NCPA - National Center for Policy Analysis

For Tottering States, Bankruptcy Could be the Answer

November 30, 2010

Continued huge federal budget deficits will eventually mean huge increases in government borrowing costs, Erskine Bowles, cochairman of Barack Obama's deficit reduction commission, predicted this month.  "The markets will come.  They will be swift, and they will be severe, and this country will never be the same."

The federal government still seems a long way from the disaster Bowles envisions.  But some state governments aren't, says Michael Barone, senior political analyst for the Washington Examiner.

  • California Gov. Arnold Schwarzenegger came to Washington earlier this year to get $7 billion for his state government, which resorted to paying off vendors with scrip and delaying state income tax refunds.
  • Illinois seems to be in even worse shape -- a recent credit rating showed it to be weaker than Iceland and only slightly stronger than Iraq.

The prospect is that the bond market will quit financing California and Illinois long before the federal government.  It may already be happening.  Earlier this month, California could sell only $6 billion of $10 billion revenue anticipation notes it put on the market, says Barone.

So it's entirely possible that some state government -- California and Illinois, facing $25 billion and $15 billion deficits, respectively, are likely suspects -- will be coming to Washington some time in the next two years in search of a bailout.  The Obama administration may be sympathetic.  But the Republican House is not likely to share that view.

University of Pennsylvania law professor David Skeel suggests that Congress pass a law allowing states to go bankrupt.

  • Skeel, a bankruptcy expert, notes that a Depression-era statute allows local governments to go into bankruptcy.
  • Some have done so: Orange County, Calif., in 1994; Vallejo, Calif., in 2008.
  • Others -- perhaps a dozen small municipalities in Michigan -- are headed that way.

A state bankruptcy law would not let creditors thrust a state into bankruptcy -- that would violate state sovereignty.  But it would allow a state government going into bankruptcy to force a "cramdown," imposing a haircut on bondholders, and to rewrite its union contracts, says Barone.

Source: Michael Barone, "For Tottering States, Bankruptcy Could be the Answer," Washington Examiner, November 28, 2010.


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