For a thoughtful discussion of State bankruptcy, listen to this podcast in which economists Kate Waldock and Luigi Zingales interview David Skeel. Without question, Skeel is the foremost expert on the subject. I was very pleased to listen to how Skeel manages to convince two progressives that State bankruptcy might actually be (part of) a grand bargain.
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A week ago I mused here on why the US Congress might afford individual States the power to restructure their debt in bankruptcy. (You can find some forgotten posts on the topic from nearly a decade ago here and here.)
As matters currently stand, if permitted by their State, municipalities can seek to restructure their obligations under Chapter 9 of the US Bankruptcy Code.To this point, however, the States themselves have no federal forum in which to restructure their current debts and future obligations. This gap is significant in several respects. First, while an insolvent State can always negotiate with their creditors, unless the bond provides otherwise, the State and consenting bondholders cannot force a recalcitrant creditor to go along. For example, even if 999 of one thousand holders of a particular issue of State bonds agree to restructure the underlying debt, a single holdout is not bound. That holdout can seek whatever relief it may under the terms of the bond and State law. The potential for strategic players to hold out makes it less likely that any other creditor will agree to take anything less than timely payment in full.
Second, what of creditors who cannot negotiate? In particular, what about retirees who are entitled to pensions and health benefits? It is not clear that even willing retirees can agree to take anything less than what was promised. (I discuss this problem as it exists in California in When Doing Less Is Doing Best (here)). And negotiating with multitudes of retirees would be especially difficult. Renegotiating deals with hundreds of thousands of retirees would challenging not only because of natural sympathy for the plights of some of them, but also because, unlike tranches of municipal bonds, there is no single indenture trustee with whom to begin negotiations.
And third, what about non-creditor stakeholders like residents and taxpayers? Perhaps the political process is enough for them (but see my discussion of the need for taxpayer standing in Who Pays the Price: The Necessity of Taxpayer Participation in Chapter 9 (here)). In any event, State constitutional protections as well as the Contracts Clause may effectively take modification of future statutory obligations off the restructuring table.
In any event, the fissiparous process of State-level politics makes it unlikely that any creditors will take seriously the promises of the current State government of fiscal reform made in exchange for debt relief when they know that those promises may be undone after the next election. Out-of-court bargaining to deal with State insolvency is unlikely to be effective.
On the other hand, why should a State care if it cannot restructure its debts? States enjoy sovereign immunity in their own courts (except as waived by their own statutes). And States generally enjoy immunity from suits by citizens of other states in federal courts by virtue of the Eleventh Amendment. Yet, while sovereign immunity is a powerful shield, it's not a sword. Sovereign immunity can't help if a State wants to restructure its debts. And a State might very much like to restructure its debts because it wants to avoid default so it can access the bond market in the future.
Well, if a State faces insolvency, some sort of federal bankruptcy-like system of jurisdiction over the State and its creditors offers a solution to the problems identified above. But might there be another fix, less intrusive and less disruptive? In short, could the federal government, with its seemingly unlimited ability to incur debt, bail out insolvent States as it has (and is) bailing out certain insolvent firms and individuals? The answer is obviously no with the current politically divided federal government. And "no" is still the better answer even if we see a regime change in November.
Several reasons not to provide direct federal funding for insolvent States come to mind. First is the problems with bailouts generally: they distort incentives. States (and yes, their voters) that have borrowed inordinately (or promised unaffordable benefits) should pay a price for their profligacy. Lessons can be learned. So should businesses, of course, which is why federal money for corporations should be limited to those that are systemically significant to the national economy. And even then, the money should come as loans so that the federal claim for repayment is ahead of the interests of shareholders. (In other words, give the lie to the charge against the 2008 bailouts: that they privatized gains but socialized losses.)
Such "strings attached" loans to the States, however, are politically unfeasible and may even be unconstitutional. The "strings" would also be unenforceable: the federal government would be remedy-less were the State later to renege on promises made when it was asking for the money.
A second issue with federal bailouts for States is found in the nature of federalism. States are so-called laboratories of policies with respect to mixes of taxes, expenditures, compensation for public employees, and economic policies (and yes, subsidies for relocating businesses). It is fundamentally inconsistent with any notion of federalism to tax the citizens of some States to paper-over the long-term unsustainability of other high-expenditure States. Think what we will of the moral probity and wisdom of low-tax, low public-expenditure, high business-subsidy States, it is fundamentally unjust to incur yet more federal debt to cover the pernicious duplicity of a State like, say, Illinois. In short, two wrongs don't make a right.
When all is said and done, State-level bankruptcy is the best solution to State-level insolvency. Bankruptcy restructuring forces players at the State level--elected government and its many creditors (bondholders, employees, retirees, and residents)--to deal with the problem of unsustainable debt. State-level bankruptcy is consonant with principles of federalism and subsidiarity. And whatever its weaknesses (and there would be many), State-level bankruptcy is better than the alternative currently on the table.
________________________________________________________________________
A week ago I mused here on why the US Congress might afford individual States the power to restructure their debt in bankruptcy. (You can find some forgotten posts on the topic from nearly a decade ago here and here.)
As matters currently stand, if permitted by their State, municipalities can seek to restructure their obligations under Chapter 9 of the US Bankruptcy Code.To this point, however, the States themselves have no federal forum in which to restructure their current debts and future obligations. This gap is significant in several respects. First, while an insolvent State can always negotiate with their creditors, unless the bond provides otherwise, the State and consenting bondholders cannot force a recalcitrant creditor to go along. For example, even if 999 of one thousand holders of a particular issue of State bonds agree to restructure the underlying debt, a single holdout is not bound. That holdout can seek whatever relief it may under the terms of the bond and State law. The potential for strategic players to hold out makes it less likely that any other creditor will agree to take anything less than timely payment in full.
Second, what of creditors who cannot negotiate? In particular, what about retirees who are entitled to pensions and health benefits? It is not clear that even willing retirees can agree to take anything less than what was promised. (I discuss this problem as it exists in California in When Doing Less Is Doing Best (here)). And negotiating with multitudes of retirees would be especially difficult. Renegotiating deals with hundreds of thousands of retirees would challenging not only because of natural sympathy for the plights of some of them, but also because, unlike tranches of municipal bonds, there is no single indenture trustee with whom to begin negotiations.
And third, what about non-creditor stakeholders like residents and taxpayers? Perhaps the political process is enough for them (but see my discussion of the need for taxpayer standing in Who Pays the Price: The Necessity of Taxpayer Participation in Chapter 9 (here)). In any event, State constitutional protections as well as the Contracts Clause may effectively take modification of future statutory obligations off the restructuring table.
In any event, the fissiparous process of State-level politics makes it unlikely that any creditors will take seriously the promises of the current State government of fiscal reform made in exchange for debt relief when they know that those promises may be undone after the next election. Out-of-court bargaining to deal with State insolvency is unlikely to be effective.
On the other hand, why should a State care if it cannot restructure its debts? States enjoy sovereign immunity in their own courts (except as waived by their own statutes). And States generally enjoy immunity from suits by citizens of other states in federal courts by virtue of the Eleventh Amendment. Yet, while sovereign immunity is a powerful shield, it's not a sword. Sovereign immunity can't help if a State wants to restructure its debts. And a State might very much like to restructure its debts because it wants to avoid default so it can access the bond market in the future.
Well, if a State faces insolvency, some sort of federal bankruptcy-like system of jurisdiction over the State and its creditors offers a solution to the problems identified above. But might there be another fix, less intrusive and less disruptive? In short, could the federal government, with its seemingly unlimited ability to incur debt, bail out insolvent States as it has (and is) bailing out certain insolvent firms and individuals? The answer is obviously no with the current politically divided federal government. And "no" is still the better answer even if we see a regime change in November.
Several reasons not to provide direct federal funding for insolvent States come to mind. First is the problems with bailouts generally: they distort incentives. States (and yes, their voters) that have borrowed inordinately (or promised unaffordable benefits) should pay a price for their profligacy. Lessons can be learned. So should businesses, of course, which is why federal money for corporations should be limited to those that are systemically significant to the national economy. And even then, the money should come as loans so that the federal claim for repayment is ahead of the interests of shareholders. (In other words, give the lie to the charge against the 2008 bailouts: that they privatized gains but socialized losses.)
Such "strings attached" loans to the States, however, are politically unfeasible and may even be unconstitutional. The "strings" would also be unenforceable: the federal government would be remedy-less were the State later to renege on promises made when it was asking for the money.
A second issue with federal bailouts for States is found in the nature of federalism. States are so-called laboratories of policies with respect to mixes of taxes, expenditures, compensation for public employees, and economic policies (and yes, subsidies for relocating businesses). It is fundamentally inconsistent with any notion of federalism to tax the citizens of some States to paper-over the long-term unsustainability of other high-expenditure States. Think what we will of the moral probity and wisdom of low-tax, low public-expenditure, high business-subsidy States, it is fundamentally unjust to incur yet more federal debt to cover the pernicious duplicity of a State like, say, Illinois. In short, two wrongs don't make a right.
When all is said and done, State-level bankruptcy is the best solution to State-level insolvency. Bankruptcy restructuring forces players at the State level--elected government and its many creditors (bondholders, employees, retirees, and residents)--to deal with the problem of unsustainable debt. State-level bankruptcy is consonant with principles of federalism and subsidiarity. And whatever its weaknesses (and there would be many), State-level bankruptcy is better than the alternative currently on the table.
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