States say ‘no’ to bankruptcy idea

Members of Congress have been quietly working on legislation that would allow states to unburden themselves of some of the weightier financial obligations they are currently struggling with, including contracts with public sector employees and their associated pension costs. But state officials are seeking to quash the proposal, which would allow them to file for bankruptcy, fearing the damage even discussing it could cause.
 
California Treasurer Bill Lockyer (D) didn’t pull any punches when he addressed the state bankruptcy idea during a conference call with reporters arranged by the nonpartisan Economics Policy Institute last month. 
 
“It’s a cynical proposal intended to incite a panicked response to a phony crisis,” he said. “Killer bees, space aliens…now it’s the invasion of the bankrupt states. The truth is, no state wants to declare bankruptcy, no state needs to declare bankruptcy, and no state would.” 
 
Lockyer hadn’t actually seen the proposal. As of a couple of weeks ago, no draft bill had been circulated, and no member of Congress had signed on as a sponsor. 
 
One of the main reasons for that is the devastating effect a state bankruptcy option could have on the already shaky municipal bond market, potentially driving away the investors states rely on for billions of dollars worth of infrastructure and other capital projects. 
 
“Just the availability of a bankruptcy option and the potential bond default could severely damage state credit ratings and destroy the trust of bondholders,” said New York Comptroller Thomas DiNapoli. 
 
The co-chairs of the National Governors Association, Washington Gov. Chris Gregoire (D) and Nebraska Gov. Dave Heineman (R), said much the same thing in a joint statement issued on Jan. 25. 
 
“The mere existence of a law allowing states to declare bankruptcy only serves to increase interest rates, raise the costs of state government and create more volatility in financial markets,” the statement said. 
 
In the last two months, over $25 billion has flowed out of mutual funds that invest in municipal bonds, according to the Investment Company Institute. And while many analysts consider a state bond default extremely unlikely, Paul S. Maco, a partner at Vinson & Elkins and head of the SEC’s Office of Municipal Securities during the Clinton administration, said the mere introduction of a bankruptcy bill could be enough to trigger “some kind of market penalty,” such as higher borrowing costs for states and downward pressure on bond values. 
 
But proponents of the bankruptcy idea say some states are so burdened that it may be the only way out for them. They also want to avoid the prospect of a last-minute federal bailout. 
 
Harry J. Wilson, the sole Republican on the Obama administration task force that ushered General Motors and Chrysler through financial restructuring in 2009, said Congress initially resisted their efforts, voting against financial assistance to G.M. in late 2008. And he suggested a repeat of that scenario seemed likely in the current Congress. 
 
“Now Congress is much more conservative,” he said. “A state shows up and wants cash, Congress says no, and it will probably be at the last minute and it’s a real problem. That’s what I’m concerned about.” 
 
The state bankruptcy idea took off in November, after former U.S. House speaker and potential future Republican presidential candidate Newt Gingrich gave a speech addressing the major challenges facing the nation, including government debt. 
 
“We just have to be honest and clear about this, and I also hope the House Republicans are going to move a bill in the first month or so of their tenure to create a venue for state bankruptcy,” he said. 
 
The prospects for a bankruptcy measure aren’t promising. On top of the fears that it could make the states’ fiscal problems worse, it also presents some thorny constitutional questions revolving around the fact that states are considered sovereign entities. David A. Skeel, a law professor at the University of Pennsylvania who published an article in the Weekly Standard last year entitled “Give States a Way to Go Bankrupt,” said those questions were “easily addressed” by making sure states can’t be forced into bankruptcy. The ready model for Congressional lawmakers, he said, is the Chapter 9 bankruptcy law for local governments, which relieves distressed municipalities of their debts while they restructure their obligations with the aid of a bankruptcy judge. 
 
But more damning for the bankruptcy proposal’s chances is that U.S. House Majority Leader Eric Cantor (R-Virginia) opposes the idea. Cantor told the Wall Street Journal last month, “There will not be a federal bailout of the states” and they already have all “the requisite tools” they need to balance their budgets every one or two years. 
 
That is a position Texas Gov. Rick Perry (R) evidently couldn’t agree with more. 
 
“Bankruptcy should not be a bailout for states that have been poorly managed,” a spokesman for the governor said last month. “Families across America have to live within their means, and state and federal governments need to do the same.” 
 
The long odds for a full-blown bankruptcy proposal could lead Congressional lawmakers to opt instead for some sort of oversight panel for distressed states, like the Municipal Assistance Corporation, which helped New York City through its 1975 financial crisis. Whatever the bankruptcy idea’s prospects or the likely outcome of the current discussions, however, union officials are worried. 
 
“They are readying a massive assault on us,” said Charles M. Loveless, legislative director for the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.” (NEW YORK TIMES, STATELINE.ORG, WALL STREET JOURNAL, CHICAGO TRIBUNE)