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The End of Liberty Bonds: Illinois Law Proposes Preferences for Bondholders over the Public

WirePoints 27 February 2017 No Comment

What could be worse than bankruptcy for an Illinois town or city?

An assetless bankruptcy. That’s when even a formal bankruptcy proceeding can’t help because there’s nothing to work with. It’s when the bank owns everything and nothing is left. That’s when it’s lights out.

But that’s just what Senate Bill 10 would make more likely. It’s one of the twelve bills comprising the “grand bargain” now under consideration in Springfield. It would assure that bondholders — who you can think of as “the bank” — get permanent ownership of the lifeblood Illinois municipalities need to provide government services.

Here’s the background: Money flowing from state government to Illinois towns and cities is essential for those municipalities to function. That money includes the municipalities’ share of the sales and income tax, school aid and other funding for expenses shared with the state. That money is usually mortgaged to secure payment to bondholders. However, many of those mortgages probably could be undone if Springfield and our municipalities ever got serious about ending our fiscal crisis. They should already be working together to do that — to recharacterize or change the way tax revenue are expenses are shared, or just not appropriate the particular funds covered by the mortgage, which would free those monies from the mortgages. That task would be especially easy, at least in some cases, if the state authorized our municipalities to file for bankruptcy under Chapter 9 of the Federal Bankruptcy Code.

The municipal bond community knows all that, though most of our politician’s don’t. Senate Bill 10 is intended to eliminate the risk of mortgages being undone and assure that bondholders come first, hell or high water, regardless of the need for essential government service. It would do that by forcing (not just authorizing) municipalities that want to use state money as collateral to transfer complete ownership of money flowing from state government to a new, separate entity created solely to pay bondholders. By doing that, the bill would create a form of mortgage that would be bulletproof even in bankruptcy. The bill would apply to all home rule muncipalities (which are all towns and cities with more than 25,000 residents plus those that have voted to become home rule).

It gets worse. Section 8-13-15 of the bill binds the state itself to “non-impairment.” That means the state would be required by statue to refrain from doing the very things it should already be doing — working to undo mortgages that prioritize bondholders over the public. And Section 8-13-20 of the bill prohibits municipalities from mortgaging their state money in any way other than the bulletproof manner created by the bill.

When I practiced law I taught secured lending and bankruptcy as an adjunct at the University of Texas Law School. I can imagine giving an assignment like this: “Draft a bill to make bondholders supreme by stiffing the public and taxpayers.” If somebody handed in Senate Bill 10, they’d get an A+.

The rationale for the bill is that it will help municipalities by lowering their borrowing costs. Interest rates are lower if bonds are more solidly secured.

That’s certainly true. The problem, however, is that other consequences of the bill outweigh that benefit. You could probably get a lower rate on your home mortgage, too, if you transferred full ownership interest of your most essential assets, including future income, to your mortgage lender. More importantly, Senate Bill 10 will just encourage more borrowing. I’ve talked to two people who know the municipal finance business from the inside, though they won’t talk on the record. Both laughed off the bill for what it really is — just another way to get municipalities to borrow more, which means more business for their industry. Is that really what we need?

Who is representing the public on this — service recipients and taxpayers? Nobody, that’s who. I doubt there are even ten members of the General Assembly who understand these things. I got hold of the House Republican Staff analysis of the bill. Unbelievably, it mentions none of the issues raised above. In fact, it says the rationale for the bill is helping municipalities by smoothing out what has become an irregular flow of their money from Springfield. Huh? That’s not what people in the muni bond industry say is the purpose of the bill and it’s hard to see how the bill smooths out revenue flows.

The bill is sponsored by Senate President John Cullerton (D-Chicago). I trust you know what that means about the public interest being served. It was negotiated on the other side by Senate Minority Leader Christine Radogno (R-Lemont). Sorry, but she’s just not up to the job, as I argued recently.

Nor has the press figured out any of this. The single exception is an article in The Bond Buyer by Yvette Shields (reprinted by Fidelity Investments and linked here). It’s excellent, but it’s technical and written for the municipal bond industry, so you cannot expect a critical analysis of the bill from a taxpayer’s perspective. It contains quotes from some of the usual sources who comment on municipal bonds. That’s a serious part of the bigger problem about municipal finance reporting: Most experts are in the business and biased towards it.

Finally, you should fairly ask whether talk that pits bondholders against taxpayers, as I’m engaging in here, is harmful. Won’t it scare off future bond buyers and push up borrowing costs?

First, the municipal bond industry is already thinking in those terms. That’s why they want Senate Bill 10. That’s why they’re already taking dibs on public bones in a number of other ways, as I recently wrote. The bond folks are running laps around the public interest. They know we are heading into the tank.

Second, the risk is routine in the insolvency world. There’s just no way to avoid it entirely, but it can be mitigated by acting quickly and decisively. Illinois and its muncipalities are doing the opposite by relying on the solution that got us here — borrowing and mortgaging more and more. The risk can also be mitigated by carefully limiting further borrowing. That’s why anything like Senate Bill 10 should be considered only if paired with stricter borrowing caps that would prevent the risk of an assetless bankruptcy from ever arising. Current borrowing caps aren’t working, but that’s a subject for another day.


Mark Glennon is founder of Wirepoints.

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