33

Today Illinois bonds were downgraded to 1 above junk. The article. Citation from article:

Despite the lack of a budget, Illinois has continued to cover payments due on its bonds, and, like other states, has no ability to resort to bankruptcy to escape from its debts. A downgrade to junk, though, would add further financial pressure by increasing its borrowing costs and preventing many mutual funds from buying Illinois’s securities.

If "Illinois cannot go bankruptcy", is it safe to buy its bonds and wait until they mature?

After reading your 4 answers, I learned that Illinois can default without going bankrupt. If they do that what do I (and other bond holders) do? My understanding is that without bankrupt, Illinois will owe me the money forever. Can I sue Illinois and ask Illinois to sell building, lands and rise taxes to pay me back?

Has any state in USA ever declared bond default in the past?

  • 16
    If it is so safe why can't mutual funds buy any? And if it's just as safe as before the downgrade why did the yield go up after the downgrade? If the risk doesn't change why grade them at all? – quid Jun 2 '17 at 5:15
  • 5
    "bonds that can never default", famous last words – William Entriken Jun 3 '17 at 20:33
  • 4
    Illinois already has defaulted on debts. (Refusing to pay debts when due is a form of default, even if the borrower does eventually pay.) Just ask any vendor who was forced to wait months for payment, or lottery winners who were not paid promptly. Defaulting on the lottery was an especially dumb idea, because failing to pay lottery winners risks causing people to stop playing the Illinois Lottery. – Jasper Jun 4 '17 at 16:22
  • Please fix typo: Illinois will own (owe) me the money forever – Hanky Panky Jun 5 '17 at 8:05
  • Ha, I have been using the wrong word long time. Thanks! Changed it. – Tony Jun 7 '17 at 0:45
60

"Can't declare bankruptcy" isn't the same as "can't default". Bankruptcy is a specific legal process for discharging or restructuring debts. If Illinois can't declare bankruptcy, that means it will still owe you the money for the bonds no matter what, but it doesn't guarantee that it will actually pay you what it owes.

If Illinois should run out of money to pay what's due on its bonds, then it will default. Unlike the federal government, Illinois can't print money to make the payments.

  • 12
    makes me think of the same issue with a lawsuit, you only want to proceed with seeking damages and what not if you're likely to collect from the other party. People can sue all they want but directed toward someone with no assets or cash all you have at the end of the day is a judgement and an award but no funds to back it up. – jxramos Jun 2 '17 at 6:35
  • 3
    Not that you want the feds to print money to pay their debts, anyway, because then you're losing value to inflation. +1, though. – jpmc26 Jun 2 '17 at 16:48
  • 3
    @Myles: Just like any other kind of debt. If you miss a couple of credit card payments, you're in default, but the debt is most certainly not gone. – Nate Eldredge Jun 2 '17 at 18:46
  • 1
    @Myles: Yes, they're things, and the value varies. Technically a bond is already in default if a single penny isn't paid that should have been paid. Now in general defaulting on bonds is considered a bad thing, so many debtors will pull increasingly desperate trick to avoid a default, and when the default finally happens there will only be pennies left. But lawsuits freezing assets may cause a company to become to become temporarily illiquid. – MSalters Jun 2 '17 at 23:17
  • 2
    @jpmc26: You're only losing money by inflation there if your wealth in dollars (not counting other assets not subject to inflation) is enormous relative to the magnitude of the debt. Not really an issue. – R.. Jun 3 '17 at 15:28
36

If Illinois cannot go bankruptcy

This is missing a few, very important words, "...under current law."

The United States changed the law so as to allow Puerto Rico to go into a form of bankruptcy. So you cannot rely on a lack of legal support for bankruptcy to protect any bond investments you might make in Illinois. It is entirely possible for the federal government to add a law enabling a state to discharge its debts through a bankruptcy process. That's why the bonds have been downgraded. They are still fine now, but that could change at any time.

I don't want to dive too deep into the politics on this stack, but I could quite easily see a bargain between US President Donald Trump and Democrats in Congress where he agreed to special privileges for pension debts owed to former employees in exchange for full discharge of all other debts. That would lead to a complete loss of value for the bonds that you are considering. There still seem to be other options now, but they seem to be getting closer and closer to that.

  • Isn't there some sort of protection in law against retroactive laws? – curious_cat Jun 4 '17 at 4:36
13

If you give money to a person or entity, and they don't have the ability to pay you back, it doesn't matter if they are legally required to pay you.

  • It may affect your ability to convince a government entity to give you taxpayer money to offset your loss. – supercat Jun 3 '17 at 21:47
  • @supercat "May", but that's part of a negotiation. These are expensive, time consuming, unpredictable, and IMHO unlikely to go in favor of people who ask questions on this particular stackexchange. (People who address the questions to professional financial advisors and their legal department have an edge in this case) – Peter Jun 3 '17 at 22:00
  • I should have said it may affect the likelihood of a government entity using money taken from taxpayers to counteract your loss. My intention wasn't to imply that individuals might effectively seek reimbursement, but rather that individuals might benefit from membership in classes that get reimbursed. – supercat Jun 4 '17 at 21:06
11

Sovereign immunity is the state's ultimate "get out of bankruptcy free" card. After all, the state has a hand in defining what bankruptcy even is in their state. Federal law is a framework, states customize it from there.

The state's simplest tactic is to simply not pay you. And leave you scrambling to the courthouse for redress. Is that an automatic win? Not really, the State can plead sovereign immunity, e.g. Hans v. Louisiana, Alden v. Maine.

You could try to pierce that sovereign immunity, essentially you'd be in Federal court trying to force the state into bankruptcy. This would pit State authority against Federal authority. The Feds are just as likely to come in on the state's side, and you lose. Best scenario, it's a knock-down drag-out all the way to the Supreme Court. You would have to be one heck of a creditor for the legal fees to be worth your trouble.

States don't make a habit of this because if they did, no one would lend money to them, and this would be rather bad for the economy all around. So business and government work really hard to avert it. But it always stands as their "nuclear option".

And you gotta know that when loaning money to States.

  • Bankruptcy is federal law, not state. – Pete Becker Jun 4 '17 at 7:12
  • Seems no state so far has ever defaulted. So Illinois GO bonds (BBB- now) seem to be safer than AAA/AA corporate bonds – Tony Jun 4 '17 at 14:26
  • "Past performance is not an indicator of future results". Especially with an anti-big-government non-traditionalist in the White House. – Harper Jun 4 '17 at 14:30
  • 5
    @Tony There have been 23 state bond defaults in the past. expectedloss.blogspot.sg/2012/05/… – Erwin Bolwidt Jun 4 '17 at 15:12
  • Very interesting link. Quote: During the 20th century, there was only one case in which a state bond default resulted in losses for individual investors: the Arkansas default of 1933. That was right after great depression. If another recession comes around, Illinois could be the next one to default. – Tony Jun 4 '17 at 16:27

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .