State Bankruptcies

Bankruptcy Coming Soon to a State Near You?

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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