The ongoing soap opera over Illinois’s budget hasn’t ended with the governor’s veto or the legislature’s likely override of his veto today. CNNMoney reports that the credit agencies may, as I warned, reduce Illinois’s credit rating to junk anyway:
Bruce Rauner, governor of Illinois, left, delivers a budget address in the House Chamber of the State Capitol building in Springfield, Illinois, U.S., on Wednesday, Feb. 18, 2015.
Even if Illinois’ House of Representatives takes action to enact a new budget on Thursday, the state still risks a downgrade in its credit rating to junk, Moody’s Investors Service warned on Wednesday.
The Democratic-controlled House on Thursday will attempt to overturn Republican Governor Bruce Rauner’s vetoes of spending and tax increase measures aimed at ending the state’s unprecedented two-year budget impasse.
Moody’s said it placed Illinois’ Baa3 rating, which is one step above the junk level, on review for a possible downgrade.
The $36 billion fiscal 2018 budget and $5 billion income tax increase passed by lawmakers over the extended Fourth of July holiday weekend, may fall short in addressing the state’s financial woes, particularly its huge unfunded pension liability and $15 billion unpaid bill backlog, according to Moody’s.
“On both those fronts, it’s not yet clear if the legislation being enacted will have a substantial and clear positive effect,” said Moody’s analyst Ted Hampton.
The legislators decided that the very smallest step they could take to head off junk status was to enact a budget, even one that fell short of the reform that Illinois needs, to reassure the ratings agencies that the state wouldn’t default immediately. That may not have been enough.
Meanwhile, I’m surprised at the narrow focus that the editors of the Wall Street Journal have taken:
Credit-rating agencies are now backing off their threat to downgrade Illinois debt to junk status after the state’s Democratic Senate with GOP support overrode Governor Bruce Rauner’s veto of a tax increase this weekend. But bondholders beware: Politicians will happily throw them over as easily as Republicans dumped their reform principles.
The three major rating agencies— Moody’s , S&P and Fitch—are constructive in highlighting fiscal deficits, but they often underestimate credit risk. Downgrades are lagging indicators of fiscal and economic stress. Puerto Rico’s debt wasn’t slashed to junk until 2014—seven years into a decade-long recession and after politicians had borrowed tens of billions to tape up structural deficits. And as they demonstrated again in Illinois, credit raters don’t much care how deficits are closed. Tax increases are fine, even desirable, if spending cuts are too politically difficult.
Earlier this year the big three credit raters cut Illinois’s rating to just above junk and warned the state would lose its investment grade if politicians didn’t pass a budget reducing its $15 billion backlog of bills. While the yield on Illinois’s 10-year general obligation bonds is 4.4%, servicing its debt is twice as expensive as for highly rated governments—and watch out if interest rates rise.
What surprises me is that they don’t point out that there’s a big difference between near-junk and junk status. Many institutions have governance rules which require them to put money only in securities that are investment grade. Junk status narrows the pool of possible purchasers of Illinois’s debt.
The additional drag that higher costs of debt servicing would place on Illinois’s budget isn’t the only consideration; whether Illinois can refinance its debt at all is a much more serious concern.
“And as they demonstrated again in Illinois, credit raters don’t much care how deficits are closed.”
The point I was making. But they obviously have taken a more holistic approach. Your last sentence says it all. And if I recall, they need not just refi’s but new issuance to cover opex. That’s like a washed up fish gasping and flopping on the beach.
Two questions for the group. Who would you envision being the purchasers of new debt? I can only think of two. Can anyone reconcile the cash outflows with the potential inflows? And recall, a judge just dictated higher pension contributions. If you ain’t got money, you ain’t got money. Period, full stop.
That’s not quite true. Using its powers in equity the courts could mandate tax increases. What the courts cannot mandate is more revenue or a viable state economy.
The courts’ powers in equity are practically limitless. In principle in the short term the courts could require a tax increase or surcharge. That wouldn’t necessarily improve Illinois’s situation but they could do it.
The two I can think of are the Federal Reserve and the Treasury.
@Drew, I don’t think there is any court order on pension-funding; I believe you are thinking of a the court order to step up payments on the Medicaid backlog. The order diverts money away from pensions.
The pensions are a separate issue. Mostly its unliquidated liability; we don’t know what the debt is other than what is currently being paid out. Illinois courts have rejected union lawsuits to require the State to pay into pensions because there is no current debt; the State has the discretion to plan (or not plan) for the future.