Is Illinois The Next Puerto Rico?

Puerto Rico filed for bankruptcy in May. That is likely to wreak havoc on investments held by many Mom and Pop investors on the island.

The state of Illinois seems to be following Puerto Rico’s lead. Will Mom and Pop investors who own Illinois bonds face a similar crisis?

On June 1, the day after Illinois lawmakers were unable to pass a budget, credit rating agencies Standard & Poor’s and Moody’s downgraded the state’s bond rating to one notch above junk status. S&P went even further to plunge the state’s appropriations debt into junk territory.

Appropriation bonds are issued by localities to fund delinquent retirement contributions. They have played a leading role in precipitating almost every municipal bankruptcy going back 20 years.

The moves by the bond rating agencies spell disaster for Illinois bondholders.

The new ratings that S&P and Moody’s  gave  Illinois’ general obligation bonds is the lowest grade the agencies have ever given to any state. Illinois has  gone over 700 days without a budget– longer  than any other state.

As with Puerto Rico, Illinois faces political problems with a stalemate between a Republican governor and Democratic leaders in the legislature over how to pass a budget and deal with an almost $15 billion backlog of bills.

S&P placed the blame for the downgrade  on the political impasse between Republican Gov. Bruce Rauner and Democratic leaders in the General Assembly, the root of the legislature’s inability to pass a budget the governor will sign. Though the state has no spending plan in place, an ‘autopilot’ budget of sorts has led to the state spending nearly $40 billion per year due to organic  growth in payments and court-mandated payments, but it has only taken in around $32 billion. That mismatch between revenue and spending has led to a $14.5 billion deficit , which led to the  S&P downgrade to junk status.

“The unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments,” S&P said. “We believe that Illinois is now at risk of entering a negative credit spiral, where downgraded credit ratings would trigger contingent demands on state liquidity, further exacerbating its fiscal distress.”

This sounds reminiscent of the rating agencies’ response to Puerto Rico’s inability to deal with its $70 billion budget deficit. It is unprecedented for a state to have its debt rating cut to junk and the retail investors and savers who invested in Illinois bonds over the years are likely to get crushed.

Both S&P and Moody’s warned that another downgrade – this time to junk status – could be forthcoming if the political standoff doesn’t get resolved.  A junk rating would mean the state’s future borrowing is much more expensive, as it becomes a much riskier investment for bond buyers. Moreover, pension funds, major buyers of bonds, will not be able to buy them.

Again, this sounds all too similar to Puerto Rico. But Illinois, unlike Puerto Rico and the city of Detroit, cannot go bankrupt because it is a state.

As was the case with Puerto Rico investors, attention will now be focused on the brokerage firms who may have committed investment fraud in misrepresenting the safety of Illinois bonds to retail investors.

As Yogi Berra once famously said: “It’s déjà vu all over again.”

Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.