The $100 billion shortfall in the pension funds for Illinois public employees did not happen overnight. Throughout the last two decades, the state systematically reduced its contributions to the funds, resulting in a pension plan that covers less than half its liabilities.
This fiscal irresponsibility affects municipal bond investors as well as state and local government employees. In March the state Commission on Government Forecasting and Accountability reported that an investigation by the Securities and Exchange Commission (SEC) had "revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009." The commission noted that "Illinois failed to disclose that its statutory plan significantly underfunded the state's pension obligations and increased the risk to its overall financial condition. The state also misled investors about the effect of changes to its statutory plan."
Illinois settled these claims by promising not to engage in such behavior anymore. The state had already begun correcting its disclosures by 2009, according to the SEC.
The relationship between municipal bonds and pension funds may be even rockier in Stockton, California. In April a judge ruled that the city may enter bankruptcy to try to restructure its debts. But the judge did not settle the question of whether bondholders or the city's pension program will get priority when determining repayment obligations, continuing what is proving to be a nasty battle.