The state of Illinois is a financial disaster that will undoubtedly be forced into bankruptcy at some point in the future. As we’ve pointed out multiple times over the past several months, the state faces a staggering $130 billion funding gap on its public pensions, a mountain of debt and $16.4 billion in accrued payables because they can’t even afford to pay their bills on a timely basis. Here are just a couple of our recent posts on these topics:
- Illinois Pension Funding Ratio Sinks To 37.6% As Unfunded Liabilities Surge To $130 Billion
- Illinois Unpaid Vendor Backlog Hits A New Record At Over $16 Billion
- The State Of Illinois Is “Past The Point Of No Return”
So what do you do when you’re effectively a junk-rated credit risk but you need to sell another bond deal to keep your ponzi scheme going a little longer? Well, you turn to Goldman Sachs to help you engineer a shady corporate structure that supposedly gives new bondholders first dibs on sales tax revenue (i.e. you prime other unsecured bondholders)…which is just clever enough to fool the rating agencies into giving it a AAA-rating but, as analysts and investors point out, is unlikely to mean much of anything in a bankruptcy scenario. Per the Wall Street Journal:
Yet the nation’s third-largest city is on the verge of selling as much as $3 billion in bonds at a triple-A rating, the latest twist in the tale of cash-strapped U.S. municipalities adopting Wall Street financial engineering in their struggle to raise money in the market.
Echoing methods adopted by Puerto Rico and New York, Chicago has created a new company to sell debt, offering a tempting pledge to investors: a dedicated first claim to the city’s sales-tax revenue.
In theory, that should make the debt as secure as U.S. Treasury bonds. But there is a catch: analysts and investors say in the scenario of a bankruptcy, it is difficult to predict whether owners of the new bonds would get paid back ahead of other creditors, pensioners or even police and emergency services workers.
The deal tests whether years of near-zero interest rates will send yield-starved investors into complex bond structures. And Chicago—with a school system that has teetered near bankruptcy and greater expenses than its revenues—could still face a funding gap down the line even if it manages to lower its borrowing costs, analysts say.
Thornburg’s Mr. Ryon said Chicago’s new entity doesn’t deserve separate credit ratings from the city’s other debt. “It’s a bit of smoke and mirrors,” he said.
Of course, anyone with half a brain should be able to realize that for Goldman’s structure to be effective it would necessarily mean that other outstanding Illinois bonds would have just been put in a subordinated position and should, therefore, be worthless. That said, per the chart below, legacy ILS bondholders still seem to be pretty optimistic about their future recovery potential.
But while the jury is still out on whether this financing ponzi scheme will be effective at priming other bondholders or is truly nothing more than “smoke and mirrors” designed to fool the always gullible rating agencies, you can rest assured that other failing states like California will line up to take advantage of similar schemes in the near future…
Other cities and states will be watching Chicago’s bond sales. Illinois passed a special statute allowing the city to issue the bonds, and now other municipalities in the state can do the same.
States including California, Nebraska and Rhode Island have passed laws in recent years aimed at giving bondholders first claims on some taxes even if the issuer is in financial distress. Illinois and Michigan have also proposed similar laws.
Investors say municipalities with weaker financials will continue to try to woo bondholders with proposed safeguards, especially with the market rattled by Puerto Rico’s restructuring.
“The idea is to provide a little more reassurance to potential creditors that they’ve got first crack at the money,” said Glenn Weinstein, a Chicago attorney at Pugh, Jones & Johnson P.C., who has advised the city in the past.
At the same time, Mr. Weinstein said, “if you don’t have financial difficulties and your credit is good, you don’t need this.”
…all of which means that when the municipal ponzi scheme, with their $5 trillion in unfunded pension liabilities, finally goes bust it will be even worse than expected.