Could Illinois Be the First State to Go Bankrupt?
Policy + Politics

Could Illinois Be the First State to Go Bankrupt?

Allen McGregor/Wikimedia Commons

Illinois has long been the poster child for a dysfunctional state fiscal policy.

The state’s Republican governor, a formerly wealthy businessman, and the Democratic-controlled legislature have been perpetually locked in a race to the bottom as the Land of Lincoln has repeatedly flirted with near- bankruptcy and junk-bond level credit ratings.

Nearly a Dozen States Are Suffering From ‘Chronic Budget Stress’

Last week, the state marked the second full year in which Gov. Bruce Rauner and a combative Democratic legislature were unable to agree on a new operating budget. The state Senate the week before rejected a House-passed budget measure premised on a $7 billion revenue shortfall after Rauner threatened to veto it.

Unlike city and county governments, states cannot legally declare bankruptcy as a means of shedding debt by forcing creditors, bondholders, and government retirees to absorb some of the loss. The last time a state declared bankruptcy was in 1933, in the throes of the Great Depression, when Arkansas defaulted on its debts.

But some legal scholars and government experts have argued in recent years that a well-orchestrated bankruptcy might be a far better solution than a federal or taxpayer bailout, and it would likely protect pension programs and health insurance from draconian cuts.

In April, a senior official at S&P Global Ratings, a premier government credit rating agency, warned  that nearly a dozen states with festering budget problems and woefully underfunded employee pension programs are struggling through “chronic budget stress” that could push them to the brink.

David Skeel Jr., a University of Pennsylvania law professor who has long championed granting federal bankruptcy protection to states, told Bloomberg that “Bankruptcy lets you get ahead of the problem.” And if ever there were a perfect candidate for such an approach, it would be Illinois.

Illinois has the dubious distinction now of being the only state to have operated without a complete and balanced budget for the past 700 days. Instead, it has been forced to conduct business under court-ordered spending and stop-gap measures while running up a massive deficit. For years dating back to Democratic rule in the State House, Illinois has led the nation in state budget shortfalls, pension fund crises, and unpaid bills to public universities, schools, social service agencies and government vendors.

As of last week, little had changed. The state was responsible for a record backlog of unpaid bills totaling $14.7 billion, causing fear among programs and local agencies dependent on state aid. State legislators also failed to approve a stand-alone kindergarten through 12th-grade education budget that was vital to the operations of the financially struggling Chicago school system, Reuters reported. A $15.7 billion bill to ensure schools open in the fall passed the Senate but was soundly defeated in the House.

States Face a $1 Trillion Pension Problem: Here Are the Worst 10

Rauner, who won election three years ago vowing to run the government like a business, complained to reporters as the legislative session ended, “We’re like a banana republic. We can’t manage our money.” He has used this same analogy before to voice his frustration working with a Democratic party that is prone to internal disagreement as well as strong differences with the conservative GOP governor.

What’s more, the state’s ragged financial picture has been steadily driving down its credit ratings with Moody’s and Standard & Poor’s while driving up its interest costs in borrowing to somehow prevent the state from going bankrupt.

The current budget deadlock has sadly boosted the chances of Illinois becoming the first state relegated to junk-bond status, according to Bloomberg. The state’s 10-year bond yields last week soared to about 5.2 percent or 3.36 percentage points more than top-rated municipal debt. That suggests that over time the state must pay much higher interest rates to market bonds of declining value. Matt Fabian, a partner with Municipal Market Analytics Inc., told Bloomberg, “After those downgrades, it became extremely likely that it goes below investment grade” or junk status. 

The state’s budget crisis was exposed in January 2011, when then-Democratic Governor Pat Quinn and the Democratic-controlled state legislature rushed to enact a major tax increase to address a looming deficit of at least $12 billion – which was roughly about a third of the entire $35 billion general fund budget. At the same time, the state employee pension fund was underfunded by $90 billion, and the state’s once-sterling credit rating was in rapid decline.

Related: Illinois Is Not Alone: States Facing $1 Trillion Pension Shortfall

Illinois experienced the worst state budget crisis in the country, and that proved to be the political undoing of Quinn. The once highly popular Democratic governor was ousted in 2014 by Rauner, who spent $20 million of his own money on the campaign. Rauner branded Quinn’s six years in office a “failure,” especially his leadership in budgeting, taxes, and education.

Just as President Trump would do two years later in his campaign, Rauner boasted of his shrewd talents as a businessman and investor. He vowed to apply his keen business sense and instincts to running the state government. Today, things are no better.

The latest fiscal crisis flare-up in Springfield coincided with similar signs of dysfunction and discord in the nation’s capital. Trump and the Republican-controlled Congress are at odds on budget and spending priorities, health care reform and tax policy, and even the timing for raising the debt ceiling to avert a first-ever default on Treasury borrowing.

Congressional Republican leaders and the White House repeatedly have voiced confidence that they can work out their differences and pass major legislation this year. But the situation in Illinois offers a bracing warning of how complicated and politically charged budget issues can spin out of control.