Ted Dabrowski
Vice President of Policy

This morning Illinois was forced to delay a $500 million bond sale – essentially, borrowing $500 million to finance state government operations. The delay was due to a drop in lender confidence in Illinois’ credit worthiness.

This setback comes on the heels of Illinois’ latest downgrade by Standard & Poor’s rating service to a level of A-minus. S&P now rates Illinois’ ability to repay its debt as the lowest in the nation. The firm also assigned Illinois a negative outlook, meaning another credit downgrade may be on the horizon.

This is Illinois’ 11th credit downgrade by the three major credit rating agencies since Gov. Pat Quinn took office in 2009. The downgrade reflects the downward spiral of the state’s finances and the failures of its governance.

The governor’s office tried to sugar coat the delay as necessary in order to let lenders process the negative implications of the downgrade. Here is how Illinois’ Director of Capital Markets John Sinsheimer pitched the borrowing delay:

“We were hearing that investors were still reacting to the rating agency actions and wanted to give the market more time to digest the news and settle down a bit.”
 
Here’s the real reason why the bond sale was delayed: The markets facing the reality of a fiscal collapse in Illinois.

Lenders are realizing just how dangerous it is to invest in a state with the lethal combination of runaway debt, unpaid bills and politicians beholden to government employee unions. Those politicians refuse to take on government unions in order to restore Illinois’ fiscal order. Illinois’ out-of-control spending may very well cause larger institutions – insurance companies and the big retirement funds – to shy away from investing more money in Illinois.

This fiscal mismanagement comes with a hefty price tag, too. Without those big institutional investors, the interest rates that Illinois will have to pay to borrow will jump significantly. Why? because without big, institutional investors, Illinois will have to reach out to smaller investors or those who make riskier bets. That, of course, means that it will cost Illinois even more money to borrow because the state will be paying higher interest rates.

It’s like people with bad credit who try to buy a car; they’ll pay a higher interest rates because their finances are in such bad shape.

Even before the S&P downgrade, Illinois already paid the highest interest rates in the nation.

The fact is, nobody wants to lend money to a state that is likely to be hit with even more downgrades – something that S&P, Moody’s and Fitch have all threatened with their negative credit outlooks.

The rating agencies are uniformly worried about the Illinois’ uncontrollable pension debt for government employees. In Illinois, the official pension shortfall is $95 billion, but everyone knows that the number is much higher when more realistic investment returns are used.

That’s why Moody’s is proposing a new methodology to better measure the size of the pension-funding shortfall. The shortfall doubles to more than $200 billion using the new methodology.

And that’s what has investors scared.

Illinois’ massive debt and politicians’ unwillingness to enact real reforms may very well result in a financial squeeze that hasn’t been seen since the New York City crisis of the 1970s.

image credit: Chicago Tribune