Illinois Ponders Pension Moonshot Gamble: $107 Billion Bond Sale

What better time than now to borrow $107 billion to invest in stocks? That's what Illinois is actually considering.

Springfield lawmakers are so desperate to shore up the state's massively underfunded retirement system that they're willing to entertain an eye-popping wager: Borrowing $107 billion and letting it ride in the financial markets.

The legislature's personnel and pensions committee plans to meet on Jan. 30 to hear more about a proposal advanced by the State Universities Annuitants Association, according to Representative Robert Martwick.

Illinois owes $129 billion to its five retirement systems after years of failing to make adequate annual contributions. Because the state's constitution bans any reduction in worker retirement benefits, the government's pension costs will continue to rise as it faces pressure to pay down that debt, a squeeze that has pushed Illinois's bond rating to the precipice of junk.

GMO 7-Year Forecast

Illinois vs GMO

While Illinois is pondering a moonshot gamble, note that GMO expects real returns to be -4.7% per year, on average, for seven years.

"Real" factors in inflation which GMO estimates will "mean revert" to 2.2% over 15 years.

If correct, assume U.S. stocks will lose 2.5% a year for 7 years and U.S. bonds will gain 1.2%.

I will take a stab that pension obligation bonds will yield 7% or so. Heck, assume a generous 6%.

The state proposes borrowing money at 6% per year while losing say 2% a year.

That's a loss of 8% per year, every year, for seven years.

One Word - One Sentence

One Word: Crazy

One Sentence: These Illinois legislators are seriously nuts.

But hey, this is Illinois. Nothing less that craziness can be expected.

Mike "Mish" Shedlock

" I assure you if you ask someone there to trade a 5 year out call/put using their forecast as the underlying you would get laughed at, they would default to where the market 'is', whereas you stick to their forecast."

So where the Hell did I propse that?

HMO and hussman both have good long-term CAPE analysis. They have both been correct on bubbles , but not timing them.

This is a simple statement of fact, not subject to debate.You threw in a bunch of BS about 5-year out puts and calls.

you used the -2.5% for yield, (sorry if I'm inaccurate on #'s - but using a cell phone, so it's hard to read back and see the exact number). So with that, you tell me what underlying you are using 5 years out (Roughly 2500?). You also left out receiving the dividend stream.

You threw in a bunch of BS about 5-year out puts and calls. - not if you are using a fwd expectation 5 years out of 2,500, I didn't. Hussman or the market. hmm... which do you think Morgan and Goldman are using to price those 5 year out calls and puts. I bet every penny I have that they are using 3023.

Forecasts are like...fill in the blank.

I have no problem believing a negative 7 year equity forecast with the way the stock markets have behaved the past year. Lots of precedent for a correction if you use technicals alone. People are easy to read and they herd as they always have. This bull will end at some point and I do not believe it will be 8 years down the road.

The day the bond issue is approved, I'm calling a top in the stock market. Couldn't ask for a better contrarian signal.

Good plan, they’re just 8 years too late.

OK, the stock market is stuffed. The bond market is stuffed. Gold is (as always) maybe stuffed but no one knows. Where the heck am I supposed to put my money?

A government's participation (buy, sell, or regulate) in a trend typically occurs at the end of the trend. This makes for an excellent contrarian signal to sell ones portfolio.

If you haven't noticed, the world is changing as trust in govt collapses under the weight of hubris, corruption, and debauched behavior of the powerful. Mismanagement, and unequal enforcement or ignorance of the rule of law by govt's at all levels is driving capital from public to private. This obviously includes the lack of prosecutions of banksters, and IRS and FBI agents; but it also includes MSU ignoring Nassar, PSU ignoring Sanduski, and Pope's ignoring their petophile priest. History repeats because the passions of man never changes.

Central Banks have been buying equities for years, as rates went negative and the trust in UNSECURED govt debt faded. Whether it's dumb luck or forced recognition of the obvious, IL buying equities is a smart move, which means I don't see them doing it.

Like a good Marxist and career politician that thinks they can manipulate markets and society by suspending the actions of the invisible hand, you are trapped in a world you wished would never change. It's why you didn't see Trump, Bitcoin, gold's decline and the rise in stocks. Old theories and rules don't work in a world that is beyond the timeframe of programers, analysts, and pundits. It's the same reason the Black Scholls model failed and brought down LTCM - https://www.armstrongeconomics.com/products_services/socrates/trading-v-socrates/.

Whether you want to acknowledge it or not, more and more foreign capital will be forced into dollar-based assets, as the soveriegn debt crisis sweeps the globe. Since the crisis is rooted in govt malfeasance, who will want to purchase govt debt? Stocks, gold, cryptos, and other assets that store value and human effort will be the beneficiary. Since stocks offer the only market big enough to absorb the flows out of govt bonds, blue chip stocks will benefit the most (outside cryptos).

It would be nice if govt would simply look in the mirror and reform, but that's just not the way it has EVER happened. Govt always drags society off the cliff trying to hold on to their perks and power. Besides, look in your muni's CAFR. They already own massive amounts of income producing assets, including stocks, that never make their way into budgets. How could they sell raising taxes if the voters knew they were sitting on massive "rainy day" funds, which are only meant for their rainy day?

Calls for a top in stocks over the last 7 yrs has been an "excellent contrarian signal", and you haven't seen anything yet. Volatility this year will get the masses off-sides, as the majority must always be wrong. The dollar pullback right now is a classic example.

One sentence: who is stupid enough to loan IL money?

You can't be 7 years early and still be considered right. Every market cycle eventually corrects, or even crashes, that doesn't make pera-bears 100% accurate.. Hussman has been the wrongest person on Earth, besides perhaps David Stockman, the past 9 years.

the reality of modern finance is that you own bonds and you own stocks at the same time, you leverage the bonds the buy stocks. conventional thinking goes that state government can't run a deficit, but they print bonds which adds to the global liquidity. They it turn buy those stocks for which they provided the liquidity. The fundamental relationship is valid.

"Whether it's dumb luck or forced recognition of the obvious, IL buying equities is a smart move, which means I don't see them doing it." It was a smart move back in 2009 or so. Not so any more. Parabolic moves always fail. IL would fail to get out of the way when the fail occurs, even if the DOW goes to Armstrong's ultimate projection high, parabolics rapidly retrace in the opposite direction.

Lets' say the state did this in 2012 - The state would look like heroes, doubling its pension assets assuming it was all in stocks. Then lets' take back that entire move over the next 7 years. The state would be further behind. because it would still be paying 6% per year on the borrowed money. The plan is insane. Just to break even the investment needs to return 6% a year to beat the interest payment!

Seems rational. If the gamble pays off-well and good. If it doesn't, declare bankruptcy. Their going bankrupt any way so if your going down for $1 billion, why not $100 billion. End result is no different.

There seem to be two questions that are impossible to answer. First, who would buy Illinois bonds? Second, how is the pension fund going to get a 6% return? I know a magic answer to both! Have Illinois issue $100 million in bonds, and sell them all to the Pension fund! Just like magic, the pension is fully funded, and has a nice 6% return, exactly matching what they need. How will Illinois ever repay the bonds? Shhh... Obviously they aren't, but in the meantime they've kicked the can down the road, and after all, isn't that the goal? No one actually wants to face the problem; they just want to kick it far enough down the road that someone else will have to deal with it. What better way to kick the can than to instantly fully fund the pension fund by making a fictitious journal entry.

Meg Whitman did something like this in the New Jersey in the late 90s and we all know how well that turned out. We're the highest tax state in the union, with arguably the most precarious pension scheme in the county, besides Puerto Rico. I know Illinois is sometimes ranked as worse than NJ, but Illinois still has lower taxes than NJ, so they have, perhaps, more wiggle room to try and catch up.

I think you can put a different interpretation on this. It will be much harder for Illinois to default on bonds than pension obligations (despite what the Illinois Supreme Court says) and so by shoring up the pension fund, there is a lower likelihood of the pensioners being stiffed (or they will be stiffed less). Pretty smart move on the unions' part.