East Moline’s credit downgrade is a warning to Illinois cities considering borrowing to fund pensions – Wirepoints
By: Ted Dabrowski and John Klingner
Borrowing to solve a debt problem doesn’t work.
Just two weeks ago we warned Residents of East Moline at the dangers of letting their town officials borrow tens of millions of dollars to supposedly “fix” the public security pensions in difficulty. The city’s plan comes down to “playing on the stock market to get out of financial trouble,” we said of East Moline’s intentions to borrow $ 41 million by issuing what are called bonds pension, or POB.
Now Moody’s Investors Services, the credit rating agency, has hit the city over its borrowing plans and exposing its residents to potential investment losses. East Moline got a double-click credit downgrade from Moody’s, leaving the city’s credit rating just two notches off a junk rating. Think of it as if your credit score is shaken because you are now riskier to lend. Not only that, but you are using up your borrowing capacity. If you need money in the future, you may not be able to get another loan.
The POB program is a bit complex, but it basically falls to the city to borrow the money and invest it in the financial markets, hoping that the returns on the investment will exceed the cost of borrowing when it is time to. pay off the debt years later. It is a risky activity called “interest arbitrage” and it is a game that only brokerages, banks and skilled traders should play. The risk of losing money is real, as evidenced by the trillions of losses suffered during the DotCom meltdowns and the Great Recession over the past 20 years.
Not only that, but if the bet in East Moline does not work, it is ordinary residents who will have to pay higher taxes to make up for the losses. It is certainly not something that city officials should be involved in and one of the main reasons why the Association of Public Finance Officers says “state and local governments should not issue POBs”.
Due to the nature of its downgrades, Moody’s is also concerned about POBs. Here’s what the agency specifically said in its decommissioning press release:
The downgrade to Baa2 reflects the city’s substantial leverage on debt, pensions and other post-employment benefits (OPEB) with high fixed costs. The city intends to limit the required increase in future pension contributions with the issuance of pension bonds, although this strategy carries risks and increases its exposure to potential losses on investments.
High fixed costs have contributed to a series of operating deficits in recent years. Management has reduced expenses to stabilize operations in 2020 and maintains adequate reserves. The American Rescue Plan Act (ARPA) funding is expected to improve the fund balance in 2021. The general fund’s cash position is very tight, although the overall operating cash flow is healthy. The rating also incorporates the city’s modest but growing tax base with relatively low resident incomes.
POBs are a problem because they are not a real solution to the retirement crises in cities. Borrowing more money does not solve the underlying problems; it just hides them and lets them fester.
Blagojevich and Quinn’s POBs
Residents of East Moline need only look at the state itself to see how the POBs have helped worsen Illinois’ pension crisis.
Governor Rod Blagojevich issued $ 10 billion in POB in 2003 and poured the money into pension plans. The extra money in the plans initially reduced the state’s pension deficits from $ 8 billion to $ 35 billion, but it only took four years for the pension deficit to grow larger than it was. was not when Blagojevich published the POB.
Governor Pat Quinn used the same playbook to borrow $ 3.7 billion and $ 3.4 billion in 2009 and 2010, respectively. And just like for Blagojevich, the shortfall continued to increase and now totals over $ 144 billion.
The loans from the two governors gave the illusion that something was being done about pensions, but the reality is they did nothing to slow it down rapid growth in the retirement promises.
To add insult to injury, the Illinoisians are still reimbursing Blagojevich’s 2003 POB. They will repay the principal and interest on the bond – a total of $ 11 billion – through 2033.
Residents of East Moline face the same problem. They will be forced to slowly pay their own POB over the course of the the next two decades. And without real pension reform, they can expect their pension deficits to increase at the same time.
Learn more about POBs: