States Can’t Go Bankrupt

September 19th, 2011 at 9:08 am | 12 Comments |

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The Wall Street Journal carried an op-ed last week arguing that many key provisions of President Obama’s jobs bill are intended as a bailout for “blue states” (defined as Democratic states with heavy union presences) and that other aspects of the same bill might make things worse for the same states.

The two authors, Paul Peterson and Daniel Nadler, muster a lot of impressive evidence to support their case and suggest that we’re better off simply allowing states to go bankrupt if they are poorly managed. I agree that bailing out poorly managed states presents a terrible moral hazard and should be off the table for Congress and the administration.

But there’s one problem. States, contrary to what Peterson and Nadler write, can’t go bankrupt at all.

Bankruptcy is a formal process with a clear legal outcome that leads to a partial or total discharge of debts. It’s available only to individuals and certain classes of organizations. Individuals, most private companies, and local governments can go bankrupt but state governments, banks, and insurers can’t. (Banks and insurers “become insolvent” and have government-run or mandated insurers pay some or all what they owe.)

States, if they can’t pay, instead must “repudiate” their debts. But state debt repudiation isn’t even a formal process like bank and insurer insolvency either; it’s more of a legislature saying “We won’t pay and, because we’re the government, we don’t have to! So there!” A lot of state constitutions require states to pay their debts so, in many cases, an effort to repudiate debts would cause a state constitutional crisis that could lead to things like courts ordering tax increases or asset sales. In short, state bankruptcy doesn’t appear to really be possible.

While the federal government, as Peterson and Nadler say, hasn’t bailed out states, it’s also true that only one state has gone for repudiation since 1900 and it actually paid back its debts the year after default. The record for local governments is mixed, Orange County was allowed to go bankrupt in 1994 but, New York City—after it bought it self some breathing time and agreed to tough conditions—did get big federal loans to help it through its late 1970s fiscal crisis.

So, while Peterson and Nadler make a very good point, I tend to think that “let them go bankrupt” requires a little more thought.

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12 Comments so far ↓

  • balconesfault

    A lot of state constitutions require states to pay their debts so, in many cases, an effort to repudiate debts would cause a state constitutional crisis that could lead to things like courts ordering tax increases or asset sales.

    And what do you think the chances are that in such a proceeding the courts find that the states should be allowed to raid pension funds, sever themselves from retirement committments to state employees, and dissolve their unions (aka the Koch-GOP wet dream behind all this “state bankruptcy” talk)? Pretty damn slim.

  • SteveThompson

    One issue facing many states is underfunded pension plans, a debt issue that will reach the critical point as baby boomers reach their retirement years. As shown here, taxpayers will be on the hook for the gap between state pension obligations and funding levels, a gap that is already in excess of $3.23 trillion:

    http://viableopposition.blogspot.com/2011/07/americas-pension-nightmare-making-bad.html

  • Churl

    “As shown here, taxpayers will be on the hook for the gap between state pension obligations and funding levels, a gap that is already in excess of $3.23 trillion:”

    Taxpayers can and will move, the solvent and employable ones can function in another state. What then?

  • JohnMcC

    Mr Lehrer would be interested in reading a NYTimes article about the 1933 bankruptcy of the state of Arkansas. It points out a simple fact that he seems not to have thought of: That when a state gov’t has no money in the bank it cannot make payments on it’s bonds. I know this is a difficult concept. But it is spelled out pretty well here: http://www.nytimes.com/2011/01/23/weekinreview/23davey.html

  • DeathByIrony

    You’re walking the line between devout adherent and parody here.

  • Sinan

    Whether you call it bankruptcy or default, the result is the same. To argue over semantics is really quite silly. A question we must ask ourselves is this “Do we believe that our nation can best compete globally without a strong federal government?”. If your answer is yes, then you are advocating a strong state government can do better than one serving the entire nation as a whole. In order to grasp this absurd notion you must actually believe that each state has what it needs to stand alone for that is exactly what you are saying if you destroy the federal government.

    • Chris Balsz

      Default is a unilateral refusal to pay.

      Being a bankruptcy debtor means being protected from all collections efforts that were not authorized in advance by a federal court after hearing.

      Getting a bankruptcy discharge means the debt doesn’t exist anymore.

      It’s more than semantics.

  • think4yourself

    Regarding Peterson & Nadler’s OpEd; there is lot to disagree with. First, I am in commercial finance (equipment leasing) including of municipalities. We have not found that interest rates for municipalities have gone up – in fact they have gone down. Also, we have not found any difference in muncipal rates between “Blue State” versus “Red States”.

    While it’s true that ending the tax deduction for muncipal financing would cause those rates to rise, that doesn’t benefit one particular state over another. As far as the author’s contention that heavily unionized states benefit more from the Obama plan and that’s why the plan is structured the way it is, the authors do not prove cause and effect. Finally, the author’s arguments that “Federalism” as it relates to states funding has created a strong US investment system is silly. Municipal funding has little to do with the US investment system.

    I’ll agree with Eli that “let them go bankrupt” requires more thought. I also agree that Federal money to support teachers has helped bail out the states. I also think it is the state’s responsibility to work out their own painful financial situation.

    • baw1064

      “the author’s contention that heavily unionized states benefit more from the Obama plan and that’s why the plan is structured the way it is, …”

      Remember, they’re writing in a Wall Street Journal Op-Ed. As such, any statement proclaiming Obama to be Che Guevara, Malcolm X, Jimmy Hoffa, and The Nutty Professor all rolled into one requires no supporting evidence.

  • ZombieTory

    If it walks like a duck and it quacks like a duck, it’s a bankrupt duck.

    Nobody really cares about the legal technicalities of insolvency. If you can’t pay your debt you aren’t creditworthy.

    If you’re a non-sovereign, non-creditworthy government, you’re screwed.

    Damned simple, really.

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