On the GOP, bankrupt states and government unions
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.
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.