Teacher Pensions Blog

Desperate times call for desperate measures, or so the saying goes. Staring down a financial crisis, Illinois is considering a fiscal Hail Mary: a massive fire sale on public debt. On Tuesday, the State Universities Annuitants Association (SUAA) proposed to the Illinois legislature a plan to fund the state’s pension system by selling a 27-year, $107 billion bond. In essence, the state would be betting they could earn more from the stock market over this period than they would pay toward the bond. While Illinois’s finances certainly are in real trouble, issuing the largest public bond in history may do more harm than good.

There are a number of reasons that selling a pension obligation bond (POB), particularly one of this size, is a perilous path for Illinois.

1. It’s a gamble that state investments earn large returns. In the past, states that made this bet have often lost. For the POB to work out in the state’s favor, the portion of the bond the state invests must generate greater returns than the interest on the original bond owed to investors. This strategy could pay out, but it also could not. Remember, consistently over-estimating returns is part of the reason pension funds like Illinois’ accrued so much debt in the first place.

2. Timing matters. The moment when a stressed pension plan needs to acquire additional funds to meet its obligations is not necessarily the best time to invest in the market. The $10 billion POB Illinois issued in 2003 performed well until the market crashed in 2008. Without a significant return, a pension obligation bond can end up actually increasing debt obligations. With the stock market currently at or near all-time highs, now may not be the best time to make this sort of gamble.

3. Beggars can’t be choosers. Illinois’s finances are in shambles. The state is in desperate need of resources to meet its pension obligations and it is constitutionally prohibited from saving money by slashing benefits. The state also has a record of political turmoil and financial strife. Investors know this. It is likely, then, that potential investors will demand a sizeable premium to purchase the state’s bonds. This will further squeeze the gap between the returns Illinois earn and what it pays on the bond. In short, it’s a seller’s market, and Illinois is in a poor position to negotiate favorable terms.

4. A debt swap still leaves debt. Issuing a $107 billion POB doesn’t really change Illinois’ financial woes; it simply moves it around. The state will still carry $130 billion in pension-related debts. One issue with this strategy is that the debt tied to the POB is more rigid, and cannot be kicked down the road as states so often do with their pension obligations. Unlike the pension debt, the bond would force the state must make regular payments to creditors or risk legal action.

5.The pension system will continue to accrue debt. Perhaps the most significant failing of this strategy is that it will do nothing to slow down the rapid pace at which Illinois is adding to its pension debts. Taking out a loan to pay down current obligations – even if successful – won’t stop new debts from piling up. This strategy, indeed any approach to help Illinois deal with its burgeoning pension debts should be paired with broader retirement reforms.

Given these serious concerns, issuing over $100 billion in public bonds likely is not the most prudent course for Illinois. That said, the magnitude of Illinois pension debts is such that doing nothing is not really an option. As we’ve written elsewhere, there are other strategies that states facing untenable unfunded pension liabilities can take. For example, the state could offer a pension buyout to reduce long term costs. States could also – and probably should – seek out new revenues. While I understand the urge to swing for the fences and to try and address their fiscal problems all at once, Illinois should instead seek out gradual and sustained reforms both to fund their existing pension liabilities, and to restructure their public retirement system. The state is in a deep fiscal hole, and part of getting out is to stop digging.