The views expressed in any article published in this blog are the author's own and do not necessarily reflect the views of Joseph Foster or Bob Lupoli.

Monday, December 6, 2010

Can U.S. States be Bankrupt?

Joe:  can a US state go bankrupt? In short the answer, like most political answers is NO (but – yes) or oftentimes it’s the other way around. I think probably what will happen is the US Government will end up bailing out the states and in return will gain more control. Interested in any comments you may have. - Bob

State Bankruptcy Fears May Be Overstated
Despite all the talk of state bankruptcies, states cannot legally go bankrupt.
Investment Dealer’s Digest
By Andrew Ward, The Bond Buyer
January 12, 2009
SAN FRANCISCO--Is your state about to go bankrupt?
Given the cries of "Bankruptcy!" and "Fiscal Armageddon!" echoing through state houses and editorial pages from California and Arizona to Illinois and Alabama, you might just think so. Arizona Treasurer Dean Martin last week warned that his state's lawmakers needed to act quickly "or the state will be looking at bankruptcy next year." California newspapers have been issuing similar warnings, though Gov. Arnold Schwarzenegger prefers "fiscal Armageddon" to "bankrupt" in explaining his $40 billion budget deficit.
The former action star's phrasing is probably better. States are out of luck when it comes to the sweet protections of US Bankruptcy Court. They can go broke. They can default. California and Arizona may pay some bills with IOUs. They just can't be bankrupt in the legal sense of the term. "States can't file Chapter 9 bankruptcy protection," said James Spiotto, a municipal bankruptcy expert at Chapman and Cutler LLP in Chicago. The municipal bankruptcy code limits filings to "municipalities" or an "instrumentality of a state."
The Congress intentionally excluded states when they wrote the law in the 1930s. Spiotto said the reason is that the US Constitution guarantees states' rights and limits the power of the federal government over states. "They are sovereigns just like United States, just like Brazil or any other country," he said. "The federal government and state governments are separate and sovereign bodies under the 10th and 11th amendments." So even though Arizona could be the Ecuador or Argentina of municipal finance, it can't follow municipalities like Vallejo and Orange County--both in California--into the bankruptcy courts. Ecuador last month repudiated $3.8 billion of bonds owed to foreign creditors. Argentina defaulted on $81 billion of debt in 2000. Brazil, for the record, hasn't defaulted since 1990 and protested Ecuador's default.

Lest Americans feel too superior or comforted, Spiotto says at least 11 US states did repudiate their debts in the 1800s. The majority were Southern states that didn't think they should pay back debts incurred by Northern carpetbaggers after Reconstruction. Ratings analysts said that even in the current steep economic downturn, all 50 US states remain solid investment-grade credits, and the fact that governors and treasurers issue dire warnings when budgets fall out of balance is part of the reason. "States tend to have well-developed budget and revenue monitoring processes," Standard & Poor's analyst Robin Prunty said last month in a report on state credit quality. "Actively identifying the stress derived from the current revenue climate and implementing difficult and what may be politically unpopular spending and revenue measures have been the key elements of credit stability to date."
The day after Arizona Treasurer Martin warned of bankruptcy, Standard & Poor's reaffirmed the state's AA credit rating, based on the "expectation that the Legislature will make expected necessary and timely budget adjustments to offset further revenue declines and a widening budget gap due to economic weakness."
California's constitution requires that the state make debt payments before other spending. Treasurer Bill Lockyer--who has himself criticized the state's "Banana Republic" budgeting--has repeatedly said that means bond investors are safe even amid rolling budget crises.

By Maggie’s Farm November 22, 2010
Maggies Farm – We are a commune of inquiring, skeptical, politically centrist, capitalist, anglophile, traditionalist New England Yankee humans, humanoids, and animals with many interests beyond and above politics.
The end of the line is rapidly approaching for unsustainable government spending. The states will be the first to reach that station. The arrival will be a painful crash. The impact will reshape much of the US government policies of the past half century.  The triage of those affected will raise bloody howls of anguish, and none will escape the effects. Those who survive the fittest will be those most adaptable to a renewed America of more effective use of personal and financial resources. All will face difficult choices. True need will be better defined, to protect those really unable to cope.  True merit will be better rewarded.

Most agree that the root cause of the crash, the bulk of most of the deficits, is bloated government policies and the agencies that implement them. Some argue, instead, that the gap be filled by increased taxes, not facing that spending excesses will then require more again, further reducing the incentives to produce and afford taxes. I’m not one to say that government workers goof off more than private industry workers. It’s not their work ethic that I fault. It is the policies that political leaders set them on that are at fault both for the financial ruin that most states and the federal government face and for the frustration expressed by taxpayers over servicing a better paid civil service than themselves.

A conservative commenter thinks that President Obama will act with his “natural tendencies to ‘rescue’ and ‘control’ things” and that “The nature of his response could determine his tenure at the White House.” A liberal commenter thinks that former US Senator Alan Simpson’s remark, that “the blood bath will be extraordinary” in April when the federal debt limit comes up for a required vote to increase it, when – the commenter fears – “we can only hope that the nation that emerges from that blood bath is still one we recognize.” (Republicans will require spending cuts.)

The public mood is contradictory. Most want someone else’s ox to be gored. Increase someone else’s taxes. Cut someone else’s entitlement. Slash government payrolls. Don’t eliminate the program that benefits me. This time, however, as in the case of California’s continuing $25+ billion structural deficit, over a quarter of its budget, there are no more cans and the end of the road is before us. Leaving it to the politicians has meant cost-cutting nibbles and kicking the can down the road with accounting tricks. Court challenges have often resulted in reversals of spending cuts, due to judicial quibbles, activism, or faulty drafting of the cuts.

Federal legislation would be needed to allow states to declare bankruptcy, or to forbid bailouts of the states, or the Congress may simply refuse to bail out the states. More howls, and more judicial meddling.  But, it is the necessary next step, if Congressional budget-hawks have the wings to withstand downdraft counter-pressures from many voters at home and, instead, soar to responsibility. State legislators and governors will be forced to make hard choices. At the state level, civil service unions will have to renegotiate contracts. Program excesses will have to be trimmed. Some taxes may be raised. There will, then, be carry-over to federal programs. There will be increased demands to trim spending mandates imposed on the states and to trim other federal programs that will be seen as excessive in light of the dimmed largesse of the states.
All will enter a new America, in which there is a more direct connection between one’s own views, own comforts, and own efforts.  It will be a difficult adjustment for all, painful for many, and would be a welcome improvement.  The alternative is greater difficulties and pain for all if we allow complete insolvency and dissolution of assets by avoiding the confrontation with realities.

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