Hidden consequences of Illinois’ credit downgrades

October 15 2013

Illinois’ credit rating is in a free fall. Rating agencies have downgraded Illinois 13 times under Gov. Pat Quinn. Most recently, Moody’s Investors Service reduced Illinois’ credit rating to A3 from Aa3 – just four notches above junk status. Even before this downgrade, Illinois already had the worst credit rating in the nation.

Illinois credit downgrade

Illinois’ constant rating downgrades have very real costs. The most immediate cost is in the form of more expensive borrowing rates for the state. The government already pays nearly 1.5 percentage points more than what the highest-rated states pay for 10-year bonds. This means hundreds of millions of dollars in additional interest costs over the next decade — money that could be used to lower taxes or pay for education, public safety and infrastructure. Illinois could also use this money to pay down its  $100 billion unfunded pension liability.

But the increased cost of state borrowing pales in comparison to the pain suffered by local governments and the people of Illinois. While most of the focus has been on more expensive borrowing for the state, it is important to highlight these dangerous consequences:

  1. Local governments will be hurt. Credit downgrades don’t just hurt the state government; public universities and local governments will be part of the collateral damage. Just like Illinois, their credit ratings will be dragged down, meaning that loans necessary for investment will be more expensive. The damage from Illinois’ overspending reaches all the way into public classrooms, libraries and other local services. All Illinois citizens — not just public workers — have a stake in reforming the state pension system.
  2. The state’s economic outlook suffers. The state is already ranked 39th in entrepreneurial activity and 48th in economic outlook by the Kauffman Foundation. Illinois’ credit downgrades and budget crisis make tax hikes more likely, creating an even riskier place for entrepreneurs to establish new businesses.
  3. Four steps away from “junk bond” status. More downgrades may dramatically worsen the state’s crisis. Illinois’ credit rating is only four steps away from “junk bond” status. “Junk bonds” are considered too risky for many retirement and investment funds. If Illinois reaches this point, these funds will no longer be able to invest in the state’s bonds. Such a downgrade would magnify the consequences of Illinois’ poor credit rating. This would further exacerbate Illinois’ credit and budget crisis.

Until the Illinois General Assembly implements bold solutions, including pension reform, Illinois’ most recent downgrade won’t be its last. Future downgrades could lead state lawmakers to push for even higher taxes and put Illinois on the path to insolvency. The legacy of our current government will be defined by its choice between two divergent paths: higher taxes and stagnant growth, or bold reform and the prosperity that follows.

TAGS: credit rating, Moody's Investor Services