Bankruptcy expert James Spiotto said any law that authorizes Illinois municipalities to file for Chapter 9 should require additional layers of review.

CHICAGO - Illinois' immediate budget problems and its partisan divide mean an uncertain fate for proposals by Illinois Gov. Bruce Rauner to establish a Chapter 9 bankruptcy law for local governments and pass a constitutional amendment on pensions, market participants and legislative aides said.

Newly elected Republican Gov. Bruce Rauner tucked the items - short of any additional detail - in the "turnaround" plan he released with his first State of the State address last week. The plan offered an array of policy and tax proposals aimed at improving the state's economy and competitiveness.

Specifics on how the administration hopes to erase a $1.4 billion deficit in the current budget and deal with a $3 billion drop in income tax revenue in the next budget cycle due to lower income tax rates won't come until next week when Rauner releases his fiscal 2016 budget proposal.

Under the "Taxpayer Empowerment and Government Reform Package" section of the plan, Rauner included the bullet points "pursue permanent pension relief through a constitutional amendment" and "extend to municipalities bankruptcy protections to help turn around struggling communities."

The bankruptcy provision has drawn mixed reviews from lawmakers, with supporters believing such authority would give local governments needed power at the bargaining table with unions. Local governments across the state face skyrocketing police and firefighter pension payments next year under a prior state mandate and are clamoring for accompanying benefit cuts.

The constitutional amendment could also offer a long-term solution to the state's troubled pension system if the Illinois Supreme Court, in a ruling expected later this year, throws out the pension overhaul lawmakers passed in 2013. The state is saddled with more than $100 billion of unfunded obligations.

Illinois statutes don't grant any general legal authority allowing for a Chapter 9 filing, said municipal bankruptcy expert James Spiotto, a managing director at Chapman Strategic Advisors LLC. The one exemption is for the Illinois Power Agency.

The state offers assistance for stressed communities with a population under 25,000 through its Fiscally Distressed City Act. The local government must ask the General Assembly for the appointment of a special commission to consider whether the municipality meets the act's criteria. If approved, the municipality can qualify for state financing assistance.

Spiotto said the establishment of a Chapter 9 provision could offer some benefits, but he cautioned it should be used as a last resort when all alternatives are exhausted. Any statute best serves a state and its local governments when it includes additional layers of review and is written with market access in mind.

"The question is how do you want to approach it? Should there be --like in 12 other states --a second look?" Spiotto said. Another 12 states don't require an additional layer of review. Since 1954, the rate of bankruptcy filings is four times higher in states with no second look compared to states that require another additional approval, he said.

"A second look requires the input of a supervising adult who can say there are other available options" and the state has to "make sure it doesn't cost its municipalities more borrowing costs" in the way it treats creditor classes, Spiotto said. Detroit's recent historic bankruptcy underscored the conflicting interests of bondholders and pensioners with bondholders taking much steeper haircuts in the city's reorganization plan.

"Gov. Rauner is committed to turning around Illinois - that includes providing relief to communities that are struggling," spokesman Lance Trover said when asked to provide additional details on what form a bankruptcy law might take "The specific details regarding authorizing communities to pursue that option will be part of an ongoing dialogue in the coming weeks."

State Rep. Ron Sandack, R-Downers Grove, recently introduced House Bill 298 to would allow local governments to file Chapter 9 with the authorization of the state.

"As more and more municipalities are looking for relief and ways to deal with rising pension liabilities and other costs, this is a tool that can help them stabilize and reorganize financial affairs in ways that benefit taxpayers," Sandack said in a statement.

As an alternative, Spiotto, working with the Civic Federation of Chicago, has proposed the creation of an authority designed to intervene before fiscal strains reach crisis stage for local governments.

The General Assembly's Democratic leaders, who enjoy a veto-proof majority, took a cautious stance in comments on the proposals. The office of Senate President John Cullerton, D-Chicago, said: "We still need to see the details of Rauner's proposals."

The state's immediate revenue crunch may dominate Illinois political discourse, at least in the short term, at the expense of longer-term proposals.

Municipal Market Analytics partner Matt Fabian said given unions' historically strong influence on the Democratic majority in the state, he thinks a Chapter 9 law faces a dim chances.

"In Illinois, it's unlikely that a bankruptcy law would be passed, and even more unlikely that what might be passed would protect bondholders over employees," Fabian said. "The cost of capital would very likely rise." Illinois' local governments already pay interest rate penalties for the financial distressed of the state government.

A constitutional amendment on pension benefits, on the other hand, could offer sweeping relief down the line, although Fabian and others believe such a measure would have a difficult time making it past the General Assembly to reach voters.

A lower court overturned the state's 2013 pension overhaul, finding it violated the state constitution's pension clause that gives contract status to benefits that cannot be impaired or diminished. The state has countered that its sovereign powers give it the right to alter the contract in times of emergency and its fiscal crisis constitutes such a case. A state law allowing Chicago to overhaul two of its pension funds is also being challenged.

Union leaders called many of Rauner's proposals in his turnaround an insult.

"Instead of seeking solutions that empower all the working families of Illinois to fuel the economy, his proposals will destabilize middle-class economic security by cutting compensation for injured workers, defunding unemployment insurance reserves, demonizing public employees and suppressing wages," AFL-CIO Illinois president Michael Carrigan said in a statement.

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