Sunday, February 20, 2011

Are Illinois Bonds Worth the Price?

In January of this year, the SEC announced it had started an investigation in September 2010 of claims made by the State of Illinois relative to the accounting of actuarial future savings from last year's two tier pension reform creating different retirement ages and new contribution rates and pensions for employee's hired after January 1, 2011.  We have previously commented on this accounting grey area in which all current employees, not just new hires, appear to be used to estimate future savings which are then considered a current contribution by the State reducing its actual monetary legally required annual contribution to the pension systems.

During the week of 2/21/2011, Illinois intends to sell $3.7 billion in general obligation bonds to fund the State of Illinois' annual contribution to the Illinois pension funds.  The official statement (prospectus) of the bond issuance clearly refers to the SEC investigation and the actuarial and accounting issues involved (page 53 of the document or Adobe page 84), including the divergence of what is allowed under Illinois law and what is prescribed in GASB 25 as amended.  The actuarial method used and the possible inclusion of all current employees in the calculation are not considered appropriate or proper by most actuaries, as detailed in a New York Times article, "The Illusion of Pension Savings"..  This Asset Smoothing Method, as used by Illinois, also does not keep the ending period open but closes it at 2045, which Illinois admits will fail if any legislatively mandated annual ramped (increasing yearly to 2045) pension system payments are not made.

This $3.7 billion general obligation bond issuance is to make this fiscal years annual payment, because the State of Illinois does not have the money to make its annual contributions.  Although the State has just passed a tax increase, there was no provision for restricted pension funding and it has not been in effect long enough to bring in new revenue.  Pension contributions by the State must be made from general revenue.  Credit default swaps for Illinois are still higher than California, but have been falling since the tax increase.  However, the market (New York Times: "Illinois Pension Bonds to Test Investors' Faith") appears prepared to require a higher yield than expected.

This $3.7 billion is part of a fiscal deficit of at least $15 billion for FY 2011.  Another part of the deficit is $8.75 billion owed Illinois vendors in unpaid bills for goods and services.  A bill presently before the Illinois Senate would authorize a bond issuance for $8.75 billion to pay vendors and is being pushed heavily by Governor Quinn.  The administration calls it debt restructuring, which is technically correct, but the opposition party calls it paying bill with a credit card.  Given that the tax increase has not had time to provide revenue to address the deficit, the choice is either let Illinois vendors/businesses go out of business and/or layoff employees or pay the vendors and Illinois businesses alive and healthier.  While Governor Quinn's administration has been exceedingly slow, for whatever reasons, to make transparent, documentable spending cuts to create efficiencies, it is well known that spending cuts cannot solve the deficit, because the people are unwilling to accept the loss of services or tax breaks they personally enjoy and expect.  To turn different groups of people against each other to deprive the other group of their services or tax breaks and paint groups of people as undesirable is divisive political manipulation which is inconsistent with a republican democracy and cannot be tolerated in a free society.

The $3.7 billion pension bonds will be snapped up, primarily by foreign investors seeking high yields and diversification from the high yields of European countries.  However, the State of Illinois cannot continue to fund pension annual contributions with debt.  There needs to be a restricted revenue source which cannot be diverted.  This needs to be the last time bonds are used to make annual pension contributions.

The $8.75 billion bond authorization to pay vendor bills is necessary to keep Illinois business and employees at work.  This should be a one time debt restructuring, but Illinois has a horrible record for not taking action on a bipartisan basis to fund the services and necessary economic safety nets the people demand and expect.

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