NCPA - National Center for Policy Analysis

Bailouts or Bankruptcy?

September 28, 2011

In early 2011, the states' financial travails were the stuff of headline news.  Deficits for the current budget cycle were estimated at $175 billion.  In some states (Texas, California, Nevada and Illinois), the shortfall exceeded 30 percent of projected budgets.  One way or the other, states closed those gaps to comply with the balanced-budget amendments contained in all state constitutions except Vermont's, and public attention shifted to the budget-and-debt-ceiling melodrama in Washington, D.C.  However, the parlous fiscal condition of state and local governments remains a lasting concern, says Michael S. Greve, the John G. Searle Scholar at the American Enterprise Institute.

Indeed:

  • Unfunded pension obligations are estimated at upwards of $1 trillion and are probably three or four times that amount.
  • Unfunded health care commitments clock in at upwards of $500 billion.
  • Bond debt issued by state and local governments comes in around $2.8 trillion.

For these reasons, public debate over the course of action for insolvent states remains lively.  While many advocate continued federal assistance through the subsidization of state programs and additional block grants, a growing number of scholars and GOP legislators are considering the idea of a comprehensive bankruptcy code for state governments.  Distinguishing between the much more common private sector bankruptcy options (chapters 9 and 11) and the options that would need to be made available to a state, it is clear that several policies would have to be accepted and implemented for such a scheme to function.

  • In order for states to file, they would require the ability to examine and renegotiate their liabilities at their foundations.
  • Similar in severity to Chapter 11 bankruptcy, states would need to be able to revisit collective bargaining agreements and pension obligations (in addition to payments to bondholders) in order to make themselves solvent again.

A bankruptcy option that does not address the stranglehold that these liabilities have on state governments does not tackle the real problems, nor will it lead to effective solutions.

Source: Michael S. Greve, "Bailouts or Bankruptcy?" Engage: The Journal of the Federalist Society Practice Groups, September 2011.

For text:

http://www.fed-soc.org/publications/detail/bailouts-or-bankruptcy

 

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