Illinois in debt death spiral, emblematic of what future?

Illinois Debt

What is happening in Illinois? It seems as if it has gone from the “Land of Lincoln” to the “Land of Debt.” Illinois is not alone but is emblematic to many other states in the U.S. News Forecasters asks, just how serious is the state’s financial situation and what are the wider implications for the country and the rest of the world?

Mercatus Center (see interactive graphic) at George Mason University ranks the 50 states according to their financial condition. The top five most fiscally solvent states are Nebraska (#1), South Dakota (#2), Tennessee (#3), Florida (#4), and Oklahoma (#5). The bottom five states in terms of fiscal solvency are Kentucky (#46), Massachusetts (#47), New Jersey (#48), Connecticut (#49), and Illinois (#50). Illinois is clearly the poster child of how not to run a state.

Illinois Debt Chart

The state of Illinois recently reported its biggest annual financial loss ever. Instead of clear reporting, the state’s finances have been misunderstood, misreported, and intentionally distorted. The biggest loss was overwhelmingly due to an accounting change that had a $42 billion impact. The change was for healthcare costs owed in the future to state retirees, called OPEBs (other post-employment benefits). But over the years there have been similar accounting issues.

A common trick politicians have used, is accounting gimmicks to hide the true state of the state’s finances when passing over-promise benefits to various groups, and then expose the financial problem when the next comptroller comes into office. It is politically expedient. Nevertheless, Illinois is going from a net financial position of -$6bn to -$184bn is eyepopping.

US Population Change

Not helping Illinois is population decline/change. Domestic immigration is declining, though international immigration is rising. This demographic change means paying immigrants leave as less paying immigrants come. From July 2017 to July 2018, Illinois’ population shrank by more than 45,000 people. State lawmakers’ passing a record-breaking permanent income tax hike in July 2017 hasn’t helped matters. This policy has deterred new investment and job creation, making Illinois a less promising state in which to find opportunity. In the inset chart, you can see where populations are going. Destination locations tend to be less populated, lower housing costs, lower taxes, and have some “natural” beauty (coastal, mountains, and climate).

But debt should not be looked at as a mere debt total, rather the debt to GDP ratio – ability to pay back the debt. The state’s debt to GDP ratio data paints a slightly different picture, perhaps even more dire. The top 5 states with the highest debt to GDP ratio are; (#1) New York: 23.53%, (#2) South Carolina: 19.19%, (#3) Rhode Island: 19.06%, (#4) Alaska: 18.69%, and (#5) Nevada: 18.59%. Using this metric and recent debt revelations, Illinois moves up into the top 5 at near 21% debt to GDP ratio.

So what does all this mean? U.S. states do not have the ability to monetize (print money) their debt like the federal government. They really do have to pay the money back either through higher taxes, debt restructuring, or bankruptcy. Higher taxes and debt restructuring has been done and is ongoing, though losing GDP via loss of population and business leaving the state can make this debt to GDP ratio accelerate. This downward spiral continues. How low can it go?

Debt to GDP ratios probably can go much higher (perhaps as high as 50 to 80%) and keep the state solvent. BUT, this all depends on whether interest rates stay low. If in the future, the state of the overall U.S. economy goes into hyperinflation mode and interest rates skyrocket, a crisis is brewing. News Forecasters believes this scenario will eventually happen in the U.S., though perhaps 5 to 10 years away.

The final solution to this state debt issue is bankruptcy – likely in perhaps 5 to 10 years. What could happen in a state bankruptcy? The most obvious event will be current state promised pensions and benefits would be renegotiated – fewer benefits. The federal government may offer some bailout funds, but for the most part, the states will be on their own. Taxes already high will go higher. This will not only include the regular tax venues that states use but also tax assessments on assets – including potential forced asset sales of public and private property (for those who can’t pay the assessments).

In 2008 and the Great Recession, homeowners of lower to middle-class standing took the hit (bankruptcy and foreclosure) during the financial crisis while others got bailed out. In a coming crisis, we move up the food chain, state and local governments, thereby targeting the upper-middle class (asset owners) to pay. Obviously, during an economic period like this, a Rubik’s cube of issues globally will be at play (a story for another time). State and local governments may be ground zero for the next financial crisis.

A video presentation of this subject:

Leave a Reply