We're Doomed

Chicago may forever be the "Second City," but Illinois is shooting to the top of a different ranking--top sovereign credit risks.

Illinois already passed California to become the riskiest state. And it topped Iceland (motto: "finances melt faster than ice") and is gaining on Greece. So, Illinois muni bond offerings had to promise greater returns--making the state more like a Third World country:

Illinois, with the lowest credit rating of any state from Moody’s Investors Service, dangled yields higher than Mexico, which defaulted on debt in 1982, and Portugal, which costs more to insure against missed payments.

Why are states such as Illinois flirting with default? Structural budget gaps generated by unfunded pension and health care liabilities. According to a Barrons article from March:

Some 80% of [state] public employees are beneficiaries of defined-benefit plans under which monthly pension payments are guaranteed, no matter how stocks and other volatile assets backing the retirement plans perform. In contrast, most of the taxpayers footing the bill for these public-employee benefits (participants' contributions to these plans are typically modest) have been pushed by their employers into far less munificent defined-contribution plans and suffered the additional indignity of seeing their 401(k) accounts shrivel in the recent bear market in stocks. . .

The prospects are bleak for many state and local governments as a result of all this. According to a survey last month by the Pew Center on the States, a nonpartisan research group, eight states -- Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia -- lack funding for more than a third of their pension liabilities. Thirteen others are less than 80% funded.

The Civic Committee of the Commercial Club of Chicago "estimates the state’s retirement-related liabilities at $130 billion." All this from "The progressive, Blue state of Illinois which gave you the reformer Barack Obama."

But wait, there's more: it happens that significant portions of recent state borrowing came from sale of "Build America Bonds," a new type of issue created by the President's stimulus package, featuring federally-subsidized interest rates. And that, in turn, could spread risks of state default to all American taxpayers:

Unfortunately, the rising popularity of BABs could make a federal bailout of the states more likely, because there is now a new class of investors (foreigners) who can reasonably claim to have been misled as to who is ultimately responsible for these debt securities. As with regular municipal debt, BABs are not backed by the federal government. Yet these bonds have the "Build America" brand​--and not the moniker that would be more accurate: "Help deeply indebted states borrow more to build more stuff."

Not surprisingly, confusion about who stands behind these obligations has contributed to the program’s popularity. The fact that cash-strapped California has issued 22 percent of all BABs since the program’s inception is one of the more troubling signs supporting the hypothesis that foreign investors view these securities as enjoying an "implied" federal guarantee.

We've seen this movie before--with the tax-funded bailout of Fannie Mae and Freddie Mac, despite no explicit Federal guarantee.

So be careful: what starts in Illinois doesn't necessarily stay in Illinois--rather, in this Administration, it tends to plague us all.

(via Instapundit, Reason magazine)