The Global Recession Forces U.S. States into Financial Dire Straits: Is Bankruptcy the Right Solution?

Sources:

WSJ: State Bankruptcy Is a Bad Idea

WSJ: A Bankruptcy Law—Not Bailouts—for the States

WSJ: Reports of Looming Municipal Defaults Are Overstated, Study Says

FT: California’s Potholed City Presents View of the Future

NYT: A Path Is Sought for States to Escape Their Debt Burdens

Few individuals or entities have managed to escape financial hardship brought about by the current global economic crisis. State and local governments in the U.S. are no exception. A consistent decline in tax revenues and a fiscally detrimental habit of overspending have led some states to the brink of insolvency. Simply put, the states’ tax revenues have not been able to keep up with the cost of providing public services, such as law enforcement, education, health care, etc.

Some experts have identified bankruptcy as a possible solution. They claim that it is the only viable means through which states can restore their solvency. The pro-bankruptcy commentators insist that allowing states to file bankruptcy is the only way to fundamentally renegotiate union contracts and restructure states’ bond debt and their unsustainable pension benefits. Additionally, these experts argue that bankruptcy is the sole alternative to a federal government bailout of insolvent states.

Currently, however, the bankruptcy code does not allow states to declare bankruptcy. Some consider such a legislative change unnecessary anyway because states already have the means for bridging their budget gaps by instituting layoffs, freezing wages, and even cutting wages through involuntary furloughs. The availability of these alternatives in cutting costs puts pressure on unions to either make concessions or see their members unemployed.  

Before politicians and scholars on both sides of this issue take a stand, they should study closely the example of the City of Vallejo, California, which declared bankruptcy in 2008 and is planning to emerge from it this year. Unlike states, cities can declare bankruptcy under the present version of the bankruptcy code. Vallejo discovered, however, that even in bankruptcy public pension agreements are difficult to modify. Additionally, the city’s legal bills are nearing $10 million. Vallejo’s experience should serve as a warning for those states that see bankruptcy as an easy way out of their fiscal problems.

Discussion Questions:

1. Could politicians at the state level find the political will to impose fiscal austerity, even if such a measure would endanger their re-election? If not, do we have the right people in office?

2. Allowing states to declare bankruptcy seems contrary to the idea of fiscal responsibility. Should Congress give states the option to file bankruptcy or should it teach them a lesson they will surely remember?