New Idea: States Should Declare Bankruptcy

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As the Wire noted earlier this month, states are low on cash and looking for ways to take the pressure off. This Thursday, Mary Williams Walsh reported in The New York Times that a number of policy makers are quietly asking whether states can just flat-out declare bankruptcy as a way to resolve their debts. For now, it's just an idea--Walsh notes that "no draft bill is in circulation yet, and no member of Congress has come forward as a sponsor"--but the idea is provocative enough that it's gotten people talking. Below, a look at some of the perspectives:

  • Could This Actually Happen?  We might have to tweak the Constitution first. In the Times, Walsh notes that "states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign." But, Walsh goes on to say, "beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout"--so bankruptcy might be the only other option.

  • How It Might Work  Walsh lists a number of possibilities. "Lawmakers might decide to stop short of a full-blown bankruptcy proposal and establish instead some sort of oversight panel for distressed states," she writes. Elsewhere, she mentions Chapter 9 of the Bankruptcy Code, a passage that may act as a road map for a state-bankruptcy plan. Chapter 9 "gives distressed municipalities a period of debt-collection relief, which they can use to restructure their obligations with the help of a bankruptcy judge. Unfunded pensions become unsecured debts in municipal bankruptcy and may be reduced." Walsh points out that "the biggest surprise may await the holders of a state's general obligation bonds. Though widely considered the strongest credit of any government, they can be treated as unsecured credits, subject to reduction, under Chapter 9."

  • Watch Your Backs, Union Members  Walsh's piece notes that "discussions about something as far-reaching as bankruptcy could give governors and others more leverage in bargaining with unionized public workers." She mentions Charles Loveless, the legislative director of the country's largest public-employees union, and writes that Loveless has been "meeting with potential allies on Capitol Hill, making the point that certain states might indeed have financial problems, but public employees and their benefits were not the cause. The Center on Budget and Policy Priorities released a report on Thursday warning against a tendency to confuse the states' immediate budget gaps with their long-term structural deficits."

  • The GOP Would Go for This, guesses James Pethokoukis at Reuters. "Republicans aren't afraid of bankruptcies... believing they restore market discipline and reduce moral hazard," he writes. "Lehman is a good example. While the common narrative is that its failure caused a market panic and financial crisis in 2008, many conservative GOPers think the real problem was that Bear Stearns was bailed out, distorting investor expectations." Pethokoukis also calls it "unlikely" that "states would be shut out of credit markets if allowed to declare bankruptcy," as the Times suggests. "Municipalities and even countries repudiate debt and yet continue to borrow."

  • Ixnay on the Ankruptcy-Bay  Felix Salmon, also at Reuters, shoots back at Pethokoukis, calling his points "completely bonkers" and "just plain wrong." He also guesses that Walsh's piece, and continued public discussion of the state-bankruptcy option, will only hurt markets. "The fact is that states are not going to declare bankruptcy, and they're not even going to be allowed to declare bankruptcy," Salmon writes. "So the worst thing that can happen, for the municipal bond market, is that people continue to talk about municipal bankruptcy for the next couple of years. Let's take the option off the table, once and for all, rather than taking it seriously and thereby only making it harder for states to borrow the money they need."

  • About Time! says rightward blogger Ace. If states were made able to declare bankruptcy, they would be "compelled to live within their means, more or less... That will be humiliating for these states and their majority-liberal citizenry; good, it should be humiliating. Deadbeats and spendthrifts ought to be humiliated." Ace draws a parallel with Southern states under Jim Crow: "Part of southern states' sovereignty was withdrawn because they did bad things with it. It's time for some other states to similarly have pieces of their sovereignty withdrawn. Any state which seeks these bankruptcy protections (should they come to pass) should, for decades, until they prove themselves, be required to pre-clear all tax and spending initiatives with some federal agency."

  • This Isn't Gonna Happen  Matt Welch at Reason writes that "until states get a little bit past considering such no-shit-Sherlock ideas as killing subsidies for film production, I won't be remotely convinced that they have come to terms with the blunt fact that they are out of money." Welch adds that "any movement initiated by the House GOP is going to look one helluva lot different after the Democratic Senate and the union-friendly White House are done mangling it. There is no way, given the realities of public sector union dominance of Democratic fundraising, that federal lawmakers are going to sign off on something that doesn't give at least partial veto power to the racket that helped get us into this mess in the first place."

This article is from the archive of our partner The Wire.