James Pethokoukis

Politics and policy from inside Washington

More on states going bankrupt

Jan 21, 2011 18:48 UTC

Lots of buzz about this NYTimes story that says Washington policymakers (Republicans, really) are “working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.” (My blog post from six weeks ago that said the same thing is here.)

Government unions don’t like the idea, of course. Neither does Reuters’ Felix Salmon, always a reliable guide to what the liberal blogosphere is thinking. He and others have several objections. A big one is this: States wouldn’t be able to borrow, being shut out from credit markets.

I supposed for a time that might be true, but only for a time.  Orange Country eventually returned to borrowing, as has Argentina. In the case of the OC, it took five years for their debt to return to investment grade. So their borrowing costs rose.  In the meantime, would states need some sort of bridge loan to from Uncle Sam to keep paying their day to day bills? Not necessarily. Tax revenue would continue to flow in. Budget cutting would commence in earnest. Assets, such as roads and bridges, could be sold or privatized. Would bankruptcy mean a radical reorganization of state government? Yes, that’s the whole point.

In his recent WSJ op-ed Prof. David Skeel, a bankruptcy expert and intellectual godfather of this idea, make a couple of great observations:

First, the governor and his state could immediately chop the fat out of its contracts with unionized public employees, as can be done in the case of municipal bankruptcies. In theory, the contracts could be renegotiated outside of bankruptcy, and many governors are doing their best, vowing to freeze wages and negotiate other adjustments. But the changes are usually small, for the simple reason that the unions can just say no. In bankruptcy, saying no isn’t an option. If the state were committed to cutting costs, and the unions balked, the state could ask the court to terminate the contracts.

Second, the state could reduce its bond debt, which is nearly impossible to restructure outside of bankruptcy. While some worry about the implications for bond markets, the alternative for the most highly indebted states—complete default—is far worse. Randall Kroszner, a former Federal Reserve governor now at the University of Chicago Booth School of Business, showed in a 2003 study that the price of corporate bonds went up during the New Deal when the Supreme Court upheld legislation that reduced payments to bondholders. The reduction increased the prospect that bondholders would get paid. The prospect of state bankruptcy could have a similar effect, and even if it didn’t a reasonable reduction in state bond debt is essential to restructuring their finances.

I am not sure a state bankruptcy would look exactly a municipal bankruptcy. The details are still being worked out. But I do know the status quo with government unions cannot hold. Also in the NYT this week was this story:

As San Francisco struggles under ballooning pension and health care costs, the city’s retirees will receive unexpected cost-of-living bonuses totaling $170 million. The city’s anticipated budget deficit for the coming year is $360 million. …

On Jan. 4, an actuarial firm reported that the $13.1 billion San Francisco Employees’ Retirement System now had an unfunded liability of $1.6 billion — triple its shortfall a year earlier. Gary A. Amelio, the system’s chief since January 2010, did not respond to questions.

In spite of the shortfall, Mr. Amelio and the system’s board quietly decreed in mid-December that “excess” earnings on investments in 2010 entitled retirees to an unexpected cost-of-living increase of as much as 3.5 percent this year. The special $170 million bonus is in excess of regular cost-of-living adjustments, or COLAs.

“The irony of issuing bonus payments to retirees at a time the pension fund is a billion dollars down is insane. It really is,” said Jeff Adachi, San Francisco’s public defender and the chief proponent of Proposition B, which he says would have saved the city $120 million this year. “It’s like a bankrupt corporation paying dividends to its shareholders.”

On the GOP, bankrupt states and government unions

Jan 21, 2011 12:58 UTC

The NYTimes finally picked up on a story I had six weeks ago:

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers. … For now, the fear of destabilizing the municipal bond market with the words “state bankruptcy” has proponents in Congress going about their work on tiptoe. No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor, although Senator John Cornyn, a Texas Republican, asked the Federal Reserve chairman, Ben S. Bernanke, about the possiblity in a hearing this month.

And from my post on Dec. 7:

Congressional Republicans appear to be quietly but methodically executing a plan that would a) avoid a federal bailout of spendthrift states and b) cripple public employee unions by pushing cash-strapped states such as California and Illinois to declare bankruptcy. This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011.

That’s why the most intriguing aspect of President Barack Obama’s tax deal with Republicans is what the compromise fails to include — a provision to continue the Build America Bonds. Republicans in the House of Representatives already want to stop state and local governments from issuing tax-exempt bonds unless they are more forthright about these future obligations.

But it’s about more than just openness. Some Republicans hope the shock of the newly revealed debt totals will grease the way towards explicitly permitting states to declare bankruptcy. Indeed, legislation  amending federal bankruptcy law is currently being prepared by congressional Republicans.

A few additional thoughts:

1) The NYT article raises the specter that states would be shut out of credit markets if allowed to declare bankruptcy, or if one should actually take that step if federal law is changed. That seems unlikely, although  some may have to pay higher interest rates. Municipalities and even countries repudiate debt and yet continue to borrow. And even investor apprehension would be balanced by states getting their finances in order, which should appeal to potential lenders.

2) Republicans aren’t afraid of bankruptcies — though not on the national level — believing they restore market discipline and reduce moral hazard. Lehman is a good example. While the common narrative is that its failure caused a market panic and financial crisis in 2008, many conservative GOPers think the real problem was that Bear Stearns was bailed out, distorting investor expectations. They also believe it was Hank Paulson’s rushed TARP proposal that sent markets reeling, a hypothesis  pushed by economist John “Taylor Rule” Taylor of Stanford.

3)  Republicans have seen the debt problems in places such as Greece and New Jersey and believe government unions undermine long-term fiscal soundness. They want to spread the Chris Christie’s battle against them nationwide. And of course it also doesn’t hurt that unions are a key Democrat constituency. But Rs think it is possible to pit public and private unions against each other by making the case that plumbers and construction workers are paying higher taxes to support cushy benefits and jobs security for teachers and bureaucrats.

4) Don’t be surprised to next hear some Republicans question whether state and local bonds should remain tax exempt, arguing it only encourages fiscal profligacy.


All levels of government in the USA have more money than the rhetoric from both sides of the isle would have us believe; no theory here folks, just hard facts. Read on:

Dear Reader, please consider what Walter Burien is doing over at http://www.cafr1.com .He traded in derivatives for 30 years, has a gift for comprehending the big numbers in government financial statements, and is educating people about the fact that collective “government” now literally owns controlling interests in all the Fortune 500 companies and more through thousands of investment accounts held at the municipal, county, state and federal levels.

The proof is revealed in the “Comprehensive Annual Financial Reports” in the public domain. Thus when government bails out various corporate entities, taxpayers are unknowingly simply rescuing government investment portfolios. Naturally, no one explains this to the public; they only get the usual half-truths, lies and obfuscation from New York and Washington D.C.. The profits from these government investments are not shared with the very taxpayers whose money was used to create them.

Fascism, American style.

According to Walter, “taxes” account for a mere third of the money collective government takes in; the rest is obscene levels of profit from investments, carefully not talked about in the mainstream media. All the talk of “budget deficits” does not take into account the “profits from investment” revealed only in the CAFRs that every level of government issues as required by law, and are in the public domain for anyone to look at.

States “going broke” is only partly true; yes, they are usually spending more than their budget funds. However, the profits outlined above are carefully not mentioned to the public. The purpose? To scare the public into putting up with their present tax burden, and to prepare for more because, after all, “the government is going broke and needs our money”.

It is identical to me pulling my empty pocket inside-out and saying to you “See? I’m broke! Please give me money!” while every other pocket is stuffed full with one hundred dollar bills.

Walter Burien explains what I’ve stated here in a new 1 hour 14 minute online documentary he created called “The Only Game In Town”. A 48-hour pass costs $3.00 available here:


I watched it twice. Walter ends his video proposing a smart simple way to address the issue of taxes: create “Tax Retirement Funds” (“TRFs”) that are financed by a small percentage of the profit that every level of government is already making.

Example: Wisconsin’s Real Financial Situation taking into account the above facts:

http://realitybloger.wordpress.com/2011/ 03/01/wisconsins-real-financial-situatio n-explained/

May truth and compassion prevail….

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