Illinois badly needs help from bond market

February 16, 2011

By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Selling debt to fund public pensions is a bad idea. Jon Corzine, former Goldman Sachs chief and one-time governor of New Jersey, called it “the dumbest.” Yet Illinois, the exemplar of fiscal train wrecks, wants to borrow $3.7 billion to plump up its chronically underfunded pension schemes.

The troubled U.S. state is, however, caught between a bad decision now and worse ones made in the past. Its politicians tried to fix pension funding more than 15 years ago, but instead made the situation worse. They passed legislation that allowed Illinois to make smaller contributions than necessary provided it made up for the lost ground later. Later has now arrived.

The numbers are grim. The proposed pension borrowing is on top of Governor Pat Quinn’s plan to sell $8.75 billion of bonds so the state can pay its past due bills. And even if Illinois can fix its regular budget issues quickly, the needed pension contributions will rise — to $4.9 billion next year and to $6 billion by 2015.

Skipping this year’s contribution could actually be worse than using borrowed money to top up the funds. Bond investors will probably charge Illinois higher interest rates than other states. But at a possible 5 percent or so for five-year bonds, that could still cost less than the 7 percent plus assumed pension fund returns that the state would have to make up later. After all, the state’s five public funds earned 9.2 percent to 15 percent on their investments last year.

But it’s a risky strategy, especially when the state also needs to borrow heavily for other purposes. A Boston College study found that most debt used to fund pensions proved to be a net drain on governments in 2009. Thanks largely to the financial crisis, the average annual return made by the five Illinois funds over 10 years has been 3.6 percent or less — not enough to cover the likely cost of the state’s proposed new pension bonds.

Illinois is far from the only state that has put off grappling with its long-term obligations for too long. And the federal government has done the same thing. But the Prairie State is among the first to face a real reckoning. With no good options, dumb ideas may be all that’s left.

Comments

Governor Pat Quinn should be recalled!

Posted by linushuber | Report as abusive
 

It is dumb to pour money into pension funds in the the middle of a recession. Pension funding rules need to be reformed. This is not a new problem, viz:

“the current combination of declining interest rates, falling asset prices, and low earnings is recurring as it typically does in a recession. Consequently, current funding rules create a counter-cyclical funding problem and compound the problem by requiring more contributions during a recession than during other times. In order to promote and sustain sponsorship of defined benefit plans, rule changes should occur in a way that is consistent with more stable funding. This would make it less likely that employers would have to make cash contributions when the economy is weak and they are less able to afford them, and more likely that employers will contribute when the economy is strong and businesses are flush.”

From 2003 testimony by Christian E. Weller before the House of Representatives.

Posted by furiouschads | Report as abusive
 

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