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Illinois to Jump Back into Bonds

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Illinois to Jump Back into Bonds

Following a nearly two year absence from the bond market, Illinois has jumped back into bonds through the January 30th offering of half a billion dollars in long-term bonds. The bonds are intended to help give the state much-needed funding for infrastructure. Bond investors, leery of the state's continued fiscal problems and 2013 accusations of securities fraud, are expected to demand compensation through high rates.

Illinois's History of High Bond Rates

For much of the last decade, higher rates have been a common demand of bond investors in Illinois. The state has been the subject of continued erosion of its fiscal position because of a series of failures. These failures included extended periods without a balanced budget, lack of passage of reform bills for pensions and state spending, and a growing record of ineffective governance. These problems have not been resolved, and bond investors will likely demand rates that are even higher for this new round of bonds.

The borrowing rate that Illinois currently pays is the highest of any US state. The premium (sometimes called a penalty) the state must pay for borrowing is likely to keep increasing as long as its budget problems remain a factor. Unfortunately, these problems aren't new; in the past seven years since 2009, the state's credit rating has been downgraded fifteen times between Moody's, Standard & Poor's, and Fitch's rating systems. Governor Pat Quinn presided over thirteen of these downgrade events. The reasons for the downgrades, some of which came as recently as October 2015, still resonate: lack of balanced budgets, and ever-growing debt. Since 2001, Illinois has operated without balancing the budget.

Another contributing factor is the pension debt held by the state. During the seven year period between 2008 and 2015, the state's pension obligations doubled, surpassing $110 billion. Also added to the mix is the jump in bond debt that occurred under two former governors, Pat Quinn and Rod Blagojevich. During their terms, over $17 billion in pension bonds were issued. The total bonded debt held today is almost $30 billion.

Securities Fraud Charges Against Illinois

In 2013, Illinois came under increased scrutiny due to the state's failures in communication with bond holders. The state was charged by the Securities and Exchange Commission (SEC) with securities fraud. The SEC alleged that Illinois had failed to keep bond holders properly informed regarding fiscal problems in the state. During the four year period between 2005 and 2009, the state issued more than $2 billion in municipal bonds, but failed to tell investors about significant underfunding of the state's pension obligations. This underfunding also increased risk to the state's ongoing financial health. The SEC also alleged that the state downplayed the effects of statutory plan changes to mislead investors.

Risks Faced by Investors in Illinois Municipal Bonds

Investors rightly look to the state government to solve fiscal problems, and the state responded in 2011 by raising taxes. Personal income taxes grew by an astounding 67%, while corporations saw their tax bill increase by nearly half. This generated additional revenue of over $30 billion over the following four years. The additional revenue ended up doing nothing at all to improve the state's financial situation because the General Assembly failed to address nearly all key reforms that could have improved it. In fact, the state's pension obligation grew by $20 billion during that period, and the state still faces a mountain of unpaid bills. Additionally, Illinois saw the absolute worst economic recovery of any state following the Great Recession. Illinois suffered five downgrades to its credit rating during the same period.

Investors also face risk due to the pension reform issue. Unless the state begins to enact fixes for the massive pension shortfall, it could face more credit downgrades and face even larger shortfalls in the future. The current credit rating of the state sits just three ranks below a junk rating.

Getting the state to move forward will require the adoption of a budget that encompasses major reforms for both pensions and state spending. Absent that, investors and residents alike will be at risk. Perhaps the real risk is in the General Assembly passing a budget that doesn't address these issues, putting the state's financial position on an ever-more-precarious perch.

Consulting a Business Litigation Lawyer

Investors who expect the state to be a solid investment may not think twice when an investment adviser recommends municipal bonds. However, if the adviser is aware of problems like those in Illinois, the investor may feel as though the adviser breached their fiduciary duty. That's when it's important to consult with a business litigation lawyer in order to determine whether a breach has occurred. Once that determination is made, abusiness litigation lawyer can then advise their client (the investor) about seeking damages and recovering losses.

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