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Investors yawn at Illinois’ failure

Thursday, Jan 10, 2013

* The failed lame duck session has so far been greeted with a yawn by investors. From Bloomberg

Illinois debt is close to the strongest in two years even after state lawmakers failed for the second time since August to fix the nation’s worst-funded pension system.

The $97 billion of unfunded retirement obligations that Democratic Governor Pat Quinn has likened to a python strangling Illinois are rising by $17 million a day. Moody’s Investors Service rates Illinois A2, five steps below the top rank and the lowest among U.S. states. Last month, it threatened another downgrade without pension changes.

Yet investors such as Eric Friedland at Schroder Investment Management North America said they expect the state will repay its general-obligation securities even though it faces a backlog of $8 billion in bills from vendors. The extra yield buyers demand on debt from Illinois and its localities shrank to as little as 1.32 percentage points over AAA munis last month, the least since February 2011.

“I anticipate credit quality will diminish, but at the end of the day, Illinois G.O. bonds aren’t going to ever default,” said Friedland, head of muni-credit research in New York at Schroder, which oversees about $2 billion of the bonds. Rating companies will probably cut the state’s credit another level, he said.

* This is why there has been no run-up in Illinois interest rates as of yet

Illinois by law must appropriate funds for debt service, according to a 2011 Fidelity Investments report that ranked it among the seven states with the strongest legal provisions.

- Posted by Rich Miller        


22 Comments
  1. - Small Town Liberal - Thursday, Jan 10, 13 @ 11:53 am:

    Does this mean the ratings agencies might not keep demanding 100% pension funding?

    Could go a long way in easing the pain of pension reform.


  2. - RNUG - Thursday, Jan 10, 13 @ 12:08 pm:

    And yet the bond people are trying to make sure their payments are ahead of pension “reform” payments like the language in failed amendment 11 from a couple of days ago.


  3. - wordslinger - Thursday, Jan 10, 13 @ 12:14 pm:

    –“I anticipate credit quality will diminish, but at the end of the day, Illinois G.O. bonds aren’t going to ever default,” said Friedland, head of muni-credit research in New York at Schroder, which oversees about $2 billion of the bonds. Rating companies will probably cut the state’s credit another level, he said. –

    LOL, except for the “credit quality” part, I agree with all of that. But does any of it make sense?

    A borrower has never defaulted, and will never default, — seems like good credit quality to me — but their credit rating will be lowered anyway.

    Meanwhile, the same crowd was rating Enron AAA four months before it disappeared from the face of the Earth.


  4. - Liberty_First - Thursday, Jan 10, 13 @ 12:16 pm:

    And Illinois’ pension protection laws are even stronger. It would seem the market competition for Illinois’ borrowing is still high.


  5. - Madame Defarge - Thursday, Jan 10, 13 @ 12:41 pm:

    Could it also be that Failure is the new Normal in Illinois?


  6. - Norseman - Thursday, Jan 10, 13 @ 1:59 pm:

    Word, you’ve been on target regarding the rating agencies. You da bond man in my book!


  7. - Norseman - Thursday, Jan 10, 13 @ 2:04 pm:

    === Could it also be that Failure is the new Normal in Illinois? ===

    Madame there is nothing new to state government failures. See today’s post - #IllinoisFail: 12-18 month delay to process medical licenses.


  8. - dupage dan - Thursday, Jan 10, 13 @ 2:14 pm:

    I remember reading here that pension funding has been lower than it is today, Someone mentioned yesterday that in 1942 it was at 28%. Could someone provide an overview (if it has been posted before I apologize for not catching it) regarding this? The level of funding could have been lower in previous years but the liability could also have been lower. Retirement ages could have been higher or life spans lower, that kind of thing. Pushing for a 95% funding level may be unnecessarily high creating a crisis where there should only be concern. Some clarity would be useful.


  9. - OneMan - Thursday, Jan 10, 13 @ 2:18 pm:

    You are going to be able to borrow, it is just going to cost more and more over time to do it most likely.


  10. - Small Town Liberal - Thursday, Jan 10, 13 @ 2:31 pm:

    - Pushing for a 95% funding level may be unnecessarily high creating a crisis where there should only be concern. -

    dan, you’re exactly right, but apparently the bond ratings agencies are demanding 100% or they’ll downgrade us further.

    It’s very silly, but since a lot of organizations can’t invest in debt rated below investment grade, it could potentially cause major problems if we drop further.

    Personally I wish these organizations would stop listening to the geniuses that rated subprime mortgages and Enron (thanks word) AAA just before their respective crashes, but sadly I don’t make the rules.


  11. - dupage dan - Thursday, Jan 10, 13 @ 2:41 pm:

    wordslinger, help us out here (NO snark intended). With the GA having a super majority, could limited borrowing help alleviate the short term crisis (real or trumped up) so as to prop up the pension funds and give Illinois some breathing room? Then with a program that involves the pain being spread out (47th Ward made that suggestion in another stream) this issue could be more manageable than the doomsday screamers would have us believe. A little effort to make sure this passes constituional scrutiny and some hand holding of the slippery governor and it could happen.

    Having just read what I wrote I can’t believe I could be optimistic. C’mon, MJM - super-majority headaches be dammed - get a move on!


  12. - wordslinger - Thursday, Jan 10, 13 @ 3:00 pm:

    –wordslinger, help us out here (NO snark intended). With the GA having a super majority, could limited borrowing help alleviate the short term crisis (real or trumped up) so as to prop up the pension funds and give Illinois some breathing room?–

    You’d be borrowing and investing money now to cover payments 20 years from now. Blago did it with a big POB to try and catch up, but I don’t think it’s a good idea.

    Maybe if there was a new dedicated revenue source it could make sense in a low-rate market, but the whiz kids who can really crunch could tell you better than I.

    Annual contributions and historic investment returns would be best. No magic beans.


  13. - dupage dan - Thursday, Jan 10, 13 @ 3:07 pm:

    I would assume that you can’t just borrow the cash without having some way to pay it back. Not looking for magic beans - just a good way to manage immediate crisis while addressing long term liabilities without resorting to costly gimmicks. Thanks.


  14. - wordslinger - Thursday, Jan 10, 13 @ 3:18 pm:

    –It’s very silly, but since a lot of organizations can’t invest in debt rated below investment grade, it could potentially cause major problems if we drop further.–

    I’d be shocked if any state was ever lowered to junk status, but then I didn’t expect S&P would ever downgrade the United States.

    Still, given the high demand for state debt, I imagine a lot of institutional investors could chance their criteria in a hurry. Everyone is chasing returns.

    Put it this way: there’s about $350 trillion invested worldwide in virtually unregulated, non-transparent Swaps.

    If you can find 10 people who can offer a clear explanation of what a Swap is, I’ll buy you a cigar.


  15. - wordslinger - Thursday, Jan 10, 13 @ 3:20 pm:

    –I would assume that you can’t just borrow the cash without having some way to pay it back–

    I was referring to bonds with dedicated revenue but also carrying the state GO.


  16. - Small Town Liberal - Thursday, Jan 10, 13 @ 3:40 pm:

    - I imagine a lot of institutional investors could chance their criteria in a hurry. -

    I would hope you are right, but I’m not sure it’s a worthwhile gamble for the state.

    Then again, I think I’d be comfortable daring them to downgrade us with a plan to get the pensions funded to 80%-90%.


  17. - soccermom - Thursday, Jan 10, 13 @ 3:46 pm:

    Preach, Word. And STL — I would be willing to call the rating agencies’ bluff at that 100 percent level. They have been plenty willing to lend at current levels. Are they downgrading other states that are at the 80-85% level?


  18. - dupage dan - Thursday, Jan 10, 13 @ 3:50 pm:

    My earlier question remains unanswered. Perhaps there is no empirical answer but I still hope. Is the pension crisis really as bad as we are being told? In the past, funding levels have been much lower but there was no hue and cry. Can we compare to the past and ease our minds?

    Anybody?


  19. - walkinfool - Thursday, Jan 10, 13 @ 4:32 pm:

    DD: Yes the pension situation is bad — but not as much because of the significant accumulated underfunding of the pensions themselves, but because keeping up with funding at any reasonable level takes a greater and greater percentage of our state budget and revenues. It is strangling our ability to pay for other needs.

    IMHO The pension funding shortfall standing alone, has been overblown. In its full context, it is becoming very serious.


  20. - Shemp - Thursday, Jan 10, 13 @ 5:24 pm:

    It’s never a big deal until it’s a big deal. Repayments are never late until they are for the first time. Is the likelihood of an all-out default high? Obviously not. However, one must ask if there is a better chance payments start getting made later and later.

    Like everything, fixing this stuff now, (let alone 5, 10 or 15 years ago) makes the forthcoming pain easier. Some day the outflow of pension payments vs the contributions and the problem of the State will be exacerbated by inflation and we’ll all be wondering why we didn’t act and the blame game will continue. As far as I am concerned, dismissing the warnings as inflated is just enabling more ineptitude in the General Assembly.


  21. - jerry 101 - Thursday, Jan 10, 13 @ 5:50 pm:

    we can’t give the bondholders a haircut, but we have to give the pensioners a haircut, eh?

    Seems like the actual bondholders aren’t too worried. It would be great to have a better funded pension system, and we should move toward that, but the whole “crisis” is bull. There is no crisis. There is a possibility that, at some future point in time, if benefits aren’t cut, or taxes aren’t raised, that the Pension plans would have to cut benefits because they don’t have enough money.

    But, in the end, it’s all an estimate. Actuaries aren’t gods. We’ve had a pension funding “crisis” for 50+ years now, in terms of being “severely underfunded,” yet pensioners are still getting their checks.

    The best result is for the state legislature to keep dithering until the crisis passes on its own. Once the economic climate in the state is stronger, then we should consider boosting the funding level in the pensions. To cut benefits or raise taxes to improve funding levels now will just hurt in the long run.


  22. - RNUG - Friday, Jan 11, 13 @ 1:31 am:

    DD,

    I didn’t want to answer until after Word weighed in since he’s probably much better at the financial / bond stuff than I am (and there are probably other people here also). But I wondered the same thing about taking a long term low interest loan, so I took a cursory look using a mortgage calculator since I was just looking for a “feel”.

    Conclusion I came to (as a non-financial person) was it might keep things from getting worse (in terms of catch-up payment levels versus the scheduled ramp increases) if you could borrow for 40 years at 3% and repaid it monthly. Shorter term or higher interest would require payments higher than the current “catch-up” amount. And given where we are at in this mess, just stopping the ramp from getting steeper would be a good thing.

    Or I could be way off base …


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