by John Rubino
When an entity needs to borrow ever-greater amounts of money to survive, the markets – that is, the people who are being asked to lend the money – eventually rebel. This rebellion takes the form of rising interest rates as lenders demand a higher return to compensate for the extra risk, and falling credit scores as rating agencies are forced by the markets to face reality.
Then one of two things happens: Either the borrower gets its act together, finds the cash it needs internally and stops borrowing. Or the rising cost of new borrowing sends it into a death spiral that ends with some form of default, restructuring, or dissolution.
Illinois – and its basket case of a city Chicago – are deeply into this process and show no signs of pulling out. Both city and state need ridiculous and growing amounts of money to cover their ballooning pension obligations (which the courts won’t let them cut), and now have to pay rates that make a course correction mathematically impossible. Here’s the latest:
(Reuters) – Moody’s Investors Service on Thursday rated $500 million of bonds Illinois plans to sell this spring one notch above junk, citing the state’s big unfunded pension liability and chronic budget deficits.
The credit rating agency assigned the state’s current Baa3 rating to the general obligation bonds. Illinois’ first bond issue this year will be sold competitively with the proceeds earmarked for capital and information technology projects, according to a state official familiar with the sale. A pricing date was not available.
Moody’s said the rating outlook remains negative, “based on our expectation of continued growth in the state’s unfunded pension liabilities, the state’s difficulties in implementing a balanced budget that will allow further reduction of its bill backlog, and elevated vulnerability to national economic downturns or other external factors.”
It warned the rating could be downgraded to the junk level if Illinois’ unpaid bill backlog increases, pension funding is reduced, or if the state is unable to manage impacts from a future recession, trade war or reductions in federal funding for Medicaid.
Illinois, the lowest-rated U.S. state, sold $6 billion of GO bonds in October to reduce an unpaid bill backlog that ballooned to a record $16.67 billion last year. It also sold $750 million of GO bonds in November to fund capital projects and information technology.
Investors are demanding higher yields for Illinois bonds than for GO bonds issued by other states. Illinois’ so-called credit spread over Municipal Market Data’s benchmark triple-A yield scale has widened from 177 basis points in early January to 208 basis points as of Wednesday.
(Bloomberg) – Illinois’s finances are so troubled that investors can make nearly as much money betting on the worst-rated U.S. state as they can on the American Dream mall project, perhaps the most despised structure in New Jersey.
An unfinished, multicolored hulk in the Meadowlands beside the Turnpike, former Governor Chris Christie called it “the ugliest damn building in New Jersey, and maybe America.” Yet bondholders are asking to get paid nearly as much to own Illinois’s debt as they are demanding in return for holding the long-delayed mall’s unrated revenue bonds — a consequence of the state’s perennial budget distress that’s left it teetering near junk grade.
The yield on Illinois general-obligation bonds that mature in 2028 averaged 4.5 percent in March, compared to an average of 4.99 percent on unrated bonds due in 2050 sold for the American Dream mall project, the shopping and entertainment center that’s years behind schedule, according to data compiled by Bloomberg.
This, remember, is during a long recovery in which most taxing authorities are raking in more than the usual amounts of money. If Illinois is near junk today, what will it be rated in the next recession when its tax take falls and its borrowing expands? Junk, apparently, which is another term for “non-investment-grade.” Buyers at that point will no longer be investing; they’ll be speculating.
For an idea of what this means, consider a pension fund, let’s call it the Public School Teachers’ Pension and Retirement Fund of Chicago, that invests in stocks (which fall during recessions) and high-grade bonds (which pay miniscule interest). Because currently employed teachers aren’t paying in enough to fully fund each year’s required increase in plan assets, the plan has to borrow to cover the difference. But because it’s a junk borrower, the interest it has to pay is higher than what it earns on its investment-grade bonds. So it generates a negative spread, increasing its underfunding from already-catastrophic levels.
With baby boomer teachers retiring en masse and demanding what they’ve been promised, what was once an accounting issue becomes a cash flow issue, in the sense that there is literally not enough cash to pay current bills. And that’s the end.
It’s not clear what happens next because states technically can’t go bankrupt. But whatever it’s called, the result will be some sort of default. And the market’s reaction will, as with all big failures, be a sudden burning interest in who’s next. That search will turn up plenty of cities and a few states, and we’ll have the catalyst for the next crisis.