Illinois is No Peter Pan

“I’ll never grow up, never grow up, never grow up, Not me!”

Peter Pan, Lyrics from play

“I knew Peter Pan and you’re no Peter Pan.”

-Vice-Presidential candidate Lloyd Bentsen, (sort of), 1988

“Top Illinois Democrats have agreed to push a plan that would temporarily boost income taxes by 75 percent and double cigarette taxes,” harked CBS Chicago on January 6, 2011. The proposed plan would increase Illinois’ personal income tax rate from 3 percent to 5.75 percent for the next three years. After that, it would drop back to 3.25%. So they say.

Illinois is a state in which the legislators have so betrayed the taxpayers that a lifetime on Devil’s Island would be too good for them. For instance, the liability of the four state pension plans is calculated at $151 billion or $280 billion, depending on the assumptions used. The $280 billion figure is analytically controversial but deductively compelling given the efforts to deny and confuse bondholders and the public alike respecting the coming collapse of the municipal bond market.

Springfield, the capital of Illinois, is a nice town. As state capitals go, it is strikingly uninhabited with a population of 110,000 (and falling, but not as fast as its benefit obligations are rising). Farm country starts about three blocks from the state house. Illinois has more representation in its capital than any other state.

The politicians raised pension benefits faster than poker bids in Macau. Presumably, they have boosted their own benefits faster the state’s public servants, who, once they retire, no longer pay one cent for health insurance.

Clay ducks would have done better at funding promises than the elected representatives. There are $70 billion of assets to support the $280 of pension obligations (See The Liabilities and Risks of State-Sponsored Pension Plans, in which Professors Novy-Marx and Rauh lay forth their provocative and engaging argument).

Illinois borrows from the bond market each year to pay benefits, a total of $16 billion since 2007. Bondholders have been paid $550 million (on the first $10 billion) for funding this pyramid scheme. In other words: Illinois taxpayers have paid a $550 million late-fee that, if there were justice in this world, would be paid by the Illinois legislators.

These legislators – and this is true across the country, not just Illinois – cannot conceive of a time when there will be no buyers of bonds to pay benefits that the politicians failed to fund. By borrowing to meet current payments, the “top Illinois Democrats” have fostered the national charade of limitless taxing authority. State General Obligation (G.O.) bonds are backed by the “full faith and credit” phrase, stamped on their offerings. Wall Street research would have it that a G.O. bondholder can take that phrase to the bank. It is from this precipice that bondholders hang by their fingernails.

Goldman Sachs research chips in: “[G]eneral obligation debt is backed by a state or local government’s pledge to raise taxes to service that debt if necessary.” Barclay’s wrote to its California-averse clients that the state is obligated “in good faith to use its taxing power as may be required for the full and prompt payment of debt service.”

There are four problems here.

First, the State of Illinois had accumulated over $5 billion of unpaid bills by the end of 2010. Electricity to the governor’s mansion will be cut off if the politicians don’t grow up.

Second, the authority to raise taxes to meet bond payments often does not work. The most recent instance is the State of Oregon. In early 2010, voters increased tax rates on high earners and businesses to fill a $700 million deficit. Civil servants danced in the streets: “We’re absolutely ecstatic,” said Hanna Vandering, a physical education teacher from Beaverton and vice president of the statewide teachers union. “What Oregonians said today is they believe in public education and vital services.” (The Oregonian, January 26, 2010) On December 16, 2010, the state of Oregon had received one-third less than was expected from windfall tax receipts. Those Oregonians who weren’t talking while Hanna Vandering was spouting decided they would rather leave town than contribute to this scandalous love-in between legislators and public unions.

Third, the authority and inclination of courts to issue a writ of mandamus (ordering state officials to raise taxes) is not a topic discussed in brokerage firm research. It is hereby suggested to municipal bondholders who are recipients of such reports to ask why this is so. There have been many decisions in which the court concluded it did not have the authority (or inclination: because efforts, such as in Oregon, are generally unsuccessful) to demand tax increases. The decisions are too varied to discuss here. (See, as a start, Tax Increases in Municipal Bankruptcies, Kevin A. Kordana, Virginia Law Review, volume 83, No. 6, pp. 1035-1107.) Readers may recall that states cannot file for bankruptcy. This is true, but an insolvent body that reneges on its obligations to bondholders will sit in the dock. Municipal decisions are the obvious precedents for the courts.

Fourth, a Sword of Damocles hovers over all transactions and contracts in the United States today: who still trusts the “full faith” of any government body? And, this is the worst situation of all: politicians who think they can fly.

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About Frederick Sheehan 53 Articles

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009). He is the co-author of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.

Mr. Sheehan was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans. For more than a decade, Mr. Sheehan wrote the monthly "Market Outlook" and quarterly "Market Review" for clients.

He is a frequent contributor to Marc Faber's "Gloom, Boom & Doom Report." He also has written articles for "Whiskey & Gunpowder" and the Prudent Bear website, among others. He currently serves as an advisor to an investment firm and a non-profit foundation.

A Chartered Financial Analyst, Mr. Sheehan is a graduate of Columbia Business School.

Visit: Frederick Sheehan's Website

3 Comments on Illinois is No Peter Pan


    Here’s how we did it in Colorado, why are more states not taking advantage of this simple solution?


    Obviously, legislators around the country are not quite as sophisticated as their counterparts in Colorado. It has never occurred to them that they could just pass a bill stating (Oh, by the way, we are no longer bound by our contractual pension obligations.) Simplicity itself! This approach makes life much easier in difficult budgetary times, and takes the burden off of GASB, state and local governments, plan sponsors and the SEC!

    Under the Colorado pension (contract breaching plan). . . . . you simply seize vested, accrued, earned, contracted benefits from retirees and pension members (incredibly, with the help of your local union lobbyists . . . . toss those retired union brothers under the bus) until your unfunded pension liabilities are sufficiently reduced to raise your funded ratio. This plan also improves the status of your bonded debt (keeping those SEC fellas happy).

    If you are as brazen as we are in Colorado you claim that your goal is to achieve a 100 percent funded ratio, instead of the 80 percent level that is considered well-funded in the industry. May as well go for the full 100 percent, no one understands all this pension mumbo jumbo out here in the west.

    The 100 percent goal provides lots of wiggle room for unexpected investment shortfalls, or more convenient under-funding in the future. Also, here is another ingenious provision that we invented. If it happens that God provides you with an underperforming pension investment staff, (I estimate that last year we underperformed by about a billion), and accordingly you have an investment loss for the year, no problemo, just state in the bill you enact that retiree contracted benefits will be further cut to accommodate the loss! My guess is that when pension investment staff around the country hear about this sweet no-accountability gig they are going to beat a path to Colorado PERA. Where can I get that kind of a job? To be fair, credit for finding this solution should go to the bright administrators at Colorado PERA. You can imagine how difficult it is psychologically to advocate a course of action that you yourself have earlier declared illegal, (see this excellent Denver Post article.)

    We know it is burdensome for busy pension administrators (particularly short timers) to have to tell elected officials that they really ought to make their annual required contributions . . . it is much easier to just let those unfunded liabilities build up year after year after year, until you have a good pile, and then wipe the slate clean with a good contract breaching!

    Our Colorado PERA pension administrators are straight shooters. They have been telling us for a couple years now, (We can’t invest our way out of this.) Now they are keeping their word . . . by missing their investment performance benchmarks by wide margins.

    Meeting contractual obligations? Performing your fiduciary duty? Acting in a moral fashion? No need to fret about these things. We’ve looked into it in Colorado and dang if these things haven’t been optional all along. Hello state and local governments . . . round up those rascally debt problems and herd them out west to us in Colorado, we have a simple (minded) solution!
    (Visit for more info, or Google “WORSE THAN BERNIE MADOFF: COLORADO’S 2010 PENSION THEFT.”)

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