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Quinn’s Illinois Budget Greeted With Sound of No Clapping

Feb. 23 (Bloomberg) -- No one interrupted Illinois Governor Pat Quinn’s budget presentation with applause yesterday. There’s nothing to cheer about in the financial condition of the fifth-largest U.S. state.

Its pension and Medicaid liabilities plus $9 billion in unpaid bills have a ravenous quality. They represent roughly half the state’s proposed $33.8 billion general fund budget, and are gobbling dollars that might otherwise pay for education and hospitals.

“Illinois is a classic case of immediate gratification, of deferring hard decisions for a later day,” said Richard Ciccarone, managing director at McDonnell Investment Management LLC in Oak Brook. “It wanted the good life now, with lower taxes and good pensions and didn’t want to pay for it now.”

U.S. state and local-government tax revenue rose 4.1 percent in the third quarter, and while states such as New Jersey, Florida and Kansas are considering tax cuts, Illinois is paying for its financial negligence. Despite raising income and corporate taxes last year, the state has the nation’s lowest general-obligation bond rating, according to Moody’s Investors Service. The Chicago-based Civic Federation warns that if nothing is done, the unpaid bills will almost match the size of the 2017 budget.

“Too many governors and members of the General Assembly have clung to budget fantasies rather than confronting hard realities,” Quinn said in his budget address yesterday. “Today, our rendezvous with reality has arrived.”

‘Hodgepodge of Ideas’

Republicans said Quinn himself hasn’t embraced reality.

The budget is “a hodgepodge of ideas that are not thought through, and that will do little to address the state’s mountain of unpaid bills,” Comptroller Judy Baar Topinka said in a statement yesterday.

Quinn, a Democrat, didn’t detail his proposal for cutting $2.7 billion from next year’s Medicaid budget -- a shortfall created partly by the Legislature’s deciding not to pay a $1.9 billion obligation from last year -- nor did he detail how to ease pension costs including a $85 billion unfunded liability.

Although Moody’s lowered Illinois’s rating to A2 from A1 on Jan. 6, the state was able to sell $800 million of general-obligation bonds just five days later, including $525 million of tax-exempt debt.

They’ll Pay Up

Granted, the state’s borrowing costs tripled from three years before. Debt maturing in 10 years was priced to yield 3.1 percent, 110 basis points more than the 2 percent of benchmark 10-year debt. That compares with a spread of 37 basis points when the state sold a 10-year bond on Sept. 16, 2009.

“It’s amazing how the market has been relatively benign in responding” to the state’s financial problems, said Ciccarone, whose firm manages about $8 billion in municipal bonds. “Many investors in the marketplace feel that they’ll come up with the money, sooner or later.”

That confidence may change, said Chris Mier, managing director of the analytical services group at Loop Capital Markets in Chicago. Last year’s tax increases encouraged investors because they suggested the state was serious about resolving its debt issues. Yet they weren’t coupled with large spending cuts, Mier said.

“People are going to take a good, hard look at Illinois issues from now on,” Mier said. “This situation is going to require diligence from them over a long period of time.”

At The Crossroads

The Federal Reserve policy of maintaining low interest rates reduce borrowing costs, Ciccarone said.

“When interest rates go back up, the state’s going to suffer,” he said.

The biggest financial threat to Illinois is pension obligations. Payments in next year’s budget amount to $5.2 billion, or 15 percent of appropriations, compared with 6 percent in the 2008 fiscal year, according to the governor’s Office of Management and Budget.

Although lawmakers have debated cutting pensions, critics have argued that the Illinois Constitution protects benefits from being reduced.

Battling the issue out in court will cost time and increase liabilities, said James Spiotto, a municipal bankruptcy lawyer at Chapman and Cutler LLP in Chicago.

“I look at this as a real crossroads,” Spiotto said. “They have to find something that is affordable and sustainable, because if you can’t pay it, you can’t pay it.”

The key, Ciccarone said, isn’t simply the coming fiscal year’s budget. “If they make the cuts, it’s a step in the right direction. But to really believe in the credit, they’ve got to maintain this diet for a long period of time,” he said.

“They’ve got to mean it.”

To contact the reporter on this story: Timothy Jones in Springfield at tjones58@bloomberg.net

To contact the editor responsible for this story: William Glasgall at wglasgall@bloomberg.net

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