Illinois and California lead other states in race to bankruptcy
On December 1, the Governor’s Office of Management and Budget (a misnomer), announced that the state had successfully sold $1.5B of tax-exempt Tobacco Revenue Bonds. This strategy of economic brilliance in the depths of financial insolvency involves borrowing money, backed by payments from the 1998 tobacco settlement agreement, that hasn’t yet been collected.
Illinois and 45 other states were awarded this money for medical costs associated with diseases caused by tobacco use. This is the state’s first issuance of tobacco bonds – and probably will not be its last. The bond sale will provide the state with enough revenue to pay off last year’s bills which ended June 30.
But Illinois already has a $5.3B deficit just since the start of fiscal 2011, which began on July 1. Where is the next loan going to come from? Will the governor and the General Assembly raise taxes 33% to 66% for this year’s bills? Comptroller Dan Hynes predicts a $15B gap between expected revenues and expenses.
The state will use the tobacco loan to pay Chicago schools nearly $164M for FY 2010 but already owes Chicago Public Schools over $200M since July. Late payments have caused program cuts in Chicago and will also result in cuts for the Rockford schools. The state payment for FY 2010 and other factors will reduce Rockford School District’s 2010/2011 budget deficit from $41M to $26M with the tobacco funds.
California has tried to get around its debt by paying off vendors with script, that has been used in some school districts in Illinois, and even delaying state income tax refunds. Illinois seems to be even in worse shape on a per capita basis. The prospect is that the bond market will stop financing states with insurmountable debt. When that happens, California and Illinois may soon be forced to go to the federal government for a bailout.
Some economists think that the only solution for some states will be a bankruptcy law that has been used in the past by Orange County, CA. and Mission Vallejo, CA. and some 10 to 12 cities in Michigan are already headed that way. Even if the governors of the states will not declare bankruptcy, the bond market may force the states to do so, because they will not lend them any more money, until they get their spending under control.
Congress may have to have to allow for state bankruptcies to prevent a crisis that could be just over the horizon. Earlier this month, California was only able to sell 60% of its bonds in the market.