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December 22, 2010

What a State Bond Default Looked Like When It Last Happened, In 1933

Arkansas just kept piling up debt, and then defaulted.

Three pieces of bad news here:

In January 1934, the bondholders got a permanent injunction against the state, blocking the use of automobile and gasoline taxes for anything other than highway maintenance and debt service.

Now “at the mercy of the bondholders,” in the words of Senator Reaves, the state in 1934 agreed to a refunding that extended some maturities and required an increase in both those automobile and gasoline taxes.

That cured the 1933 default.

So I assume this means that bondholders could do this today. The bad part isn't that they essentially garnish the state wages; it's that the state then raises taxes otherwise to make up for the money flowing out to bondholders.

I do not know if employee unions have the same sort of legal position, where they can compel states to direct monies into their pensions and such.

In the mid-forties, the state threatened default again, and couldn't sell bonds except at very high rates of return (which would make them appealing enough to investors to overcome their risk aversion, but would be too expensive for the state to pay). So the RFC (FDR's Reconstruction Finance Corporation) came in and bought the bonds, all of them, at a rate favorable to the state. Essentially, then, the federal government subsidized the state for borrowing so much and mismanaging its finances and repeatedly defaulting and threatening to default on its obligations, sparing it from having to pay a high cost for its spendthriftery.

Just making everyone else in the country pay for it.

Here's the difference:

In 1933, nobody thought Washington should get involved in a state bond default. In 2010, that’s the first place we would look for help.

So back then, it was a surprise that the federal government should do this; now it's just expected.

So what incentive do states have to make tough cuts? None, it seems.

digg this
posted by Ace at 05:05 PM

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