New Illinois GOP governor to deal with worst fiscal mess in the nation

Illinois's new Republican governor, Bruce Rauner, will be sworn in today, and he is facing what most experts agree to be the worst fiscal crisis of any state in the nation.

The Democrat-controlled legislature simply can't restrain itself.  That, and a pension time bomb set to go off in the next few years, swamping the state's finances, makes Rauner's job the most challenging of any new governor elected in November.

Some of the numbers in this Reuter's report are incredible:

Pension payments are projected to jump to nearly $7.6 billion in fiscal 2016 from $6.8 billion this fiscal year. And outgoing Democrat Governor Pat Quinn's budget office recently estimated Illinois' pile of unpaid bills will climb to $9.8 billion at the end of fiscal 2016, from $4 billion this year.

"In the modern era ... the state has never been in this poor of financial condition," said Laurence Msall, president of the Civic Federation, a Chicago-based government finance watchdog group.

To make progress, Rauner will need to find a way to work with a legislature dominated by longtime Democrat power broker Mike Madigan, speaker of the Illinois House. David Merriman, an Illinois budget expert at the University of Illinois, said Rauner needs to focus on what is politically achievable. "You have a Democratic legislature and a Republican governor so they're going to have to figure out some way to work together," he said.

Robert Amodeo, a portfolio manager at asset manager Western Asset, put Illinois in a same class with the most troubled municipal bond issuers in the nation. "We will continue to monitor developments in Puerto Rico, New Jersey and especially Illinois, all of which face challenging fiscal conditions," Amodeo said.

To sell its debt, Illinois has had to offer hefty yields. Illinois bonds due in 10 years yield about 140 basis points more than stellar AAA-rated debt, according to Municipal Market Data. California, which is bouncing back from its fiscal morass, has a so-called credit spread of only 24 basis points.

Illinois' credit ratings at A-minus and A3 are the lowest among the 50 states and rating agencies have warned of further downgrades. An immediate concern is the Jan. 1 partial expiration of 2011 temporary tax hikes that moved the personal income tax rate down to 3.75 percent from 5 percent, and dropped the corporate rate to 5.25 percent from 7 percent.

Quinn's budget office projected that income tax revenue will drop by $5.16 billion to $14.64 billion in fiscal 2016, which begins July 1. The state's projected general fund deficit is expected to balloon to nearly $5.8 billion, from just $180 million this fiscal year.

A pension reform plan that passed the legislature in 2013 only after former Governor Pat Quinn cut off the pay of legislators was weak tea for what ails the system.  But even the tiny reforms the legislature spilled so much blood over were successfully challenged in court by the public employee unions.

Don't expect Rauner to pull a Christie and battle the unions.  They are far more powerful in Illinois than in New Jersey.  The state is also on the hook for the city of Chicago's municiple unions, including police, firefighters, and mass transit.  They, too, have pension woes for which the state is fiduciarily responsible.

With the state having to offer what amounts to junk bonds to fund its deficit, they sink into a debt trap.  Those high-yield bonds have to be paid off eventually, and that will precipitate another fiscal crisis down the road.

Education funding is a bloated mess, and reforms should realize some savings.  But infrastructure needs over the next decade – including $20 billion to fix wastewater treatment facilities – make for another ticking bomb.

It is entirely possible that Rauner will be unable to get a grip on this mess.  The Democratic legislature is not going to be in a mood to cut its pet projects, or go against the public employee unions to bring about true pension reform.  As an outsider, Rauner is being viewed warily even by Republicans in Springfield.  He appears to have the temperament to be successful – a sunny disposition and an optimistic outlook.  But how will that work when both parties dig in their heels at the expected pain his reforms will bring?

It's going to be a very rocky ride for Rauner this term.

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