The State Of Illinois Is "Past The Point Of No Return"

Everyone knows Illinois’ financial condition is poor. Conventional thinking seems to be that a bond default, should that happen, would be many years in the future. Pardon me, but wasn’t that the thinking right up to Puerto Rico’s, “We can’t pay” announcement?

To answer the question of just how badly off is Illinois, I assembled a list of key creditworthiness indicators and applied them to New York, a highly rated state, and Illinois.

Commentary and Benchmark Private Bond Ratings

The State of New York is managing its financial resources and obligations in a better-than-average manner. Particularly, the State’s employee pensions are reported to be 90% funded, but the general fund deficit must be contained and then eliminated. Unfunded OPEB costs are too high and can be renegotiated. Funded and pro forma unfunded long-term contractual obligations equaled 23% of general fund revenue in FY ended June 30, 2017, and exceeds the 15% threshold for a Benchmark AA or AA+ credit rating.

*Both NYS income tax and sales tax bonds are payable from annual general fund appropriation. For additional information, click here.

Commentary and Benchmark Private Bond Ratings

The State of Illinois, in my opinion, is past the point of no return. It does not have the ability to raise taxes or cut spending to the degree necessary to reduce the annual cost of bond and retiree benefits from 33% to a sustainable level. The amount of debt issued by Illinois requires a moderate 8% of general fund revenues to pay P&I.

The insolvency is not the result of too much bonded debt, but rather the government promising retirement and other post-employment benefits that aren’t affordable.

Bear in mind that direct debt of the State is exempt from any form of bankruptcy. Most believe that the State’s pension benefit obligations are on parity with states’ general obligation bonds and bankruptcy-exempt as well.

Let’s assume the State did find itself in a “no money to pay everyone” position and chose bond default as the relief value over failing to appropriate sufficient funds for pension funding and OEB costs.

Since neither GO bond holders nor pension fund creditors are subject to any bankruptcy court, who would win? Together they would be by far the State’s largest long-term contractual obligors. I think the State’s GOB investors would come out ahead because the State would not be able to borrow in its own name until it makes good on past due GO P&I.

Retired public employees might understand that it is better to negotiate a fair agreement than to demand one the employer can’t afford. This is the only scenario, however unlikely, where Illinois stands a change of pulling itself out of its deep financial hole.

Benchmark and rating agency ratings

Puerto Rico Could Be Forced Under SEC Jurisdiction

Submitted by Simon Black of Sovereign Man

What happened:

Puerto Rico has long been a safe haven for businesses and investors weary of the Securities and Exchange Commission. Despite the fact that Puerto Rico’s public sector is going through bankruptcy, the private sector has enjoyed relative freedom from the intrusive hands of the U.S. government.

That will change if a bill making its way through Congress becomes law.

Companies formed in Puerto Rico (and other U.S. territories) have always been exempted from the Investment Company Act of 1940 if they only offer investments inside the territory. This means the SEC doesn’t have a say in how investment funds are structured and managed.

But the U.S. Territories Investor Protection Act of 2017 will end the exemption. The act has passed the house and is now being debated in the Senate.

The bill will give the SEC jurisdiction over Puerto Rico and other U.S. territories. The supposed purpose is to prevent companies from making risky investments, or defrauding their investors.

What this means:

Initially that might sound like a good thing, to extend protection to investors in Puerto Rico.  But the issue is that the SEC doesn’t have the best track record, and investors may be specifically looking for markets not under their jurisdiction.

For example, the SEC gave Enron a clean bill of health, failing to discover their cooked books before it was too late to save investors. That type of regulation is worse than none at all, because it gives people a false sense of security. If investors know there is no organization watching out for them, they will do it themselves.

In the end it was James Chanos, a short seller, who did the digging into Enron and found out about the fraud. So an entire government agency missed what a single investor discovered. And we trust the SEC to protect investors?

If this bill passes, it means more companies brought under the umbrella of the SEC, limiting choice, and taking power away from the individuals involved. Many of those investors are perfectly capable of doing their own research--and may see a benefit in going with riskier or unique investments.

Alternatively, it also means that various hedge funds who have focused on Puerto Rico as an SEC-exempt territory, and opened domestic offices, will no longer find special exclusion rights and could depart, taking away significant sources of capital away with them.