The Week in Public Finance: Punishment for Illinois, Budget Battles and New Jersey's Win

A roundup of money (and other) news governments can use.
by | June 10, 2016

For previous editions of "The Week in Public Finance," click here.

A Battle Over Illinois’ Downgrade

Illinois was downgraded this week to two steps above junk status by Moody’s Investors Service. The downgrade is largely due to the state’s inability to pass a budget for the past year and a half. A political stalemate has crippled lawmaking in the state and Illinois -- already the lowest-rated state -- is being docked now with a Baa2 rating. The state’s current budget gap has only worsened over the past year. The structural budget deficit, including what Illinois is supposed be spending on pensions but isn’t, amounts to 15 percent of total general fund expenditures, Moody’s said. A day after the Moody's downgrade, Standard & Poor's also downgraded Illinois.

Apparently unperturbed by the fact that its overwhelming debt is what got it into this pickle, Illinois plans to borrow a half-billion in bonds later this month. The downgrade will likely increase the interest rate Illinois will have to pay on those bonds and impact the state’s outstanding $26 billion in debt.

Not long after the downgrade, the world’s largest money manager said investors should boycott Illinois’ upcoming sale.

“We as municipal market participants should really be penalizing in some way, by almost not giving them any access to the market,” said BlackRock’s Peter Hayes, according to Bloomberg News. “Think about it -- they’re a state without a budget, they refuse to pass a budget, they have the lowest funded ratio on their pension of any state, and yet they’re going to come to market and borrow money.”

The Takeaway: If Hayes’ view catches on, it could mark a new era for the municipal market, or at least for Illinois. To-date, governments with bonds to sell have almost always been able to do so. The most infamous case-in-point was in 2014 when debt-laden Puerto Rico, which has long been rated at junk status, was still able to sell $3.5 billion in bonds to investors. The island paid a steep interest rate, about 8 or 9 percent. Puerto Rico now has about $70 billion in debt it says it cannot pay and Congress is debating a rescue bill this month.

If demand for Illinois bonds goes down later this month, the state’s finance officers could cancel or postpone the sale. It's not unheard of for a state or municipality to do that. When Detroit filed for bankruptcy in July 2013, some governments postponed their planned bond sale because the bankruptcy filing created temporary uncertainty in the municipal market. But investors taking it upon themselves to punish a state for its poor finances is an unusual move.

Dipping Into Savings

Two energy state legislatures this week sent budgets to their governors that dipped into savings to afford the total spending plan. One budget was vetoed outright, the other is still awaiting a signature.

In West Virginia, where natural gas and mining revenues have taken a hit, the legislature passed a spending plan that used about one-third of the state’s reserves to balance the budget. Gov. Earl Ray Tomblin called the plan “irresponsible” and vetoed the budget as promised.

In Alaska, lawmakers in a special session passed a budget that gobbles up half of that state’s current reserve. Alaska, which has been battered by falling oil revenues, has already taken money from its savings in its prior two budgets. Gov. Bill Walker has yet to sign the plan but has criticized lawmakers for once again relying on savings and for not including any of his proposed fiscal reforms.

However, legislators are currently debating implementing those reforms for future years. The state Senate this week passed a key part of Walker’s proposal: an overhaul of Alaska’s Permanent Fund, which pays out dividends -- as much as $2,000 -- annually to each resident. Walker’s proposal limits those payments to $1,000 annually and diverts some of the fund’s investment earnings to the state’s operating budget instead.

The Takeaway: These debates show what can happen when states don’t have specific rules about withdrawing from savings. While many states' statutes say rainy day funds should help stabilize revenue during economic recessions; only a few are more explicit. Virginia’s Constitution, for example, says state leaders can use the fund to cover no more than 50 percent of a shortfall in a fiscal year. Thus, the policy also requires lawmakers to make spending cuts or tax changes to balance the budget during periods of revenue decline.

Alaska and West Virginia have broad definitions for how their rainy day funds should be applied, according to research from the Pew Charitable Trusts. That ambiguity can a leave a lot of room for lawmakers to argue, costing time and taxpayer money.

New Jersey’s Pension System Scores Legal Win

The New Jersey Supreme Court this week lifted a huge burden from the state pension system when it ruled New Jersey could suspend cost-of-living increases (COLAs) to retirees. The $83 billion pension system is one of the lowest-funded state systems in the country with a little less than half the assets it needs to meet all its liabilities. An adverse ruling would have added more than $15 billion in liabilities back to the system’s books.

Moody’s issued a statement Thursday saying the ruling “eliminates a major threat to the state’s fiscal stability, which is already challenged by narrow reserves and large, rapidly growing pension costs.”

The Takeaway: The ruling in New Jersey comes a little more than a year after the Illinois Supreme Court decided the exact opposite on pensions. It said suspending COLAs was against that state’s constitution, a mandate that further limited Illinois’ options in resolving its fiscal crisis. The contrast shows how differently pensions are treated state-by-state and how critical language is in each state’s constitution when it comes to pension protections.