E. Jason Wambsgans/Chicago Tribune
Illinois Statehouse, Springfield, Illinois
You may have noticed a scary sounding headline the other day: "SEC Charges Illinois for Misleading Pension Disclosures: The Securities and Exchange Commission today charged the State of Illinois with securities fraud for misleading municipal bond investors about the state’s approach to funding its pension obligations."
Securities fraud: that sounds bad. The net effect, though, is minor. The SEC settled with the state…for the state promising to never do it again. "Slap on the wrist" isn't even a good metaphor; it's more like the SEC banging its broom on the ceiling so Illinois will cut it out. Bloomberg's Jonathan Weil calls it "SEC self-parody at its finest" in a short post entitled And the SEC Wonders Why Investors Think It's Spineless.
What'd we do wrong? The SEC explains:
The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations.
Weil aside, not that many people seem worked up about the SEC's unwillingness to pursue a pound of flesh from the state, for reasons that have to do with the oddity of bonds, bond ratings, and bond investing. It's not like Illinois was actively trying to cover up its mess, as the SEC acknowledges. What it would do to the pension funds was well-reported at the time:
For the budget year that begins July 1 [2005], the governor's office had pegged the pension payment at about $2.1 billion. The proposal, relying on what Democrats call future savings, would give the pensions $1.5 billion instead.
For the budget year that begins in July 2006, the next election year for governor, the pension target had been about $2.5 billion but would be reduced to $1.8 billion.
And by 2005 there was already substantial precedent:
According to Bauman's latest analysis, each $1 that does not go into the pension systems now will add $11 to taxpayers' burden 40 years from now.
But the prospect of deferring payments to future generations has never slowed lawmakers or governors, who since World War II have used the state's pension systems as a cash cow to avoid politically controversial ways of raising money.
In 1989, lawmakers approved a 40-year plan aimed at reducing all but 10 percent of what was then the state's unfunded pension liability–the difference between pension assets and pension payouts. That amount then totaled about $10 billion.
Despite a tougher law passed six years later aimed at making sure the state's contribution to the pension systems automatically came out of the budget over the next 50 years, state payments continued to be insufficient. Now, the unfunded liability of the state pension systems has risen to about $35 billion.
The SEC is mad that the state literally said "we're cutting back now, but we'll fix it in a couple years." It's tricky because these are things you'd expect institutional investors (not to mention residents who follow politics) to know—that Illinois, as states go, is a poor credit risk. And as Cate Long notes, the SEC was in a fix. If they took it out on the state, that would hurt taxpayers; if they took it out individuals, it probably wouldn't work. She passes along a plan that would "strip the federal tax exempt status from the bonds of any municipal entity if they don’t follow the federal disclosure requirements." Which would be much more devastating than a fine, but would at least set the punishment up front.
And it's not like Illinois isn't paying already. Having pulled one bond issuing after a credit-rating decline, it's trying again with a bigger one: "Investors demand a yield penalty of 1.3 percentage points above AAA securities to own debt of Illinois issuers, almost seven times the average in 2005, when the SEC said the inadequate disclosure began."