(Bloomberg) -- Illinois is on the verge of its third straight fiscal year without a budget as Republican Governor Bruce Rauner and Democratic lawmakers struggle to agree on how to rein in the government’s chronic deficits, edging it closer toward becoming the first junk-rated U.S. state.
The gridlocked leaders have until midnight to reach an agreement to end an unprecedented impasse that’s left Illinois without a full-year budget since mid-2015. Without a deal around July 1, S&P Global Ratings has warned that the nation’s fifth-most-populous state will likely get downgraded again, losing its investment-grade status.
On Friday, House Speaker Michael Madigan, a Democrat who controls much of the legislative agenda, pleaded with rating companies to "temporarily withhold judgment” as lawmakers negotiate. House will be in session Saturday.
“If they miss this window, then they drop off a big cliff,” said Richard Ciccarone, the Chicago-based president of Merritt Research Services LLC, which analyzes municipal finances. “They would jeopardize their ability to maintain the services of the government, throwing it into serious crisis, and that provides a justification for a downgrade below investment grade.”
Without a spending plan, the state has effectively been on autopilot, leaving it with a record $15 billion of unpaid bills as it spent over $6 billion more than it brought in over the past year. The impasse has devastated social-service providers, shuttering services for the homeless, disabled and poor. The lack of state aid has wrecked havoc on universities, putting their accreditation at risk.
If the standoff isn’t resolved, Illinois officials have said they won’t be able to pay contractors and road construction will shut down, putting thousands out of work. The yields on the state’s bonds have risen as investors anticipate a downgrade.
At its root, the fight is a showdown between former private equity executive Bruce Rauner, who in 2015 became the first Republican to lead Illinois since 2003, and Madigan, who’s served as speaker for decades. The two can’t agree on how to end deficits that were exacerbated when tax hikes expired just as Rauner took office.
The partisan gridlock has created the longest budget standoff ever for a state, according to the National Conference of State Legislatures. Rauner has demanded any plan come with parts of his self-described pro-business reforms like a property-tax freeze and legislative term limits. Democrats have resisted, saying his agenda would devastate the middle class. They’ve passed some of his initiatives, but Rauner argues they didn’t go far enough.
Without a budget that includes borrowing to pay down the bill backlog, Illinois by August will run out of money for key expenses for the first time since the stalemate began, according to Comptroller Susana Mendoza, a Democrat. That means school funding, state payroll, and pension payments could be affected, she said. There won’t be enough money for these mandated or court-ordered payments.
This won’t jeopardize debt-service payments, she said. Illinois hasn’t missed any bond payments and state law requires it to make monthly deposits to its debt-service funds.
The shortfall will get even worse if a U.S. federal judge rules against the state on Friday. U.S. District Judge Joan Lefkow is expected to decide whether Illinois must prioritize payments to managed care organizations that provide Medicaid services. The state owes them about $3.1 billion. The plaintiffs, Medicaid recipients, have asked Lefkow to order Illinois to pay $1.1 billion a month to catch up on new and old bills. The actual burden on the state would be closer to $543 million a month because the federal government shares the cost of Medicaid, but that’s still money the state doesn’t have.
“If we don’t have a budget deal in place by midnight on June 30, it is almost a guaranteed certainty, because the credit-rating agencies have already said as much, they will downgrade us into junk-bond territory, and then good luck trying to climb out of that,” Mendoza told reporters in Springfield on Thursday. “People need to understand this is really happening.”
Investors have been punishing Illinois for its fiscal woes. Yields on the state’s 10-year bonds have soared to 4.8 percent, 2.8 percentage points more than those of benchmark debt. That’s the highest yield of all 22 states that Bloomberg tracks.
On Thursday, Senate Minority Leader Christine Radogno announced that she planned to resign Saturday. That news is "certaintly not encouraging,” said Eric Friedland, director of municipal research in Jersey City, New Jersey, for Lord Abbett, which holds about $20 billion of municipal debt, including some Illinois securities. Radogno had been a key player in a budget compromise that ultimately failed.
The state’s legislative leaders have been meeting this week. On Wednesday, Rauner said he would keep the lawmakers in session if they didn’t reach a deal before the deadline.
“Both sides have given a little bit, but each of the compromises they’re making come with a lot of conditions,” Friedland said. “I’m not yet seeing anything that makes me believe, at this point, that they’re close.”