ILLINOIS STATE BUDGET “COMPROMISE”: IN THE LAND OF LINCOLN, THE CARNIVAL COMES BEFORE THE STATE FAIR

ILLINOIS STATE BUDGET “COMPROMISE”:   IN THE LAND OF LINCOLN, THE CARNIVAL COMES BEFORE THE STATE FAIR

7/7/17

A number of people have asked over the last few weeks why I haven’t written on the Illinois budget shenanigans.   The answer is that yours truly doesn’t have much to say that hasn’t been said already and I try to keep my perspectives original.   Here are a few random, and hopefully, original thoughts:

·         The Governor got most of what he wanted and the Democrats in the legislature (read “Mike Madigan”) got most of what they (he) wanted.   The way politics works, one would think that no one would be happy with such an outcome; at least for appearances’ sake, the prevailing attitude would be one of grudging acceptance.   However, it sure seems like the Democrats aren’t anywhere near bereavement mode, so one suspects that the big winner, at least from a legislative/policy perspective, is a certain Democrat from the southwest side who has been around awhile and thus knows how to play the game with an aplomb at which his GOP opponents can only gawk.   This relative abundance of joy, or at least lack of lugubriousness, on the part of the Democrats might have something to do with the genuineness of the spending cuts in the legislation.   It would be nice if these reductions were real; it would also be nice if each of us were to suddenly develop hollow bones and wings, which would enable us to fly.  

·         Another related source of concern is the couple billion dollars or so set aside to service the debt the state will take on to refinance the IOUs currently being held by state vendors.   If history is any guide, this money will not be held in reserve to service new debt, but will prove an irresistible temptation to the politicasters in Springfield who see their role as prodigiously plowing through the populace’s purse.   Soon, we will see discussions on the floor regarding how to spend these “surplus” funds to meet “urgent needs” that, mirabile dictu, only became apparent when the money suddenly became available.   The state of Illinois will still borrow the money and pay off some of the IOU holders, but debt service will have to come out of, say, new taxes because, after all, the state has obligations to those who depend on it.

·         Yours truly been away from managing institutional fixed income for a long time, so I might be wrong here, but I suspect too much has been made of Illinois’ bonds potentially being downgraded to “junk” status even after passage of this budget deal.   The bonds already trade like junk, though it’s hard to say what “trad(ing) like junk” means since there are currently no states that have a junk (Ba1, BB+ or below) rating and there have been no junk rated states in recent memory.  

Further, and perhaps by way of explanation of the point made in the prior paragraph, municipal bonds (of which, through a quirk of tradition, include those issued by states even though the adjective “municipal” is derived from a Greek word meaning “city,” but I digress), due to their federal tax-exempt status, are held primarily by individuals rather than by institutions.   Most institutions (e.g., pension funds, insurance companies) have clauses in their investing rules that forbid, or severely limit, their exposure to junk rated bonds.  Hence, these institutions would, in most instances, have to sell all, or large portions of, their newly rated junk paper and, in almost all instances, would have to curtail or halt further purchases of such paper.    But since the overwhelming majority of the municipal paper, including Illinois paper, is held by individuals rather than institutions, these institutional restrictions are not a consideration.   Certainly, most municipal bond mutual funds are limited in their holdings of junk and thus might have to sell and/or curtail or end new purchases of Illinois paper should it be downgraded, but one suspects that the impact would be minimal because the holdings of Illinois paper by conventional municipal bond funds are probably limited at this juncture.   “High yield” municipal bond funds would, if anything, see their interest in Illinois bonds pick up in the wake of a downgrade.   “If anything” is the operative term here; again, the paper already trades like junk so high yield muni funds probably already hold as much Illinois paper as they want to hold.

Will Illinois bonds be downgraded to “junk” even after the budget deal?   Yours truly suspects the answer should be “yes” but will probably be “no” due to political pressures, but I can’t get inside the heads of the rating agencies.   In any case, however, too much has been made of the damage a potential downgrade would wreak on the state’s finances.

That is about all yours truly has on the budget proceedings, or at least all I have that you can’t read somewhere else.