California was rated BBB in 2004, two steps above junk.
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