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January 21, 2011

Let's Make It Official: Congress Quietly Working On Bill To Permit States To Declare Bankruptcy

Let's not notice the states in danger of bankruptcy are those controlled absolutely by liberals.

Before you say "They should be forced to live with their debt," remember (as I failed to) that the states have made contractual obligations to, for example, their unions' pension funds, and states are constitutionally barred from canceling/modifying their contracts. As things stand. (If I have this right: they're so barred by their own constitutions. See the link at the bottom of the post.)

So... I think if states are going to unilaterally change their contracts with unions they will need some escape clause like this. Whether that's Constitutional or not I don't know. It sounds like a "not" but, as I'll quote later, some guy says this is an easy call, and it's quite constitutional.

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

...

Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.

Putting aside the constitutional question (just because I don't know the answer), there would be two good effects:

1. There would be no further empty promises of future contributions to state employee pension/retirement funds because no one would ever believe a state again. All further such schemes would have to be cash-and-carry, contributions happening now, and that will tend to limit them, because...

2. States, especially incorrigibly liberal tax-eating ones, will not be able to issue bonds except in small amounts, and they'll have to pay higher rates just to sell those, and they'll wind up being far less attractive to states. No one will trust them. States will be compelled to live within their means, more or less.

On the other hand, this seems likely to produce a crisis of confidence. But then, I think we're already living in a crisis of confidence (and for good reason), so this is mostly just a recognition of reality.

On the constitutional question, this professor writing at the Weekly Standard says the issues are "easily addressed."

When the possibility is mentioned of creating a new chapter for states in U.S. bankruptcy law (Chapter 8, perhaps, which isn’t currently taken), most people have two reactions. First, that bankruptcy might be a great solution for exploding state debt; and second, that it can’t possibly be constitutional for Congress to enact such a law. Surprisingly enough, this reaction is exactly backwards. The constitutionality of bankruptcy-for-states is beyond serious dispute. The real question is whether the benefits would be large enough to justify congressional action. The short answer is yes. Although bankruptcy would be an imperfect solution to out-of-control state deficits, it’s the best option we have, at least if we want to have any chance of avoiding massive federal bailouts of state governments.

Start with the issue of constitutionality. The main objection to bankruptcy for states is that it would interfere with state sovereignty—the Constitution’s protections against federal meddling in state affairs. The best known such barrier is the Tenth Amendment, but the structure of the Constitution as a whole is designed to give the states a great deal of independence. This concern is easily addressed. So long as a state can’t be thrown into bankruptcy against its will, and bankruptcy doesn’t usurp state lawmaking powers, bankruptcy-for-states can easily be squared with the Constitution. But the solution also creates a second concern. If the bankruptcy framework treads gingerly on state prerogatives, as it must to be constitutional, it may be exceedingly difficult for a bankruptcy court to impose the aggressive measures a state needs to get its fiscal house in order.

That bothers me, because I'd like to see conditions imposed here that this guy is saying can't be imposed.

Southern states are famously not completely sovereign as regards their election laws. This is due to federal law, prompted by Jim Crow and then the Voter Rights Act -- the states of the old Confederacy must submit their proposed changes to election law for "pre-clearance" by the Justice Department, which then either certifies or rejects the proposed changes, based on whether the changes (in their opinion) would disadvantage minority voters.

In other words, part of southern states' sovereignty was withdrawn because they did bad things with it.

It's time for some other states to similarly have pieces of their sovereignty withdrawn. Any state which seeks these bankruptcy protections (should they come to pass) should, for decades, until they prove themselves, be required to pre-clear all tax and spending initiatives with some federal agency.

States' rights, you might object. Well, yes, but adults have full legal control of their lives; children and incompetents and mental defectives do not. And these states are children and incompetents and mental defectives.

That will be humiliating for these states and their majority-liberal citizenry; good, it should be humiliating. Deadbeats and spendthrifts ought to be humiliated.

So when this guy says the law and courts will have to "tread gingerly" to avoid usurping state sovereignty... well, if so, that seems very far from optimal to me.

With liquidation off the table, the effectiveness of state bankruptcy would depend a great deal on the state’s willingness to play hardball with its creditors.

That's the rub, then -- what's being proposed may give politicians beholden to the unions the power to modify contracts, but they might simply refuse to exercise that power -- in which case, what is gained?

Monty's Take:

It's not clear to me if these bankruptcy discussions are actually serious proposals, though, or just a way to try to scare the unions into making deals. And the unions aren't stupid; they know that a real state bankruptcy is very unlikely, and that pension/healthcare cramdowns for public employees in many states wouldn't survive a court challenge. So it's going to make for some interesting brinksmanship going forward.

The professor writing at the Weekly Standard doesn't agree that the cramdown is a problem:

But if they dug in their heels and resisted proposals to restructure their debt, a bankruptcy chapter for states should allow (as municipal bankruptcy already does) for a proposal to be “crammed down” over their objections under certain circumstances. This eliminates the hold-out problem—the refusal of a minority of bondholders to agree to the terms of a restructuring—that can foil efforts to restructure outside of bankruptcy.

I don't know.

I think Monty is right at least about the threat to unions this could hypothetically present, but in reality does not: If liberal politicians in liberal states were serious about reneging on absurd promises made to secure union support, just the threat of bankruptcy could spur renegotiations and restructurings.

But those politicians are not serious about doing that. So... again, I wonder, without taking away their power to decide their spending and tax policy (which the professor seems to believe is completely unconstitutional), what is gained?

Hey, You Know What Might Be Just Swell? Some Punitive, Confiscatory Taxation: The good kind.

What good kind, you ask?

Well, AmishDude has an idea about how to fix the problem with these bankrupting pension fund obligations if the unions won't play ball:

So what? Put a 100% surtax above a certain amount for revenue earned from a union pension fund state employees.

Problem solved.

Perfect! In theory, the state pays out its commitments, but then just taxes that payout above the level its comfortable with at a full 100% so the money goes "out" for half a second and then is immediately impounded again as a tax.

It's using their tactic of "tax 'em hard until we tax our preferred world into existence" strategem against them.

That's kind of brilliant, really.

Isn't it?


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posted by Ace at 12:40 PM

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