Tuesday, January 25, 2011

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?


Joel Farnham said...


What is the alternative Andrew? Riots? Arresting the whole legislature and removing them from office? Arrest any actor or actress who dares open their mouths outside of their work.

I think that cutting taxes to new lows would work. Remove whole agencies designed to destroy businesses by regulations that makes no sense would work. Any enviromental agency would be a good choice.

Burn existing regulations. Have everyone start over. This time have requirements that every year any regulation has to be renewed individually by the legislature.
It would mean that 99% of the politician's time would be spent having to vote up or down on regulation after regulation. The virtue? It would give them little time for new mischief.

The main worry I have about bankruptcy being applied to states is the power that a judge would necessarily have to set things right. Which judge would be used? A conservative one? Or a liberal? Will he be able to rewrite the state's constitution?

What happens if the judge is Hillary Clinton? What then? Or better yet, what happens if the judge is actually a Muslim and decides everything according to Sharia law? I think riots might be preferable in either case.

Tennessee Jed said...

I never thought of bankruptcy as evil per se. I would say let them in exchange for state constitutional amendments capping taxation, outlawing government unions, requiring a balanced budget, and deportation of all illegal aliens . . . . for starters.

T_Rav said...

Andrew, I see the benefits but I don't see them outweighing the problems that would come with bankruptcy. California made it very clear in November that it is not willing to pull away from the government teat for even a moment; as you said, its citizens are content to suck every last benefit from the current apparatus and then depend on Washington to fix it all.* If for no other reason than to avoid the precedent that would set, I think that when--not if--California finally exhausts its resources and tries to pass the buck, the GOP needs to dig in its heels and let the state go belly-up. And it's not even about "getting back" at The Golden State for sticking with the Dems; it's about demonstrating that actions have consequences and that this is the sort of thing for every other state to avoid.

*By "its citizens," of course, I don't mean LawHawk and the other responsible people who still live there. Sounds like that State of Caliente may have to be formed sooner rather than later.

AndrewPrice said...


On the Muslim issue and re-writing the Constitution, any bankruptcy judge's decision can be appealed up the usual chain of federal courts, so the chances of a rogue decision are pretty minimal -- plus, bankruptcy courts don't work that way. They try to cause as limited an impact as possible.

In terms of cutting taxes and agencies, that's easy to say but it's just not a practical solution because there aren't enough people who would accept it. You are much more likely to find the inverse, voting for much higher taxes and stiffer regulations, i.e. to try to prevent the economic cycle from punishing the state.

What is the alternative? That's a good question. I suppose California is already giving us clues on that. The state goes broke without the ability to reorganize. So their obligations pile up unpaid. Services end, payments for things like welfare, salaries and pensions end. They issue IOUs. And the legislature looks desperately for ways to solve the problem. Right now the only thinking they can come up with is (1) raise taxes, (2) beg Washington. What happens when it gets worse? I'd say this stuff intensifies. When that doesn't work? Who knows?

AndrewPrice said...

Jed, Putting conditions on it would be a definite possibility. Would the Congress choose those conditions? I doubt it. But it would probably go a long way toward fixing things.

AndrewPrice said...

T_Rav, I agree, and you'll be happy to know that the Republicans are flat out refusing to support any bailout of the states. That makes me very happy. Even the RINOs are standing strong on this.

I don't see letting California go under as "getting even", I see it as a necessary moment in straightening them out. It's like letting an addict hit bottom -- if they don't do that, you can't fix the problem.

California voters showed that they simply don't want to behave responsibly, and they expect that we're going to bail them out when it finally gets bad enough. But we can't let them get away with that, because it will only encourage them to do it again and it will encourage other states to do the same.

Only by letting them hit bottom, when basic services start failing, all the goodies they get from the state stop coming, and the last few sane people flee the state will they ever start to realize that they can't do what they've been doing.

It's unfortunate that this will do a lot of damage to the state, but they have brought this on themselves.

AndrewPrice said...

By the way, I'm not advocating bankruptcy, I can see a lot of pros and a lot of cons, but it is an interesting idea and a lot more Republicans are talking about it every day.

And in truth, even if they got this power, I don't think any of the states would ever use it. I can't see a single governor being willing to be "the guy" who broke their state. But it would give them a good deal more leverage when dealing with unions and legislatures.

Ed said...

Interesting idea. If they don't have the power to file bankruptcy, what happens if they just stop paying their bills?

AndrewPrice said...

Ed, That's a good question and I'm not sure anyone knows. Here are some possibilities.

1. The state will be sued for not meeting its obligations. The courts have already decided that they can order a state to impose a tax to meet the state's obligations -- this happened in a Kansas City desegregation case. So the court's might impose a tax increase.

2. The feds might try to force the state to fix it's budget. But here, questions of federalism will interfere with the fed's efforts. So what the feds can really do isn't clear.

3. The state will limp along unable to borrow and unable to pay it's bills. That's the most likely possibility, but I don't know how long you can get away with that before the whole state collapses.

4. States try to sell off their assets, like selling state property or state land.

5. They finally raise taxes or cut the budget.

It's just not clear how any of this would play out, but California seems interested in exploring the possibilities. Everyone else seems intent on avoiding this fate.

Unknown said...

Andrew: Good, short explanation of how bankruptcy works. In California, it would mean voiding the contracts for public employees, and a referee determining what can be budgeted and sustainable in the future. Although I never thought I'd say this, it will require the federal government to impose fiscal responsibility on a state. California's irresponsibility is legendary, but the biggest piece of this stinkburger is the spiraling obligation to overpaid public employees, both those "working" and those retiring. Still, California's problems will not be solved until the state government also gets its jackboot off the back of business.

AndrewPrice said...

Lawhawk, You may well be right. It might be that a state like California simply will not fix itself, and will need the feds to impose some discipline. I guess we'll see, but I'm honestly not seeing anything out of Jerry Brown and his crew that even points in the right direction. The cuts he's talking about are peanuts and even the taxes they're talking about are both destructive and way too small. So what's left except they simply go broke?

The pension problem is actually huge. State workers (like federal workers) are on "defined benefit" plan -- which means they get a certain amount no matter what they paid in. And that's created a $15 trillion unfunded liability in the states. That's the entire US economy and then some. How in the world they can pay that is not clear.

In any event, this is a mess.

And while I'm not sure I like the bankruptcy idea, at least people are starting to think out of the box rather than just talking about bail outs.

T_Rav said...

Andrew, I definitely don't think we should treat this as a "getting even" moment with CA. For one thing, it's not like that's the only place this could happen; for another, I consider one of the hallmarks of conservatism to be the placing of the common good and the social order above the indulgence of a particular ideology. If CA doesn't change its ways (in fact, maybe even if it does change its ways), things are going to get very ugly. After all, the breakup of state administration would mean a lot of nasty details we don't always consider--parks closing, trash collection stopping, roads crumbling, all of which could permanently alienate people from the government and cause them to start ignoring whatever obligations they have to it (taxes, etc.). That would not be good; and if it looked like the GOP had essentially caused the total collapse of one of the most populous and economically powerful states in the country by snubbing it out of irritation over November, we would all be demonized, and rightfully so (assuming that was true, anyway).

All of which is to say, I understand the arguments in favor of state bankruptcy, considering the unpleasant alternatives; and while I'm ultimately against it, I think this absolutely has to be presented as a necessary step to prevent future irresponsibility, in Sacramento or elsewhere.

Unknown said...

Andrew: The Purple Shirts of the SEIU have already turned out in full mob force at the mere suggestion that they be required to contribute to their own retirement. How dare we suggest such a thing? The inmates have truly taken over the asylum.

AndrewPrice said...

T_Rav, I think you're right about not turning this into a revenge thing. Spite is never good policy, and it doesn't fit the conservative way -- which is to try to set the country on the right course. And it would have the nasty types of consequences you mention.

Not to mention, we don't want a mass exodus from California. We've already had that in the 1990s and it did a lot of damage to surrounding states as these people swamped other western states and immediately set about remaking California in those states.

That said, I don't see it as spiteful at all to refuse them a bailout and to let them suffer the consequences of their actions. Indeed, I don't think stepping in before they've hit bottom will work. Not only will they not agree to make necessary changes, but we'd be blamed for everything that went wrong after that point, even if we didn't have any control over their actions. In other words, until they are ready to listen to us, we need to let them try to fix it themselves.

Still, bankruptcy could be a powerful (and possibly a necessary) tool to solve this problem. But it doesn't come without problems. And I'm just not sure if the problems outweigh the benefits or not? Maybe giving them the option is the best way to go and letting them make the decision?

At the very least, I'm glad that people are thinking outside the box on this. In the past, the only answer would have been to force Texas and Georgia and Colorado to bail them out -- and that is unacceptable.

I'll tell you what though, this is the moment for politicians to make names for themselves. If you want to be a future president, then be the person who saved California. Unfortunately, that seems to go against the grain of most politician's instincts -- as they would rather scurry into rat holes to hide.

AndrewPrice said...

Lawhawk, That seems to be the union way. They are FURIOUS about the bankruptcy suggestion because they know that they took too much from the states and they know they'll be forced to give it back.

Whatever happens, I suspect things will need to change between the states and the unions and particularly with regard to their pensions.

Notawonk said...

oooo, i don't know. taking gov'ment cheese from those who believe they are owed it, seems risky.

StanH said...

My problem with bankruptcy for a state, it wont be a real bankruptcy, but a GM type bankruptcy. I’m not an attorney but, as I recall in the real world if at least three vendors get together that are owed money ninety days beyond the set terms, you can force a company/entity into BR, setting up a DIP (Debtor In Possession) guaranteeing some kind of payment, usually a pitiful amount. I believe California is paying it’s vendors with IOUs, so could the vendors force BR? Also with a DIP you would preset the sale to the state guaranteeing the vendors payment, who would be the DIP? …Barry, lackey? Also many bond holders with states are small time people, not a sophisticated investor like GM. Just a couple of my concerns.

Now you can trounce on me counselor. : - )

AndrewPrice said...

Patti, True. But the cheese is going to disappear one way or another. I guess the only question is how?

AndrewPrice said...

Stan, That's true, it won't be a real bankruptcy, it will be a very unusual bankruptcy. So many of the normal rules won't apply -- like the one you mention where creditors can force a bankruptcy. I'm pretty sure that only the state will have the power to decide to enter bankruptcy.

In terms of who gets hurt, it will be a lot of regular people (as compared to large company creditors). But, they're going to get hurt either way. In other words, at some point, California will simply run out of money and will have no choice but to stop paying its bills or really jack up it's taxes. Would bankruptcy make this more orderly? It probably would.

But, that would not be very democratic, nor can we say for certain that offering bankruptcy as an option won't just cause the state to "give up" on trying to fix itself and possibly finding a better solution. It's hard to tell, and that's why I'm not sure if this is a good or bad thing. I think there may just be too many unknowns? But it's worth considering:

Could these states fix themselves with out it? Sure. Do they have the political will? I don't know. Would they be better off in bankruptcy or not? I don't know.

Ed said...

It almost sounds like bankruptcy would be the easy for politicians to avoid making hard choices, something at which which they excel.

AndrewPrice said...

Ed, I that's a danger, though I think it's unlikely to be that cut and dry. They may see bankruptcy as an easy way to push hard decisions on someone else, but they will bear the blame for pushing the state to that point. So I suspect there will still be a pretty strong desire to avoid it. But I'm just guessing. It could well be that they will use bankruptcy the same way they use the courts or commissions -- as a way to avoid responsibility for making unpopular decisions.

CrispyRice said...

Interesting take, Andrew. Would it hurt the country if the states could file bankruptcy?

AndrewPrice said...

Crispy, I don't think so. Each state (and municipality) pays different bond rates already to reflect their credit worthiness. So only the state that filed would get hurt. But it's hard to say what that would do to the general view of the US. It might hurt our credit rating if people start thinking that "the US" doesn't stand behind it's debts.

I would think it won't hurt, but I can't guarantee that.

rlaWTX said...

who in their right mind is taking IOUs from California???

sounds like a "committee" of judges would be necessary to cover all of the various pieces of pie involved.

That CA election is mind-bogling everywhich way you look at it...

AndrewPrice said...

rlaWTX, I couldn't agree more. If California wanted to pay me in IOUs, I would immediately stop providing whatever service it was they were getting from me.

And you're right, that election was insane. They're in deep trouble, so the go overwhelmingly to the people who caused their problems and who seem to be promising to make them worse? Pure insanity!

Be glad you live in a sane state like Texas, which would never follow California's example! And be even more glad that you aren't going to have to pay to bail out California!

LL said...

California is one of the largest 'donor states' to the federal exchequer. If it went, BK, would it be allowed to "keep" all of the money it sent to the Feds and to apply that to paying off its own debts.

Under Chapter 9, that is precisely what Orange County, CA did during the term of its BK.

At the time, I worked for Orange County DA and ran that investigation.

AndrewPrice said...

LL, I'm not sure how much power a bankruptcy court would have vis-a-vis the federal government, that's one of the many questions that remain unanswered.

98ZJUSMC said...

as these people swamped other western states and immediately set about remaking California in those states.

I will never understand this. I see the same thing with the Chicago clowns who relocate down here in Southern Illinois. "Oh, I just can't stand Chicago."

...and they go right ahead and try to implement the same type of things.

Flippin' people are nutz.

State bankruptcy?

Yes. YES!!

....with very strict fiscal limits placed by a court that has the authority and the will to hold it (the State) to it.

AndrewPrice said...

98ZJUSMC, I don't understand it either. We had tens of thousands of Californians move to Colorado, and every one of them complained: "I left California because.... too many laws, too much regulation, taxes were too high, too whacko, etc. etc." But then they'd start with "hey, Colorado doesn't have a law allowing the state to ____, and we need regulations to stop businesses from ____, and what about the rights of ____." Then they start supporting tax increases to pay for these new regulations.

They left California because it was such a mess, but then they wanted to recreate that exact mess here?? What the heck?

It's like some form of insanity.

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