Illinois is About to Stick its Head Deeper in the Sand

By RRuntsch @ Shutterstock.com

For years Illinois has underfunded its five pension systems. For years I have been waving a red warning flag about the American pension charade (see here, here, here, and here for a small sample), but public pensions are controlled directly or indirectly by politicians. Those politicians don’t ever want to subject their constituents to the painful measures it will take to fully fund pensions, and so rather than doing what is necessary to make the systems solvent long term, they place their faith in overly optimistic return assumptions.

Illinois is trying one last ditch effort, using the same overly optimistic strategy. The state is considering borrowing money and investing it to fund its pension system. To benefit the pension system at all, the state will have to earn a higher rate of return on the investments than it must pay in interest. That won’t always happen. In any years with negative returns on the investments, not only will the pension system receive nothing, but taxpayers will be asked to put their resources into funding the debt rather than shoring up the pension system. Even less money will be spent on the services the state actually exists to provide.

Perhaps worst of all, the state’s plan relies on market timing. That’s a bad strategy in good times, but in the heat of the second longest bull market in history, it seems even worse. Elizabeth Campbell reports on the plan for Bloomberg:

“We’re in a situation in Illinois where our pension debt is just crushing,” Martwick, a Democrat who chairs the committee, said in a telephone interview. “When you have the largest pension debt in the world, you probably ought to be thinking big.”

Illinois owes $129 billion to its five retirement systems after years of failing to make adequate annual contributions. Because the state’s constitution bans any reduction in worker retirement benefits, the government’s pension costs will continue to rise as it faces pressure to pay down that debt, a squeeze that has pushed Illinois’s bond rating to the precipice of junk.

Many American governments have sold bonds for their pensions, albeit on a much smaller scale. Illinois did so in 2003, when it issued a record $10 billion of them. New Jersey also tried it, only to see its pension shortfall soar again after the state failed to make adequate payments into the system for years. Detroit’s pension-fund borrowing in 2005 and 2006 helped push it into bankruptcy.

On the whole, the track record has been mixed, according to a study by the Center for Retirement Research at Boston College. Much hinges on timing the stock market: While most pension bonds have been profitable because of equity gains since the recession, those sold after the late 1990s rally or before the 2008 crash lost money, the study found. The S&P 500 Index climbed 19 percent last year and has continued to hit new highs.

E.J. Smith - Your Survival Guy

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E.J. Smith is the Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH, where he completed course-work in Practical and Defensive Handgun, Conceal Carry Pistol, Shotguns, Precision Scope Rifle and Kidnapping Prevention. E.J. plays a Yamaha Recording Custom drum set with Zilldjian cymbals. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com. Sign up here to receive all the best content from Richardcyoung.com each week.