Bailouts or Bankruptcy – How Can America Help Financially Troubled States?

In an important op-ed piece in The Wall Street Journal this week, University of Pennsylvania Law Professor David Skeel takes on the issue of financially troubled states such as California, New York, and Illinois.  California, for example, faces a potential state budget deficit of $20 Billion in the next 18 months, along with state pension funds whose underfunding exceeds $500 Billion.  What can we do to help California and other financially troubled states?  Should the Federal government bail them out?  Should we let them go bankrupt and default on their bonds?  For that matter, can a state even go bankrupt?  These are vital questions that will likely impact our economy.  How can America help financially troubled states?  Let’s talk more about this important issue now …

While bailouts might seem to be the preferred option for some states in some special circumstances, bailouts can’t be justified on an on-going basis.  When state financial problems are structural (i.e., when they are built into the system and are long term), an emergency bailout is not a real solution – it’s just a temporary fix.

Fortunately, there is a process for developing a long term fix.  It’s called bankruptcy.  For people who find themselves in terrible financial straits, bankruptcy can be the means to be released from debt obligations that they simply do not seem to be able to meet with their current resources.  It can wipe the slate clean so-to-speak and give people a new start on life.

Some of our states seem to be struggling with incredible deficits and massive pension obligations today and do not appear to have the financial means to get caught up.  Bankruptcy might the best option for some states.  

Right now, cities are allowed by law to file for bankruptcy under Chapter 9 of the Bankruptcy Code.  Professor Skeel proposes that Congress enact a new law that adds a similar bankruptcy chapter for states.  If Professor Skeel’s proposal is enacted, how might that help?

According to The Wall Street Journal op-ed piece, there are three ways in which a state bankruptcy filing might help a state regain its financial footing.  First, it can allow states to cut out waste in some public employee union contracts.  A bankruptcy court can step in, if both unions and the state government can’t agree on contract terms.  Second, a state bankruptcy probably can also permit a state to restructure its bond debt.  While some might think this a bad idea, it’s still far better than a complete default by the state.  Markets would likely rebound.  Third, state employees’ Cadillac pension benefits could be renegotiated as well (something “vesting” often does not allow).

Given the incredible problems facing some states, bankruptcy seems like a reasonable alternative.  Certainly, structural solutions are needed by states that find themselves with structural problems.

How can America help financially troubled states?  One real option is to let them file for bankruptcy.

Choosing the Good Life Blog by Gerard Francis Lameiro, Ph.D.