Henes: Focusing on Unsustainable Debt

On March 18th, in a CNBC blog, I explained that our states are too big to fail and too big to save. I also pointed out that certain of our states, in many ways, have already failed. As they try to balance their structural budgets, public education and public services are being cut drastically, thereby harming young minds and failing to provide taxpayers with the benefit of their bargain - i.e., paying taxes in exchange for quality services and protection.

On Monday, May 23rd, Dan Rutherford, the Treasurer of Illinois, began a crusade against the incurrence of more debt. Specifically, he announced that the State of Illinois is on the verge of financial disaster and, in a concise report, he disclosed certain important fiscal facts about Illinois, including:

  • The amount of Illinois’ general obligation bonds has increased from $12 billion in 2002 to $45 billion today;
  • $25 billion of borrowing has gone to making pension payments;
  • Illinois unfunded pension and retiree health-care liabilities are $140 billion;
  • Illinois has more than $8 billion of unpaid bills to vendors;
  • Illinois spends $3 for ever $2 of revenue (even with the 67 percent tax increase earlier this year); and
  • Each household in Illinois is on the hook for $42,000 due to the debt burden (including unfunded pension and health-care liabilities).

This report should be taken seriously. In short, it tells the citizens of Illinois that kicking the can down the road by continued borrowing and spending more than the state takes in is not a solution; rather, it is a recipe for financial disaster. Consequently, Illinois (as well as many other states in similar fiscal situations) should focus on restructuring its balance sheet and operations by using tried and tested techniques in the corporate setting.

Over-levered corporations in financial distress use comprehensive restructurings to reshape their businesses and position them to compete and grow. The process used makes good business sense. First, corporations hire seasoned professionals experienced in restructurings to help them determine the right path to consummate a restructuring. Second, the corporation and the professionals analyze the corporation’s fiscal condition, focusing on projected revenue, spending needs and proper debt levels. Third, the corporation prepares a long-term business plan. Fourth, the corporation’s stakeholders are organized to enable good-faith negotiations. Fifth, the corporation and its stakeholders engage in negotiation regarding a restructuring plan. Sixth, the restructuring plan is implemented.

While these six steps are over-simplified, they provide a framework for fixing a corporation’s balance sheet and operating issues. These same six steps can be used by states to help consummate comprehensive restructurings. Restructurings are not easy and can be rough as stakeholders need to make sacrifices. But, with a fair process and open communications, a state’s stakeholders will understand the need for the sacrifices and the future value and opportunities to be attained when the state becomes fiscally strong.

And this brings us back to Treasurer Rutherford’s report. Disclosing the true state of a state’s fiscal affairs is critical. Citizens need to understand the fiscal issues and be aware that there is no easy solution to the structural budgetary problems faced by states across the nation and the overwhelming amount of unfunded liabilities for which the tax payer will ultimately be responsible. After understanding the problem, politics should be set aside and the problems should be attacked through a comprehensive restructuring plan, which may lead to short-term pain, but, if done correctly, it will lead to long-term gain.

Jon Henes is a partner in the Restructuring Group of the law firm of Kirkland & Ellis. Jon's practice involves representing debtors (including portfolio, privately-held and public companies), creditors' committees and distressed investors (including hedge funds, private equity funds and companies) in acquisitions, restructurings and bankruptcy cases.