Bankruptcy for States?

People who file bankruptcy are irresponsible. They spent too much, took advantage of the rest of us, and are just trying to get out of paying the consequences. Only liberals love bankruptcy. Right? Well, not really. And, interestingly, more and more conservatives (e.g. Newt Gingrich, Tim Pawlenty, Mark Kirk) are suggesting that bankruptcy might be the best course for some of our states?

Let’s start with some background. By law, state governments are required to balance their budgets. Some of these, most notably California and New York, have gotten around this by using pure fantasy numbers and accounting gimmicks to hide the real state of their budgets. But years of lying have caught up to these states and they can't hide the truth anymore. So naturally, they want Washington to bail them out. But the Republicans (even the RINOs) are steadfastly refusing because there’s no justification for the responsible states being forced to pay the debts incurred by the irresponsible states, especially as irresponsible states like California don’t seem willing to make any necessary changes.

This has raised the issue of bankruptcy. Right now, the states are prohibited from filing bankruptcy by federal law. But Congress could change that. Should they?

Bankruptcy is not as evil as many people believe. The concept behind bankruptcy is that sometimes, people need a fresh start. For whatever reason, they’ve overextended themselves and nothing they do will ever be able to dig them out of the hole they’re in. Rather than leaving them as permanent paupers, bankruptcy offers a chance for them to start over from scratch, to turn their lives around and to become useful members of society. The theory on this makes a lot of sense. The problem, of course, is abuse.

But bankruptcy of governments poses a bigger problem. For one thing, we expect governments to be responsible, and it’s troubling that a government would default on its obligations; this is unsettling to people who rely on the government to provide essential services and pensions. Secondly, whereas some people honestly cannot pay their debts, governments can always raise taxes and cut spending; thus, they are not legitimate candidates for bankruptcy. Third, this sets a horrible precedent because it encourages governments to be irresponsible because they can rob their own treasuries and then escape their irresponsibility when it becomes unsustainable -- something politicians would happily do. Moreover, there is something un-democratic about having a bankruptcy judge decide which government obligations will continue to be met.

But there are good reasons to allow bankruptcy too.

For one thing, the current system is not doing any better at getting states to act responsibly. Look at California, for example, which is well past the point of bankruptcy. Rather than fixing its budget, Californians voted for Democrats who will turn up the spending spigots to full, all in the hopes of getting as much as they can before the federal government turns off the spigots and bails them out.

But even more importantly, bankruptcy may be the best way to ensure that the cost of fixing the problem is borne mostly be the people who caused the problem. This is what explains why some conservatives are starting to suggest bankruptcy.

In the event a state goes bankrupt, it’s likely that essential services and benefits will continue. It’s also likely that pension benefits currently being paid will continue untouched. What would most likely be cut are state employee salaries and future benefits, non-essential programs, and obligations to bondholders, and taxes would be raised. Let’s think about each group.

Group 1: State employees. State employee unions have been breaking the back of state governments for years. Indeed, it’s amazing how expensive state employees really are compared to what it would cost to hire private firms to take over those services. A bankruptcy judge can break the union contracts and impose a new pay scale, revise benefits, and change workplace rules. Would this be fair? You tell me. For years now, these employees have benefited from being vastly overpaid and underworked because their unions have been able to bully politicians.

Group 2: Non-essential programs. This is called pork. There is no doubt that a judge would keep services like police and fire going, and would continue payments made to people who depended on them (welfare and pensions). But they would look to cut unnecessary projects and lavish expenses, i.e. the things lobbyists obtain for their clients that run contrary to the public interest.

Group 3: Bondholders. Bondholders will get burned. But bondholders know default is always a possibility, which is why they charge different rates to different borrowers. And as the borrowing costs of the states do reflect the possibility of default, bondholders have no room to complain.

Group 4: Taxpayers. There is little doubt a court would order an increase in taxes. This may seem unfair to people who never asked for the out of control spending, but consider this. At some point, these states would need to raise taxes anyway, thus this is nothing that wouldn’t happen otherwise. And a bankruptcy judge, whose job is to determine equitable solutions, is much more likely than a proven-irresponsible legislature to spread the tax hike out in a manner that requires everyone to share the pain, and is less likely to try to single out an unpopular group or protect a popular one.

Thus, allowing states to file bankruptcy may result in (1) breaking public sector unions, (2) the elimination of pork, and (3) a more equitable sharing of the tax burden. This could be why liberals (and unions in particular) are furious at the idea. And let's not forget, if liberals like Jerry Brown don't like it, they can always figure out other ways to pay their debts. . .

What do you think? Good idea?