Michael Cembalest is Chairman of Market and Investment Strategy at J.P. Morgan Asset Management.

His report released yesterday, The ARC and the Covenants, updates his earlier research comparing the percentage of state revenues needed to pay interest on general obligation debt, and meet all future pension and retiree healthcare obligations. [The link to the report appears to be working sporadically: https://www.jpmorgan.com/directdoc/ARC4_ES.pdf ]

Most states, he concludes, have manageable burdens (which he defines as 15% or less).

Not Illinois, which is far worst among the states. By his calculations, 51% of state revenue would have to go towards debt, pensions and retiree healthcare to reach full funding, and that would take 30 years. He assumes all pensions will earn 6% per year on invested assets. His comparison chart is below.

For the worst off states, particularly Illinois and New Jersey, Cembalest says a solution based on tax increases or higher employee contributions is probably neither economically or politically viable.

Hence, the bankruptcy option:

I participated in a seminar at Harvard’s Kennedy School last year, and there was a sense that the US should use the Promesa legislation for Puerto Rico as a dry run for creating  state-level bankruptcy rules, just in case. I think the expansion of Chapter 9 legislation for states makes sense, and I’m not the only one.

He cites former FDIC Chairman William M. Isaac, who earlier wrote:

The city of Chicago and the state of Illinois should act now to restructure their liabilities and put the fiscal mess behind them. This can be accomplished by utilizing Chapter 9 and other tools Congress just gave Puerto Rico. The process would entail about two years of unpleasant headlines, but the city and the state will rebound far sooner and less painfully than if t hey stay on their current paths.

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