Illinois lawmakers may satisfy nobody as they gauge bond sale
Illinois lawmakers face the prospect of pleasing no one as they try to pay off $8 billion in overdue bills in the closing days of their budget session scheduled to end May 31.
Months of negotiations over Democratic Governor Pat Quinn's proposal to borrow $8.75 billion have produced neither votes to approve a bond sale nor consensus on how to pay the back debt and balance the proposed $52.7 billion 2012 budget.
At the same time, there is growing demand for debt, according to money managers, creating favorable conditions for Illinois to balance its books by doing what has gotten it into trouble for years: borrowing.
“What makes the solution very complex is that you have very vocal and powerful constituents that you can't satisfy,” said Christopher Mier, managing director and chief strategist at Loop Capital Markets in Chicago, who says the state should sell bonds. Borrowing, Mier said, may just be “a political reality.”
Republicans, led by Treasurer Dan Rutherford, oppose debt and argue the state must cut the budget and control spending, particularly for unfunded pension and health-care liabilities.
Illinois, which has borrowed to make its two most recent annual pension payments, is tied with California as the lowest- rated in the estimation of Moody's Investors Service at A1. Standard & Poor's has it at A+, one level above California.
After raising the personal and corporate income taxes in January and wiping out half of a current-year deficit of at least $13 billion, about $8 billion in unpaid bills remained. Quinn proposed borrowing the money to pay off the vendors.
“That's not a balanced budget,” said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, where he helps oversee $7 billion. “It's deficit financing. We're not at a point where we want to manage government with debt issuance.”
“They probably argue that this is a one-time-only event, but how do we know that?” Ciccarone said in a telephone interview from his office in Oak Brook, Illinois. “They have to show a track record that shows that.”
In the absence of agreement on cuts, the temptation to borrow is enhanced by the appreciating value of debt.
Interest rates on tax-exempt debt issued by states and cities are down about 59 basis points since April 7, according to a Bloomberg Valuation index. Yields on top-rated bonds maturing in 15 years touched 3.33 percent on May 17, the lowest since Nov. 12. A basis point is 0.01 percentage point.
The movement has helped cut the extra yield investors demand to hold Illinois debt by about 27 percent in the past four months, Bloomberg data show. A state general obligation bond maturing in March 2018 was yielding 3.63 percent on May 20, or 177 basis points above top-rated debt, according to Bloomberg Valuation pricing. That compares with a so-called spread of 243 basis points Feb. 4.
Still, opposition to borrowing is vocal. The Chicago-based Civic Federation, a nonpartisan group that advocates efficient government, said in a May 9 report that borrowing would make the state's fiscal condition “worse over time.”
Rutherford said in a May 22 news release that state debt is $42,000 per household and that Illinois needs to “cut our spending and break our unsustainable borrowing cycle before we realize a further financial disaster.”
In the final days of the budget session, Democrats and Republicans are negotiating changes in retirement systems that would cut short- and long-term costs. Illinois's unfunded pension liability is at least $80 billion and it has amassed a $40 billion long-term obligation for retired public employees' health care, according to a 2010 report from the Pew Center on the States.
Ciccarone said continued borrowing puts the state at increased risk in the event of another recession.
“You may be forced to make a choice between debt service or workers or retirees, and you don't want that,” he said. “It's a dangerous road to go down.”
Mier of Loop, whose firm is the 16th biggest muni underwriter, said he expects lawmakers will approve a smaller amount of borrowing, along with budget cuts.
“We need to figure out the total amount of the budget before we go out and borrow, so that we only borrow what we need,” said Tom Johnson, president of the Taxpayers' Federation of Illinois, which argues for containing the size of government until the budget balances.
Johnson said the unpaid bills need to be included in negotiations aimed at reducing pension costs and establishing a plan to reduce overall spending.
“If you borrow an amount that does not require expenditure cuts, then it is not a long-term fiscal plan,” Johnson said.