The Blue Model.

Minus the tax base.

The following piece was written by Mary Williams Walsh, escapee from The New York Times and now managing editor of News Items. At The Times, she covered the intersection of finance, public policy and the aging population. This included pensions; public debt; bankruptcy, especially Chapter 9 municipal bankruptcy; and insurance, including insurance provided by governments. She covers a similar “beat” for News Items. We call it the “debt beat.”

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Today we have a hypothetical: 

Mike has been running a life insurance company for decades — running it into the ground, that is. It’s undercapitalized. Its investments are so-so. There’s never enough money to pay the claims. Basically, Mike’s been running the place as a ponzi scheme, constantly bringing in new premium-paying customers, whose money is used to pay the claims of the long-time customers. 

It’s illegal to run an insurance company that way. Regulators should have taken the keys away from Mike years ago. But he’s a powerful man, with loyal apparatchiks everywhere, and he insists his insurer is fine. Doubters are punished. The policyholders all support Mike. All they care about is that he always pays claims. They don’t care where the money comes from. 

And now, a Deus ex Machina moment. Federal prosecutors have convinced a grand jury to indict Mike on racketeering and bribery charges. He can’t lead his insurance company now. His trial is set for October. Meanwhile, a couple of the insurer’s newest customers have figured out that their premiums are being used to pay other people’s claims, and they’re furious. They’ve gone to court to get an injunction. 

(Remember those two. They’re very important.) 

Our questions: What will happen to Mike’s insurer if Mike is convicted? If he was running it as a Ponzi scheme all those years, will his conviction make it viable? Of course not — courts can’t make billions of dollars appear out of thin air. But if the court orders the insurer to stop using new customers’ premiums to pay long-time customers’ claims, what will it pay the claims with? 

How can you shut down a Ponzi scheme without hurting people? 

That last question isn’t really hypothetical in Illinois. Perhaps by now you’ve deduced that “Mike” is Michael J. Madigan, 82, for years the most powerful politician in Illinois, now indicted on bribery, racketeering and related charges. He has pleaded not guilty. 

The indictment describes a “Madigan Enterprise,” built on rewards, favors and punishments. There’s plenty of unsavory detail about how two companies, AT&T and Commonwealth Edison, effectively bought the enactment of bills they wanted by giving jobs to Madigan’s chosen allies — from summer interns all the way up to ComEd’s board of directors. But for many Illinoisans, the bigger question is whether the end of the “Madigan Enterprise” will be the beginning of a new era, when the state can start digging out from under the $142 billion in unfunded pension obligations it’s been saddled with. Actually, more than that, because there are a number of local pension funds, too.   

Madigan’s case should have been tried already, but it was delayed for six months while the U.S. Supreme Court decides another bribery case. That one involves an Indiana mayor convicted of soliciting and accepting $13,000 when his city acquired some garbage trucks. The question the Supreme Court has taken up is whether the federal bribery statute wrongly criminalizes “gratuities” — payments to reward an official for an action taken without a quid-pro-quo agreement. (I’m nervous already.) 

Madigan requested the delay, saying the Supreme Court’s thinking on gratuities versus bribes could have bearing on his case. The judge reluctantly agreed. But the delay will leave a distasteful mess outstanding at the end of August, when tens of thousands of delegates, volunteers and visitors will come to Chicago for the Democratic convention. Illinois Gov. J.B. Pritzker naturally wants to show them a bustling metropolis with safe streets, growing businesses, a proud history of progressive politics — a place where the Blue State Model works. Now, he’ll have the consummate Chicago machine politician awaiting trial, the man more responsible than anyone else for pushing the Blue Model past the breaking point. 

“Whatever his complicity in helping to create the problem, he’s also going to be essential to its solution,” the Democratic political consultant David Axelrod told Reuters in a profile of Madigan. The headline: “The man behind the fiscal fiasco in Illinois.”

Madigan was a state lawmaker for 50 years, Speaker of the Illinois House for 36 of them, the longest-serving legislative leader — state or federal — in U.S. history. He’s also been chairman of the Democratic Party of Illinois, Democratic Committeeman for Chicago’s Thirteenth Ward, chairman of the Thirteenth Ward Democratic Organization, a partner in a law firm that handles property-tax disputes, and so on. For decades, he appointed committee chairs, controlled campaign cash, and single-handedly decided whether bills would come up for a vote.

The son of a precinct captain in the Thirteenth Ward, Madigan learned about power, patronage and loyalty from Mayor Richard M. Daley, who gave him his very first job, on the back of a city garbage truck. At the request of Madigan’s father, Daley also arranged for his first white-collar job, in the city’s legal department between his first and second years of law school. Three years after law school Madigan was a delegate to a state constitutional convention, where an unusual provision was added, saying public workers in Illinois could never have their pensions “diminished or impaired.” Madigan, then 28, voted for it.  

Any state with a pension fund has to contribute fresh money every year. Lawmakers usually set the amount when they enact the budget. In many states, they have failed to contribute enough, at one time or another, because shortchanging a pension fund makes the budget so much easier to balance. Illinois had already been doing that for years by the time Madigan first won his seat in the House in 1970. 

When you shortchange a pension fund year after year, you create an off-balance-sheet debt — a debt of the taxpayers, in effect, to the workforce. The way the math works, it’s a debt that compounds at a high rate of interest, unseen. Do nothing about it and eventually it can get so big you’ll never be able to pay it off. 

In Illinois, low annual contributions were just part of the problem. Under Madigan’s leadership, lawmakers sweetened the benefits and disrupted the funding again and again. There was a 3 percent, compounding annual pension increase for all retirees, which Madigan himself has called “unaffordable.” There was the notorious “Edgar ramp,” a lengthy funding holiday followed by accelerated funding that Illinois couldn’t pull off. (Madigan championed it mainly to thwart a political rival.) There was an early-retirement window that cost four times as much as projected. There were billions of dollars of bonds issued to fund the pension system, yet the underfunding only grew. There were tax increases devoted to pension funding that didn’t solve the problem either. 

Perhaps the most portentous pension measure came shortly after the global financial crisis, which decimated public pension funds in Illinois and everywhere else. Then-Gov. Patrick Quinn saw the gravity of the situation and tried to reduce the system’s benefits. That was at odds with the constitutional provision, but Quinn argued that judicious pension cuts wouldn’t really be cuts under the circumstances — they would make a collapsing system viable.  

Madigan bought into the premise. 

“The bill would not have passed without me,” he said later, in an interview with Crain’s Chicago Business. “I was convinced that standing fast for substantial savings, clear intent, and an end to unaffordable annual raises would result in a sound plan that will meet all constitutional challenges.”

But he was wrong about that. Public employees’ unions sued and, eventually, the state supreme court ruled that the 1970 constitutional provision really meant what it said: No Illinois public worker or retiree could ever have their pension reduced, for any reason. The only people whose pensions could be cut were the public workers that Illinois and its local governments hadn’t hired yet. 

Illinois still needed to reduce its pension debt, so lawmakers set a cutoff date of Jan. 1, 2011. Every public worker hired before that date would be in “Tier 1,” earning the same pensions as before. Everybody hired after that date would join “Tier 2,” and earn the smaller pensions that Gov. Quinn’s pension reform had tried to give everybody. 

The cash savings generated by Tier 2 wouldn’t materialize for decades — the people first had to be hired, then work for years, then retire. But the legislation also authorized Illinois’ actuary to calculate each year’s pension contribution as if Tier 1 had vanished from the scene and everybody was earning Tier 2 pensions. This would save the state money, but starve the pension system of the dollars that it needed to fund Tier 1’s benefits. What had started out as a reform ended up making the imbalance worse.

And the two tiers were, and still are, terribly inequitable. Tier 1 workers can in many cases retire at age 60 with a full pension; Tier 2 workers can’t retire until they turn 67. Tier 1 workers get pensions that compound at 3 percent every year; Tier 2 workers are promised 3 percent increases that do not compound. (Compounding is where all the value is.) Both tiers have 9 percent of their salary withheld from every paycheck and contributed to the pension fund — but for Tier 2, 9 percent is more than the cost of their own pensions. The excess is used to subsidize Tier 1’s pensions. 

Remember those two people in our hypothetical? The ones who figured out that their money was diverted to pay other people’s claims? 

They’re real. Their names are Natosha Toller and Patricia Kievlan. Both are judges in Illinois, and they may be in a position to bring down this whole shabby house of cards. 

Both of them worked in the public sector for many years before rising to the bench. Kievlan was a community college instructor. Toller was a prosecutor in Cook County. Both earned years and years worth of Tier 1 pension credits in those jobs. But their judicial appointments fell after Jan. 1, 2011, so when they rose to the bench, they actually fell back, into Tier 2. 

Kievlan has calculated that if her years as a judge earn just the Tier 2 pension, she’ll retire on $73,000 a year less than if she could earn the Tier 1 pension. 

The judges’ lawsuits have been combined. They argue, first of all, that the decision to put them into Tier 2 violates the Illinois constitutional guarantee of equal protection under law. If that were their only cause of action, the state might be able to shut down their civil action by putting them back into Tier 1. 

But there’s more. The judges also argue that Tier 2 should be voided, because of the way it was enacted. Lawmakers, under the leadership of Madigan in the House, rushed the bill to enactment under a procedure known colloquially as “gut and replace.” As the Cook County Record explains it, “gut and replace” means taking a “shell bill” — some existing bill about anything, pending somewhere in committee — and deleting all the text, then pasting in the text of the bill that’s on the fast track. 

Lawmakers can then rush the new bill to the floor of the General Assembly, for a vote in the dead of night if they want, so that no one’s around and opposition cannot be mobilized. 

Judges Toller and Kievlan argue that the “gut and replace” process violated a constitutional requirement known as the “Three Readings Rule,” which requires lawmakers to read every bill three times in the House and the Senate, before voting on it. 

The Three Readings Rule has been trampled so many times in Illinois that the state supreme court has a well-worn workaround. It says violation of the “Three Readings Rule” doesn’t matter, as long as the Speaker of the House and the President of the Senate sign a document affirming that the legislation was passed constitutionally. It doesn’t matter if the legislative record shows otherwise. This workaround is called the “Enrolled-Bill Doctrine.” 

Isn’t it interesting that the state constitution is enforceable for the pension-impairment clause, but not the Three Readings Rule? 

But enough of these charades, say the two judges. “The courts should no longer permit the Enrolled-Bill Doctrine to block judicial scrutiny of the legislature’s disregard of constitutional requirements,” they say. “The time to revisit this doctrine has come.” 

That may be. The two-tiered pension system in Illinois is the very picture of intergenerational inequity. Union officials have been lobbying for years to make it go away. But if you throw out the Enrolled-Bill Doctrine, and find that the law creating Tier 2 was unconstitutional, what are the practical implications? Is Tier 2, in fact, null and void? Should everybody — not just those two judges, but Illinois’s whole public workforce — be put into Tier 1? Retroactive to 2011? 

And what about the provision that lets Illinois pretend everybody is a Tier 2 employee for pension-funding purposes? 

“We need, obviously, to make some changes,” Gov. J.B. Pritzker recently told lawmakers in this year’s budget discussions. “We don’t yet really know what that’s going to cost.” 

But it sounds terribly expensive. The whole point of creating Tier 2 was to reduce unfunded obligations. If Tier 2 were now tossed out, the unfunded obligations would come rushing back, worse than ever. And the person with the most experience in solving seemingly unsolvable fiscal problems, Michael Madigan, isn’t around any more to come up with another deal. He’s at home, awaiting trial, collecting his Tier 1 pension.