NYT: Congress quietly looking at ways to create bankruptcy option for states

posted at 4:13 pm on January 21, 2011 by Allahpundit

Forget the economics of it for a moment and think of the politics. Are we actually going to have a bizarroland national debate in which the right is defending federal legislative prerogatives and the left is championing state sovereignty? Public employee unions — the new Tenthers? If it happens, I hope the Supreme Court decides the constitutionality of this statute on the same day it decides the constitutionality of the ObamaCare mandate. Imagine how confusing the reaction could get among protesters camped outside the building.

Granted, bankruptcy is preferable to new federal bailouts, but political reality being what it is, how much good will this do, really?

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the 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…

Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors…

For now, the fear of destabilizing the municipal bond market with the words “state bankruptcy” has proponents in Congress going about their work on tiptoe. No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor, although Senator John Cornyn, a Texas Republican, asked the Federal Reserve chairman, Ben S. Bernanke, about the possiblity in a hearing this month…

“They are readying a massive assault on us,” said Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.”

So, no new TARP for the states and a legislative license to take a Christie-like sledgehammer to labor contracts. What’s not to love about the bankruptcy option? Well, for starters, why do we assume that labor would bear the brunt of a state restructuring? Public employee unions own the White House and most of the Democratic caucus; with a new presidential campaign around the corner and Obama aiming to raise a billion dollars, they have more leverage over him now than ever. Just think: How did GM’s bankruptcy work out for the UAW? Says Matt Welch, “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.” Indeed. And a federal judge’s authority to force a state to target union contracts could be limited because of the Tenth Amendment issues raised. Quote: “If the bankruptcy framework treads gingerly on state prerogatives, as it must to be constitutional, it may be exceedingly difficult for a bankruptcy court to impose the aggressive measures a state needs to get its fiscal house in order.”

So Democrats and the state governments they control will likely look for ways to shaft bond holders instead, who aren’t nearly as organized electorally as the unions and whose financial loss can be sold as a de facto tax on the “rich.” The big deterrent against that is the fear that restructuring municipal debt will make a state toxic to capital markets, with no sane person willing to lend to it ever again. Maybe, but see this response by James Pethokoukis, who argues that any toxicity would be temporary and that in the interim states would be forced to make the sort of austere spending cuts that they should have been making all along. Fair enough — but that only makes the logic of stiffing bond holders instead of the unions more compelling to liberals, doesn’t it?

All that said, I think a bankruptcy option is worth pursuing for the same reason I think Paul Ryan’s roadmap is worth talking about: It helps focus public attention on the sort of gruesome either/or decisions that’ll have to be made to avert a fiscal catastrophe. Right now, I suspect, a lot of voters hear about state pension liabilities and volatility in the muni bond market and think “well, we’ll have to cut spending” without any concrete idea of how deep and broad those cuts will have to be. (You see the same ignorance at work when poll respondents suggest eliminating the deficit by cutting the defense budget, which isn’t nearly enough to do the job.) But toss the bankruptcy option in there — i.e. someone’s not getting their money — and suddenly the gravity of the situation hits home, even if states don’t end up actually availing themselves of the option. The coming standoff over the debt ceiling, as worrisome as it may be, is similarly salutary as a way to concentrate the voters’ minds. Plus, from the narrow, cynical perspective of partisan politics, forcing Senate Democrats to consider a bankruptcy option for states would be useful to the GOP. Reid and most of the caucus will go to bat for the unions, but what about Ben Nelson and Jon Tester and Mark Pryor and McCaskill and the rest of the “fiscally responsible” centrists? The GOP could very easily get 51 votes for this measure and quite a bit more if they frame the debate as the only way to avert yet another wretched, politically radioactive federal bailout. And if they somehow got to 60, then suddenly this is on Obama’s desk and he has to choose between alienating unions by signing it and alienating independents who loathe bailouts by vetoing it. Dilemmas, dilemmas.

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Threatening a BK option may scare the unions into voluntarily restructuring their contract (most likely). The states could also attempt to avoid the contracts citing collusion and conflict of interest in the negotiation of the contact. Again, a novel idea that may or may not work, but one that might convince the unions to renegotiate, which is how this must end anyway.

They will still get a better retirement than the rest of us, but hopefully it won’t be obscenely better like it is now.

tommylotto on January 21, 2011 at 8:27 PM

A State could amend its constitution to deal with the pension issues. At that point, a Union’s only retort is to sue in the State’s court system, which would be, of course, driven by the State’s Constitution, and would be obligated to find in favor of the State. At that point, the Union must find a way in Federal Court, but their progress will be severely hampered by Hans v. Louisiana (which found that a citizen cannot sue his own State in Federal Court) and Energy Reserves Group v. Kansas Power & Light, which sets the standard for interpretation of Article I, Section 10 (the “contracts clause”). That standard would seemingly be met by any State modification of its pension plans in the face of a fiscal emergency.

unclesmrgol on January 21, 2011 at 8:33 PM

“Somebody with some common sense would realize there’s trillions of dollars of wealth off-shore of California just needing to be drilled, plus billions of agriculture dollars just waiting on some water in the Central Valley. Don’t tell me you’re serious about the financial catastrophe you’re facing until you maximize the resources available to you. As I said, somebody with some common sense… – PatMac on January 21, 2011 at 8:00 PM

Let us hope the Governor (Moonbeam) Brown will make the cuts and adjustments that Arnold was not able to make.

SC.Charlie on January 21, 2011 at 8:41 PM

Sackett on January 21, 2011 at 5:25 PM

So, taking it up one level, then, if the United States becomes insolvent, it loses its sovereignty and the United Nations gets to reapportion it as they wish.

I cannot see the Senate agreeing to your ideas at all. Nobody wants to report back to their citizens that they’ve just traded away state sovereignty for economic peace.

The States will handle things at the State level, and that will be that.

unclesmrgol on January 21, 2011 at 8:52 PM

Need a Constitutional Amendment.

Any state declaring bankruptcy reverts to being a territory. Then is broken up into no less than three parts. Is only re-admitted to the Union after ten years.

take that NY, CA, etc.

patch on January 21, 2011 at 9:44 PM

OK, this is probably an obvious question, but here goes:

Why, if states are soverign, do they need federal bancrupcy? Why can’t the state simply say “We aren’t paying debt ‘X’?”

Why do federal bankrupcy courts need to get involved?

Yeah, I think the constitution says the federal courts handle bankrupcy, but this is for corporations and citizens, right?

Couldn’t we just exempt states from this?

EFG on January 22, 2011 at 3:40 AM

Yeah baby! Just like the GM cram down where for the first time in US bankruptcy history bondholders were screwed and rendered into unsecured creditors. Imagine what this will do to the muni bond markets . . . . where large institutions and pension funds invest. Talk about financial disaster? Knowing the democrats, they’ll screw the bondholders and leave the public employee union pay and benefits alone. No cram down there, folks. What could go wrong? Indeed!

kens on January 22, 2011 at 1:18 PM

For more fuel on the fire, check the link here and listen to the podcast labeled “Bill Lockyer 6PM (1/21)”.

This was an interview on the John & Ken radio show with the CA State Treasurer on Friday night. From the initial listen, he isn’t too thrilled with the idea. That being said the interview is fairly informative on the issue.

Suihei Deloi on January 22, 2011 at 5:15 PM