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Municipal Meltdown: Teacher Pensions, Bondholder Coupons, Go to Court

Politics / US Debt Jan 26, 2010 - 05:36 AM GMT

By: Submissions

Politics

Best Financial Markets Analysis ArticleWhile the Illinois Constitution protects vested pension benefits, that promise, like all the state's obligations, is only as good as its ability to pay." -Crain's Chicago Business

"Illinois Enters a State of Insolvency" cried a January 18, 2010 headline from Crain's Chicago Business: "As Illinois' fiscal crisis deepens, the word 'bankruptcy' is creeping more and more into the public discourse."


Illinois' lack of discipline is no surprise; it is in the vanguard of the spendthrift states. Revenues are falling and expenses are rising.

The Land of Lincoln, without authority to print greenbacks, is in arrears. Over $5 billion of state bills were unpaid at the end of 2009. Over $1.4 billion in Medicaid claims have not been processed. More than $2.25 billion in short-term financing is coming due. Crain's continued: "State employees, even legislators, are forced to pay their medical bills upfront because some doctors are tired of waiting to be paid by the state."

There is a good chance several states will face a similar predicament in 2010. On January 15, CNNMoney quoted a college professor: "It is surprising that political leaders don't seem to take seriously the magnitude of the problems."

Maybe it is not surprising. Most states are required to balance their budgets each year, but this is often accomplished with a good deal of hokum. For instance, states borrow in the bond market to tide themselves over, then ignore bond covenants and slip funds raised to build highways into the operating budget.

The Obama administration's fiscal stimulus is an additional means to delay the inevitable. Illinois received a 22% pay raise from the federal government as a beneficiary of the stimulus bill. Legislators probably assume, if worse comes to worse, they can go back to the Federal government.

A good part of the country makes this assumption, including too-big-to-fail banks, retired municipal workers and municipal bondholders. Most experts will discount warnings of financial forfeiture. Experts are recognized as such because they say what their audience wants to hear. Americans should discount the experts.

On January 13, the U.S. Treasury Department released an updated Monthly Treasury Statement for December 2009. Scrolling down to Table 3, estimated revenues for the fiscal year (which ends September 30, 2010) are $2.2 trillion. Budget outlays are expected to be $3.7 trillion. This is the type of financial rectitude practiced by President Mugabe in Zimbabwe.

The $1.5 trillion deficit for the current fiscal year needs to be funded, but the market for Treasury securities has a limit, certainly if it expects to sell securities at 3.7% (the current yield on a 10-year Treasury bond). If the U.S. dollar is to avoid Zimbabwe's predicament, where the annual inflation rate passed 200-million-percent some time ago, the negligent states will be told to solve their own troubles.

This will leave many people in a fix, including public sector retirees. It has long been assumed by most government workers, particularly those in unions, that their pensions are guaranteed. This is not true. Every state has legal recourse. (See page 9 of "The Coming Collapse of the Municipal Bond Market" on my website, AuContrarian.com).

Crain's may be one of the first to contemplate the fragility of these benefits: "The sharp rise in pension payments is the biggest factor pushing Illinois toward what a legislative task force last November called "a 'tipping point' beyond which it will be impossible to reverse the fiscal slide into bankruptcy."

Crain's quotes a "little-noticed report" produced by a legislative task force that addressed the state's pension problems. The report-that-nobody-wanted-to-read claimed: "the radical cost-cutting and huge tax increases necessary to pay all the deferred costs from the past would become so large that many businesses and individuals would be driven out of Illinois, thereby magnifying the vicious cycle of contracting state services, increasing taxes, and loss of the state's tax base."

Crain's goes on to explain the problem of a destitute state, legal claims not withstanding: "While the Illinois Constitution protects vested pension benefits, that promise, like all the state's obligations, is only as good as its ability to pay." [My italics.]

Americans are not used to limits. There is always a solution to a problem. Most often, ignoring it, then borrowing and spending more has worked. (Illinois has borrowed to meet contributions for worker pensions. Other states have done the same.) Today, dollars to pay the legally binding benefits are growing scarce. Crain's quotes a Chicago research organization: "All the obligations of the state, whether vested or not, will be competing for funding with the other essential responsibilities of state government. Even vested pension rights are jeopardized when a government is insolvent." [My italics.]

Bondholders, high-school teachers, university professors (and students), day-care directors and building contractors should take precautions now to ensure their last dollar is not negotiated in a court room.

By Frederick Sheehan

See his blog at www.aucontrarian.com

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, November 2009).

© 2010 Copyright Frederick Sheehan - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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