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Figure1:$480MILGOBonds,SeriesofJanuary2016Actualvs.CounterfactualBondPriceComparison,

Maturity-by-Maturity(%ofPar)

ActualPrice CounterfactualPrice

JANUARY 2016

FACT SHEET

Still in the Penalty Box: The $53M “Financial Condition Penalty” on Illinois’ January 2016 Bond Sale Martin J. Luby, DePaul University and the University of Illinois Institute of Government and Public Affairs Background On January 14, 2016, the state of Illinois sold $480 million in General Obligation Bonds (the “2016 Bonds”). This was the state’s first bond issue since the Illinois Supreme Court struck down the pension reform legislation in May 2015 and while the state is still without a budget − both of which contributed to its recent credit rating downgrades. Just as for consumers, the state’s credit ratings affect its borrowing costs. So just how much of a “financial condition penalty” did Illinois pay on this month’s bond sale? Methodology To answer this question, I assume that the state sold its 2016 Bonds at the relative prices it received on bonds it sold 10 years ago when the state’s credit ratings were much higher.1 I then compare these counterfactual prices to the actual prices Illinois received on its 2016 bonds. The difference between the counterfactual and actual bond prices is the financial condition penalty paid on the 2016 bond sale. Findings • Depending on bond maturity, the state

received actual prices on its 2016 Bonds that ranged between 98 percent and 114 percent of the par amount. The 2016 counterfactual bond prices ranged between 104 percent and 127 percent of the par amount. Figure 1 compares these prices. The gap between these lines represents Illinois’s financial condition penalty.

• Based on these individual bond prices, the total dollars the state actually received for the 2016 Bonds was $514,971,072. The total dollars the state would have received if the 2016 Bonds carried the relative prices on Illinois bonds 10 years ago (i.e., the counterfactual price) was $567,875,712.

• The aggregate difference between the actual and counterfactual bond prices was $52,904,640,

which is the financial condition penalty. This nearly $53 million financial condition penalty is an estimate of the cost to the state on this bond issue as a result of the deterioration in its financial condition over the last 10 years.

1 The “relative prices” used in this analysis are based on the state’s bond yields relative to the benchmark MMD AAA bond index as published daily by Thomson Reuters

2

Future Policy Implications • The $53 million financial condition penalty estimate only relates to the 2016 Bonds. Assuming that

future debt sales will be at typical levels of about $1 billion each year, this financial condition penalty grows to $106 million per year.

• Furthermore, based on recent analyses, the state will need to issue much more annual debt than in the past to address its growing infrastructure needs. A recent estimate of the annual bond amount required to address these needs is $4 billion. At this $4 billion annual bond level, the financial condition penalty estimate grows to $424 million per year.

• Even in the context of the overall state budget, this $424 million is a significant annual amount of money, especially given the dire fiscal straits the state finds itself in today. For example, this $424 million would provide a substantial amount of the extra funding that the Chicago Public Schools is requesting from the state to address its budget deficit.

Conclusion In addition to the benefits that would accrue to service provision, economic stability, and faith in government, this analysis underscores that future policy actions to improve the state of Illinois’ financial condition could save the state tens of millions of dollars annually in borrowing costs. Receiving higher prices for its bonds means that the state would have more resources for funding its other policy priorities. Conversely, inaction on improving the fiscal condition will result in a significant and continuing financial condition penalty.