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Updated March 13, 2013 By: Mark Glennon

Illinois, we already knew, pays a penalty rate to borrow money because of its bad credit rating, which taxpayers ultimately bear. What we didn’t know is that, beyond that credit penalty, we pay a still higher rate because of our dirty reputation.

An analysis by the Fiscal Futures Project at the University of Illinois’ Institute of Government and Public Affairs found that even after controlling for different credit ratings and fiscal, economic and financial factors between Illinois and other states that sold  bonds between 2005 and 2010, the yields on Illinois bonds were still higher. They used a “scarlet letter’ metaphor to describe the special risk premium demanded by investors on bonds that carry the dirty name ‘Illinois.’

These findings suggest the presence of a reputational risk premium on Illinois debt that is in excess of the risk premium associated with the state’s actual default risk,” the analysis said. Articles on this today are linked here from Reuters and Associated Press.

How much does that cost us? As much as two-tenths of 1 percent, the study says, or about $80 million on general obligation bonds sold between 2005 and 2010. That’s not so much in a state with hundred billion dollar problems. However, that’s just for the state’s general obligation bonds. Other bonds and those issued by Chicago, Cook County and other local issuers probably have the same problem, thanks to the “Chicago way” and similar perceptions. The authors of the study also said ordinary creditors of the state — that backlog of unpaid bills — probably also charge a similar penalty. The state has to pay most of them 18% per year in interest. The authors also said the problem has probably gotten worse since 2010.

In other words, it’s not just the sharp-penciled credit analysis that dings Illinois in the financial markets. It’s the sense that we’re run by fools and crooks.

No wonder so many believe in the wisdom of free markets.

Illinois isn’t just financially bankrupt, it’s reputationally bankrupt, too.

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