Bankruptcy Coming Soon to a State Near You?

Tuesday, November 30, AD 2010

Most attention regarding public debt tends to be riveted on the Federal ocean of debt.  However, several states have also gotten themselves into a fiscal morass.  California faces a pension shortfall of half a trillion dollars.  Comparatively speaking, Illinois is in the worst shape of any state in regard to public employee pensions, with a shortfall of 54 billion. Illinois was in the red 13 billion this year and Democrats in the General Assembly want to borrow 4 billion in new debt to make this year’s pension payments.

This cannot go on.  States like California and Illinois have amassed debts that they simply cannot pay under any reasonable forecast of state tax revenue over the next two decades.  Even if spending were slashed to the bone in these states, continuing to operate the state governments and meet the present obliagtions appears to be mathematically impossible.  This leaves two options for the debt of these states.  The first option is a federal bailout.  Although I do relish the image of a bankrupt Federal government bailing out bankrupt state governments, this is simply not going to happen in the current political environment.  The second option is that the states go bankrupt.  Current law allows local governments, cities, counties, towns, etc to go bankrupt but  not states.  The bankruptcy code would have to be amended to allow this, and the only way for this to be done is for Congress to do it.  Mainstream commenters like Michael Barone are beginning to seriously discuss the prospect of states going bankrupt.

I do not see the political will yet to amend the code in Congress, for the President to sign it if such an amendment were to pass, or for states to declare bankruptcy if the option becomes available.  However, I do see it coming eventually.  Already California has found it difficult to sell recent bond issues, and Illinois bonds have been downgraded in credit ratings.  However, assuming states in fiscal holes reach a point where they can no longer borrow, and we may reach that point sooner rather than later, bankruptcy may be the least terrible option.

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6 Responses to Bankruptcy Coming Soon to a State Near You?

  • On the federalism question, I don’t really see a problem. Allowing a state to go bankrupt indicates federal inaction, and there are really no Constitutional prohibitions upon inaction. The only guarantee in the Constitution with regards to the states is that they shall have a republican form of government, and I don’t think bankruptcy violates that clause. But as you said, the political will to do so is a completely different question.

  • Three states defaulted on their debts during the early Depression years. You might look into how that was handled at that time for precedent. I think that under point 5, the default view of the Democratic caucuses in various legislatures will be that their preferred constituencies (i.e. unionized public employees) are always at the head of the line.

    California’s constitution requires supermajorities to enact tax increases. You have gridlock because the Republican caucus will not countenance tax increases and the Democratic caucus will not countenance spending reductions. That would make for the most likely default, though I think priority of disbursements in California is accorded to paying interest on bonds and accounts payable down the line are accorded IOUs when necessary, so perhaps not.

  • The concept of unions for “Public Service” employees has always appeared to be a bad idea. The very fact that in places like Illinois where these Unions use the dues of it’s members to buy and sell politicians has led to the crisis.

    What is required is legislatures who do their duty (Mike Madigan led Illinois House makes this doubtful) and a Govenor with the courage to sign the bills defunding these pensions.

    What has happened to courage…

  • While everyone was wrapped up in the hullaballoo over Illinois legalizing civil unions (more on that topic tomorrow from Don), hardly anyone other than hard core political/fiscal junkies noticed this post on The Capitol Fax Blog:

    “Illinois paid a pretty high price for its tobacco bond sale yesterday…

    “Illinois drew robust investor interest for a $1.51 billion tobacco bond, but at a price: it offered a yield above 6% for its longest maturing debt, more than a full percentage point over other recent muni offerings.

    “The state agency selling the bond increased the size by about $50 million and shaved the yield 0.15 percentage point from its original starting point Tuesday, as the deal’s hefty return and conservative structure offset worries about Illinois’ finances and falling cigarette sales. Citigroup was the senior manager on the sale; Barclays Capital was the co-manager.”

    Following is Captain Fax himself, Rich Miller, offering his explanation of what the above info means in layman’s terms:

    “Most of that $1.3 billion the state will get up front will be used to pay off overdue state bills, which means we’re exchanging soft debt for hard, Wall Street debt. That’s risky business, but the state is so freaking broke it basically has no choice. We’re borrowing long-term for current operations. Scary stuff.”

  • Just to clarify, the “tobacco bond” is so called because it’s being leveraged by the state’s share of the tobacco settlement proceeds. Which if I remember correctly, were supposed to be used to fund anti-smoking initiatives but of course now gets spent on just about everything but that.

  • “That’s risky business, but the state is so freaking broke it basically has no choice. We’re borrowing long-term for current operations. Scary stuff.”

    Scary stuff indeed. Elaine, our poor Illinois has had idiots running it for so very long who have handled our finances with such consumate folly. This is definitely not going to end well.