States in distress: Is bankruptcy an option?

What’s a poor state to do? said Mary Williams Walsh in The New York Times. With dozens of states facing billion-dollar budget deficits and unfunded pension obligations that could reach a collective $3 trillion, Newt Gingrich and some other conservatives have offered a bold prescription, arguing that “the only feasible way out may be bankruptcy.” Several House Republicans are talking about legislation that would enable states to declare bankruptcy, which would, if nothing else, give governors more leverage in bargaining with public-employee unions. Some investors are taking the bankruptcy talk to heart, said Annie Lowrey in Slate.com. “Investors set a new record for weekly withdrawals from municipal mutual funds last week, taking out about $4 billion.” A U.S. state hasn’t gone bust since Arkansas, in the Great Depression. Could it happen again?

It should, said David Skeel in The Wall Street Journal. Look at California: “Thanks to decades of implausibly generous promises to public union employees and other fiscal misdeeds, the state’s budget deficit for the next 18 months could exceed $20 billion.” In Illinois, state pension funds are underfunded by more than $200 billion, and New York and New Jersey are in big trouble, too. If Congress enabled states to declare bankruptcy, states “could immediately chop the fat” out of union contracts, and restructure the “Cadillac pension benefits” enjoyed by union retirees. If the unions balk, “the state could ask the court to terminate the contracts.” Only bankruptcy offers states the “fresh start” they need.

That argument is “hopelessly naïve,” said Nicole Gelinas in the New York Post. Most states, including New York, aren’t responsible for all “their” debt. A host of separate legal entities—transit authorities, state universities, and such—issue bonds by their own rules and contractual agreements. Of New York’s $78.4 billion in total debt, for example, only $3.5 billion is actually the “general obligation” of the state; the rest belongs to other entities. If the state declared bankruptcy, those details “would take years to sort out in courts, hardly fixing practical problems in the meantime.” Besides, you can’t fix fiscal problems when you’re “shut out of credit markets,” as every bankrupt state would be, said Felix Salmon in Reuters.com. There’s no shortcut to solvency—just the hard work of cutting spending, raising taxes, and borrowing the rest. So let’s dispense with this fantasy of bankruptcy “once and for all.”

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