MIKE MADIGAN SHOULD TAKE A FINANCE COURSE…I KNOW A GOOD INSTRUCTOR

3/14/13

Emblazoned across the front page of  Tuesday’s Wall Street Journal was the news that the SEC had charged the state of Illinois with securities fraud and that the state had settled without contesting the charges.   Illinois had defrauded investors in its bonds by not disclosing the extent of the state’s pension problems.  There will be no fines or penalties because, the federal government argues, those fines would only have to be borne by the already heavily burdened taxpayers of this state.   Such considerations would absolve a lot of people and entities from some very nefarious conduct, but I digress.  The “penalty” will be a promise by the state to be more transparent and forthcoming in its financial disclosures in the future.   It’s amazing that anyone takes the word of any politicians from our state about anything, but, again, I digress.

Now comes House Speaker Mike Madigan, telling reporters regarding the SEC affair

“It’s important to understand that the buyers of Illinois’ debt have all been paid their interest and their principal.  We have not reneged on our debt payments.  So there are no victims here.  Nobody’s lost any money.”

According to Mr. Madigan, no harm, no foul. 

In a very limited sense, the Speaker is right.  No one lost any money on these bonds…yet.   Aren’t any of the issues still outstanding?   Investors may still lose money, and, if they do, the reason will be the pension problems that were not adequately disclosed in the bond issues’ prospecti.

More importantly, though, Mr. Madigan’s comment shows a fundamental misunderstanding of finance that surprises me.   Even if everybody investor gets every dime to which s/he is entitled, there would still be losses involved here.  Surely, Mr. Madigan must be familiar with the concept of opportunity costs.   If the full extent of the pension problems had been disclosed, Illinois would have had to offer, all other things being equal, higher interest rates on the bonds in order to sell them.   Since those risks were not disclosed, the state was able to get away with paying a lower interest rate than was justified by the risk inherent in the bonds.   Put simply, the investors were not adequately compensated for their risk because of the duplicity of the issuer, the state of Illinois.   The investors thus did indeed lose money...the interest they would have earned had the bonds been priced to reflect their true risk.

Even a finance instructor like yours truly will freely admit that opportunity costs, though theoretically as real as out of pocket costs, are not quite the same as real costs.   Not making money you could have or should have made, while painful, is much easier to take in the real world than losing money you actually had at one point.   Nonetheless, opportunity costs are very real.   So Mr. Madigan is simply wrong when he argues that “Nobody’s lost money” due to failure of the state of Illinois to own up to its fiscal incompetence and/or chicanery.

See my two books, The Chairman, A Novel of Big City Politics and The Chairman’s Challenge, A Continuing Novel of Big City Politics, for further illumination on how things work in Chicago and Illinois politics.