State bankruptcy: The best fiscal fix?

  Dateline Sacramento, Jan. 5, 2012: The state of California today filed for federal bankruptcy protection, citing a worsened economy that has blown out even the most pessimistic assumptions about its long-term financial picture.

Would that be a nightmare come true — or the only logical way out of the state's deep fiscal crisis?

For now the question is purely academic because federal law doesn't allow states to file for bankruptcy. But that could change if some conservative factions prevail in Washington.
There is a move afoot to persuade Congress to pass a law expressly permitting any of the 50 states to seek bankruptcy protection, a right that municipalities now have in about half the states.

Proponents of the idea say they're doing California and other deficit-ridden states a huge favor. Given the severe budget shortfalls facing many governors and legislatures in 2011 and 2012 — and their massive unfunded employee pension and healthcare liabilities — the argument for bankruptcy is that it would allow a state to put everything on the table at once and plot a sustainable long-term financial recovery plan.

If it worked for General Motors, why not a state?

Among those backing the right of states to enter a formal bankruptcy is Americans for Tax Reform. Its director of state affairs, Patrick Gleason, doesn't deny that the anti-tax group specifically wants to force the issue of pension and healthcare benefits to the forefront, which obviously would be a serious challenge to organized labor. But he says unions need to face up to the reality of state finances.

"It's in their interest to renegotiate these contracts to something the states can afford," Gleason said.

Some unions see a more sinister motive: crippling organized labor in its last great bastion, the public sector, where 37% of workers are union members compared with just over 7% of private-sector workers.

Chuck Loveless, director of legislation for the American Federation of State, County and Municipal Employees, says the groups agitating for the state bankruptcy option are doing so "for the express purpose of reneging on collective-bargaining agreements.

"We take this very seriously," he said. "They're trying to create this hysterical atmosphere."

Some proponents of a state bankruptcy option, including former House Speaker (and potential 2012 presidential candidate) Newt Gingrich, emphasize another motivation: They see the idea as a way for Congress to make clear to the states that they shouldn't come looking for a federal bailout.

In a speech in November championing the concept, Gingrich specifically named California, New York and Illinois as states he feared would otherwise end up on Congress' doorstep looking for more handouts.

The bankruptcy option for states still is in the realm of the hypothetical, but the rising debate already may be costing investors in the $2.9-trillion municipal bond market real money.

Lobbying efforts for a law making state bankruptcies possible are further eroding investor confidence amid what is already the worst sell-off in tax-free muni bonds since the financial-system meltdown in late 2008.

The market initially was slammed in November by a rise in interest rates on longer-term bonds in general and by a rush of new bond issuance by many states and municipalities.