Jan. 11, 2012 _ On Friday, January 6, 1012, Moody’s Investors Service downgraded Illinois’ debt from “A1 (negative outlook)” to “A2 (stable outlook),” ranking Illinois the lowest of all 50 states. Moody’s stated that, “The downgrade of the state’s long-term debt follows a legislative session in which the state took no steps to implement lasting solutions to its severe pension underfunding or to its chronic bill-payment delays.” Two major rating services, Standard & Poor’s and Fitch, did not change their evaluation of Illinois’ credit worthiness. IGPA economist Richard Dye (left), co-director of The Fiscal Futures Project, provides the following analysis of the effect of this action.
There are four elements to the state’s fiscal crisis: (1) a structural deficit, or mismatch between sustainable revenues and spending obligations; (2) large unfunded liabilities for pensions and other future obligations like retiree healthcare; (3) a serious cash-flow problem resulting in bill-payment delays lasting many months; (4) a borrowing constraint, as concerns about Illinois’ ability and willingness to meet its obligations have raised its cost of borrowing and may threaten the availability of credit.
Illinois has made enormous strides in the last year in addressing the structural deficit, with a large income tax increase and sizable reductions in spending. Even so, the structural deficit has not been eliminated and painful additional steps will be necessary to bring spending and revenues in line over the next five or 10 years.
As noted in Moody’s statement, Illinois has failed to deal with its backlog of unpaid bills which is on the order of $7 billion. Although Illinois has reduced pensions of state workers hired after January 2011 it has not dealt with unfunded liabilities arising from pension obligations to workers hired prior to that date. The good news is that investors/lenders are still willing to buy Illinois bonds, even if the interest rates are slightly higher. The bad news, signaled by Moody’s downgrade, is that without seeing policy actions that will (1) eliminate the structural deficit, (2) reduce unfunded pension obligations, and (3) eliminate the bill-payment backlog, investors might abruptly become unwilling to hold or buy promises to pay from a fiscally and politically challenged Illinois.
