by Sarah Curry
Director of Fiscal Policy Studies
We all know cities can file for bankruptcy. Look at Detroit, and they aren’t the only municipality that has taken advantage of bankruptcy to clear their crushing financial obligations. But federal law doesn’t allow states to go bankrupt. A professor from the University of Pennsylvania Law School, David Skeel, has become the leading proponent of an idea that federal bankruptcy law should be changed to all a state to declare bankruptcy.
The National Journal highlights some of his ideas in a recent article,
“If a state’s financial distress is truly irresolvable, the only current options are a federal bailout or a massive default,” Skeel told me. “Bankruptcy would provide an additional, more orderly alternative.” Default would cause chaos; state governments would have to choose willy-nilly which services to fund. Bankruptcy, by contrast, compels stakeholders to come together and work out a legally binding solution, blessed by a judge. Bankruptcy also allows for drastic adjustments—major haircuts for bondholders, for example—that the normal political process cannot, in many cases, legally accomplish.
So is this an idea that is supported by Republicans or Democrats? The idea was most popular from 2009 to 2011 during the Great Recession when multiple states were facing severe financial problems. High profile politicians have supported the idea such as Newt Gingrich and Jeb Bush, and some Congressional Republicans drafted a bill in early 2011. Not all Republicans support the idea, which is why it never got any serious traction in Congress. Democrats don’t have much support for the idea either. Most Democrats worry that a state bankruptcy would harm public sector pensions. The article quotes former California state Treasurer Bill Lockyer, “I think it’s a way to attack public-sector employees because [Republicans] don’t like their politics,”.
Some have questioned the constitutionality of a state bankruptcy, and as the recovery from the recession led to more state revenue, the idea has been taken off the short list. Skeel has made comments about both of these issues as well.
Questions were also raised over the constitutionality of state bankruptcy, because states are treated as sovereign entities under the Constitution, and a federal bankruptcy law could be construed as undue interference in state business. In response, Skeel has written, “This concern is easily addressed. So long as a state can’t be thrown into bankruptcy against its will, and bankruptcy doesn’t usurp state lawmaking powers, bankruptcy-for-states can easily be squared with the Constitution.”
As the economy has steadily improved and states have begun collecting more revenue, the issue has receded among Democrats and Republicans alike. But that won’t last, according to Skeel. He argues that the current economic uptick will provide only a temporary respite for states facing deep structural deficits. (Some critics on the left, including the Center on Budget and Policy Priorities, disagree with this. The Center argues that states have “adequate tools and means” to meet their financial obligations over the long term.) According to data from State Budget Solutions, a conservative think tank, California carries unfunded pension liabilities of $754 billion, despite favorable economic conditions. Illinois, another state with perennial budget woes, has some $330 billion in pension obligations it won’t be able to meet.
“Detroit showed that it’s possible to restructure pensions … without leaving people out on the streets,” Skeel told me. Indeed, Detroit retirees in the general system were subject to only a 4.5 percent monthly benefit cut, the elimination of cost-of-living increases, and reduced health care benefits (they will still have access to Medicare). It’s little wonder, then, that more than three-quarters of Detroit retirees backed the deal. For the first time in decades, Motown may serve as something very different from its usual role as cautionary tale: It could be a model to emulate.