Who’s In Charge, Here?

Congress is mulling legislation that would allow States to seek bankruptcy. Is that a good idea?

In the past couple of weeks several proposals have surfaced that would allow States to declare bankruptcy. Some lawmakers have said they are concerned that some fiscally challenged States may seek a Federal bailout. After all, isn’t California too big to fail as well? Under Federal law, only cities and localities in some states may file. If a town fails to pay principal or interest in a timely manner, the lawsuits begin to fly, writs of mandamus are issued, and local officials become consumed with legal matters. Bankruptcy offers them time to organize their finances and address their financial problems in an orderly fashion.

But bankruptcy is overseen in Federal Court. And State bankruptcy would raise thorny Constitutional issues, because States are sovereign entities. Also, municipal bankruptcy is a long and tedious affair. Because judges have no power to raise taxes, cut spending, or force asset sales—liquidation is not an option—Chapter 9 proceedings usually last for years, especially when a large entity is involved.

Moreover, no governor or state is asking for a bankruptcy solution. California treasurer Bill Lockyer put it succinctly: “To the folks in Congress cooking up this baloney: Don’t bother. States didn’t ask for it. We don’t want it. We don’t need it.” There’s widespread speculation that the real target is union contracts. Because politicians fear the political clout of the unions, they might use the power of a federal judge to help them re-write pension contracts.

But municipal bankruptcy is always voluntary. A politician can’t blame a judge for re-writing a contract if that politician asked the judge to re-write the contract in the first place. Sovereign states have to deal with their own issues.

Bankruptcy would take a wrecking ball to a State’s economy. Hopefully this proposal goes nowhere.

Douglas R. Tengdin, CFA
Chief Investment Officer
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