Should States Have Bankruptcy as Option?


California is but one of many states facing the possibility of bankruptcy.

Inquiring minds are looking at The Corner where the idea of giving the option to indebted States the ability to file BK is raging. Every article that has come to SurvivingCalifornia.com’s attention is to create this option. Every article, that is, until this one by Veronique de Rugy:

There is a debate raging right now about whether Congress should create legislation giving states the option to file for bankruptcy, something along the lines of the existing law allowing for Chapter 9 municipal bankruptcy.

The question is not whether States are in trouble. It is what to do with those states? The actual problem is enormous:

To be sure, states are in big trouble: Total state debt is estimated at over $1 trillion, and that’s in addition to unfunded liabilities (from pensions and other obligations), which are estimated at over $3 trillion. Given the federal government’s $9 trillion in existing debt — which, according to a recent CBO report, will double in the next ten years — taxpayers cannot afford to bail out the states. Nor can we afford the precedent it would set. Federal bailouts should be off the table.

Here are some of the problems connected to allowing States to declare bankruptcy:

…critics of the plan contend that bankruptcy will only make states’ problems worse by jeopardizing their ability to continue to borrow and finance their debt. In the New York Times, Paul Maco summarized this concern:

The mere introduction of a state bankruptcy bill could lead to “some kind of market penalty,” even if it never passed. That “penalty” might be higher borrowing costs for a state and downward pressure on the value of its bonds. Individual bondholders would not realize any losses unless they sold. […] A deeply troubled state could eventually be priced out of the capital markets.

Interestingly, Standard and Poor’s believes that the potential “market penalty” of bankruptcy would be so large that it would discourage states from even considering bankruptcy as a real option:

We believe the financial implications, in terms of increased borrowing costs and reduced market access, of a bankruptcy filing typically outweigh the benefits of restructuring debt service, which on average represents only 4 percent of expenditures for states.

To that argument Bush and Gingrich respond that states would “consider their long-term lending potential and credit worthiness” in restructuring, thus minimizing the market penalty.

Also, there’s this issue:

Besides, as the Manhattan Institute’s Nicole Gelinas explained in this Boston Globe piece, “Bond-market brinkmanship and bankruptcy threats can’t save the states from themselves.”

A more damning argument against state-bankruptcy legislation is it that it may forestall needed reforms. Think about it this way: Constitutionally, states cannot be forced into bankruptcy by their creditors. That means that any bankruptcy proceeding would have to be voluntarily initiated by state legislatures. But what makes us think that they would do that?

An unresponsive, unrepentant enitity is not a good prospect to do business with…even if it is a state.

There is plenty more to read. Please click on the above link to read the entire article.

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