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Broke States Trying New Tricks to Wrangle Lending

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With faith quickly disappearing in the ability of Illinois and Connecticut to pay their general obligation debts, the states are employing a new method that draws directly from tax revenues to secure financing. The Wall Street Journal editorial board provides the example of Puerto Rico as a warning that this gambit may not work out as well as intended. The editors write:

Detroit’s Chapter 9 bankruptcy in 2013 set a precedent by subverting GO bondholders to pay public workers and retirees. Prior to Detroit, creditors considered GO bonds sacrosanct and figured courts would compel local governments to raise taxes or cut pensions to repay them. That assumption proved incorrect. So creditors are now demanding higher yields for GO bonds issued by fiscally irresponsible governments.

Hence, Connecticut lawmakers recently authorized bonds backed by state income taxes as a substitute for GOs. The budget noted that “the new type of borrowing authorized in the bill may be viewed more favorably in bond markets because it is linked directly to a large and relatively stable revenue source.” Hmmm.

Income-tax revenues in Connecticut have repeatedly fallen short of estimates due to tepid economic growth. Last year they were off by $530 million. Perhaps Democrats consider this a rounding error on a $3.5 billion deficit. Chicago has reassured investors that the new “corporation would be considered bankruptcy-remote” (our emphasis). However, “in the unlikely event of a municipal bankruptcy, bondholders would still be paid.” Not so fast.

Puerto Rico likewise established a special public corporation in 2006 to issue sales-tax “Cofina” bonds, which were billed as more secure than debt paid from the commonwealth’s operating fund. And for a time that appeared true as politicians raised the sales tax (which was later converted into a VAT) to repay creditors.

But last year Puerto Rico’s governor issued a debt moratorium, which led Congress to impose a fiscal control board and create a quasi-Chapter 9 bankruptcy process. Cofina and GO bondholders are now vying for the same, small pool of money, and both will be lucky to get half of what Detroit bondholders recovered.

Americans are fleeing states with high taxes for places with better prospects like Florida. How long before the tax base of Illinois and Connecticut have emigrated entirely?

Originally posted at Yoursurvivalguy.com.

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E.J. Smith

Editor-in-Chief
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com.