Could Illinois be first state to file for bankruptcy?

Illinois residents may feel some solidarity with the likes of Puerto Rico and Detroit.

A financial crunch is spiraling into a serious problem for Illinois lawmakers, prompting some observers to wonder if the state might make history by becoming the first to go bankrupt. At the moment, it’s impossible for a state to file for bankruptcy protection, which is only afforded to counties and municipalities like Detroit. 

Chapter 9 bankruptcy protection could be extended to states if Congress took up the issue, although Stanford Law School professor Michael McConnell noted in an article last year that he believed the precedents are iffy for extending the option to states. Nevertheless, Illinois is in a serious financial pickle, which is why radical options such as bankruptcy are being floated as potential solutions. 

Ratings agency Moody’s Investor Service earlier this month downgraded Illinois’ general obligation bonds to its lowest investment grade rating, citing the state’s growing pile of unpaid bills and its mounting pension deficit. Illinois, by the way, has the lowest credit rating of any state. Lower ratings mean higher borrowing costs, since lenders view such borrowers as riskier bets.

“Legislative gridlock has sidetracked efforts not only to address pension needs but also to achieve fiscal balance, allowing a backlog of bills to approach $15 billion, or about 40 percent of the state’s operating budget,” the agency noted. 

As noted by the Fiscal Times, Illinois is the only state that’s been operating without a balanced and complete budget for almost two years. 

“We’re like a banana republic. We can’t manage our money,” Gov. Bruce Rauner said after the Illinois Legislature failed to produce a full 2017 budget earlier this month.

The situation has prompted comparisons with Puerto Rico, which earlier this year announced a historic restructuring of some of its $70 billion in debt through courts after negotiations with bondholders failed.

Like Puerto Rico, Illinois has a massive pension crisis. Its unfunded pension liability for the state’s five major plans grew 25 percent alone in one year, reaching $251 billion, according to Moody’s. On a per-household basis, the state’s pension debt burden stands at $27,000, according to the conservative-leaning Illinois Policy Institute. 

So how did the state’s pensions balloon into such a crisis? First, the pension problem has been a long time in the making. The state has more than 660 government pension funds, which are sometimes called defined benefit plans because they promise workers will receive a specific pension when they retire. 

But critics say some of those pensions carried overly optimistic assumptions, especially given periods of market turmoil like the global financial crisis, which ate into investment returns. The state’s general assembly wasn’t required to fully fund pensions, which meant tax money was spent on other priorities such as schools or infrastructure. 

The result? Growing unfunded liabilities, or money promised to workers in their pensions when they retire that the state doesn’t have. Other contributing factors include inadequate employer contributions and benefit increases, according to the Civic Federation. 

Adding to the state’s financial pain is a shrinking tax base. For the last three consecutive years, Illinois has lost residents. Its population is now at its lowest in a decade. Tepid wage growth on top of fewer residents puts a strain on the state’s ability to grow its tax revenue. 

It’s not unprecedented for a state to default on its debt. Arkansas defaulted in 1933 as it struggled to repay debt during the the Great Depression. Spending on an ambitious road-building project and a series of natural disasters heightened the Southern state’s problems. 

Bankruptcy is often seen as a last-ditch effort, but it also can help struggling cities or companies reinvent themselves on a stronger financial footing. Detroit serves an example of how a reorganization can help, at least in the near-term. The city is now paying its bills and is keeping up with maintenance, although it still has a looming pension payment that could spell trouble in just a few years, according to the Detroit Free-Press. 

As Michigan Treasurer Nick Khouri told the publication, “We certainly know many people were hurt during the bankruptcy, but what would have been the alternative and how would they have been hurt under the alternative?” 

As for Illinois, Rauner on Thursday called state legislators to a 10-day special session starting next week to hammer out a budget deal and end an unprecedented impasse that could soon enter a third year.

The Republican announced the news in a Facebook video and statement, accusing majority Democrats of “ignoring” his recommendations.

“We have tough, urgent choices to make, and the Legislature must be present to make them,” he said.

Lawmakers adjourned last month without a deal before a critical May 31 deadline, triggering the need for a three-fifths majority vote instead of a majority on a budget agreement. The new fiscal year begins July 1. Rauner has called for a special session running from June 21 to July 30.

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