State of Illinois, meet Reality

Illinois, while not the most populous state, has led the nation in unfunded pension liabilities and bond debt. Now, however, its borrowing binge may be ending

The change has not come about because the state is defaulting on its payments or seeking bankruptcy. As of now Federal bankruptcy law does not allow states to file in Federal court for bankruptcy protection. The real reason for the change is that the SEC (Securities and Exchange Commission) charged the state of Illinois with securities fraud for misrepresenting its financial position from 2005 to early 2009. In most of those years the Governor of the State was Rod Blagojevich, the carefully coiffed chief executive who was convicted of trying to sell Barack Obama's senate seat when he resigned to run for president.

The governor was convicted of corruption and is now serving a 14-year sentence. Unfortunately, the damage he did to the fiscal stability of Illinois and the taxpayers of Illinois will last much longer than his incarceration. Under his leadership, the state consistently passed wildly irresponsible budgets, and even though the state constitution requires a balanced budget, the budget was "balanced" by issuing bonds every year.

However, after Blagojevich left, from March 2009 to January 2013, the state of Illinois saw its credit rating lowered a total of 11 times by Moody's, Fitch, and S&P combined. This means Illinois must pay 1.45 percentage points more than the nation's AAA-rated states on 10 year bonds. This deprives state programs that assist the poor of badly-needed services, and led the state to choose to cut back on Medicaid spending rather than on lavish pensions. It also has a stack of unpaid bills to vendors amounting to over 7 billion dollars. The Cato Institute has called Illinois Governor Pat Quinn, who followed Blagojevich, the worst governor in the nation for failing to show any leadership in either fiscal responsibility or pension reform.

Today $96.8 billion dollars of unfunded pension debt looms over the state's fiscal future. This will place heavy burdens on the taxpayers of the state for decades to come. And Cook County, the county that contains the City of Chicago and some of its satellite suburbs, also has a startling debt of $140 billion of its own in addition to the state debt. This single county obligation is far greater than the total debt of most other states.

Since the SEC has accused Illinois of misrepresenting its debt, however, Illinois may no longer be able to bail itself out by selling bonds on Wall Street. Just this past January it tried to raise $500 million by selling bonds and Wall Street said no. Its borrowing days are over.

Just a few days ago Illinois passed a new law that will begin to rein in its unfunded pension liability. Now state workers will no longer have their pensions increased three percent per year on their entire pension, just the first $25,000.

For all but two of the past 30 years the Illinois State House has been run by Speaker Michael Madigan. He so thoroughly dominates the Illinois legislature that the state has been renamed "Madiganistan" by Chicago Tribune columnist John Kass.

But in this case the speaker's total control over the legislature does have a benefit. Having been forced to finally begin to come to terms with the state's debt, the speaker is the one person with the power to change things. If Michael Madigan tells the state's public sector unions the state's borrowing days are over, they have no choice but to listen. They have supported him and his party for decades.

But this change was initiated not by the politicians but the private sector. And this may be a harbinger of things to come for Washington, D.C. and Obama's borrowing binge. President Obama learned his spending/borrowing habits from Illinois state leaders and the City of Chicago's mayors. It's no surprise that under his leadership the U.S. has seen its first reduction in its credit rating.

But the private investors who no longer want to invest in Illinois bonds may be the first sign that Obama's spending days are coming to a close. Foreign nations may no longer be willing to buy U.S. Treasury bonds. This point comes nearer every day. In the meantime the president is using Federal Reserve QE3 to raise the national debt limit, since an obstinate House will no longer vote for a significant increase in the debt ceiling.

The inability of Illinois politicians to control their spending is finally being recognized and restrained by the private capital market. This is all good news for residents of Illinois and the U.S. taxpayer. One can only wonder if the SEC will direct is attention toward the Obama's Administration spending; or if the SEC has the authority to charge the White House with misrepresenting the nation's long-term fiscal stability when it issues T-bonds to the global bond market.

While presidents in the past have fought with Congress over spending, Obama has now bypassed the Congress and is spending using the Federal Reserve and Treasury Department. This issue, along with major entitlement program spending liabilities, dominates the long-term economic landscape.