Democrats and republicans in Washington are quietly fighting about what will become of the states’ trillions of dollars of debt. The GOP is pushing for allowing states to declare bankruptcy, and the democrats are hoping to pay their debts with more “stimulus.” Meanwhile, Governor Andrew Cuomo has declared that New York state is “functionally bankrupt.”
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I’ve been posting recently on the possibility that in the near future states could be able declare bankruptcy and renegotiate contracts (think unions) and reorganize debt (think bonds), just as cities do.
It turns out that Newt Gingrich, who has been championing this idea for months now, is becoming more specific on the subject. Reuters has the story:
Legislation that would allow U.S. states to file for bankruptcy will likely be introduced in Congress within the next month, Newt Gingrich, the former speaker of the House of Representatives and a powerful Republican party figure, told Reuters on Friday.
“We’re faced with the danger that the states are going to try to show up and say to Washington: You have to give us money,” Gingrich said. “And I think we have to have an alternative that allows us to say no.”
While he declined to comment on who might introduce legislation, Gingrich said there was support in both the House and the Senate. He said lawmakers have been looking into the idea for three or four months.
Some states are saying they aren’t interested in such an option:
And California — a state which Gingrich said would likely turn to Congress for financial help along with New York and Illinois — said on Friday it has no interest in using bankruptcy to solve its fiscal problems.
California, the eighth largest economy in the world, would not benefit from the legislation, Treasurer Bill Lockyer said.
“States didn’t ask for it. We don’t want it. We don’t need it,” Lockyer said. “Bankruptcy would devastate states’ ability to recover from the recession and make the infrastructure investments that create good jobs.”
I don’t believe them. The thing is, their obvious first choice would be for them to get a bailout (or a round of stimulus) from the Washington. They can’t show their hand that bankruptcy could work for them, or they’d lose their bargaining leverage. That’s not how you play poker. But the more immediate issue is the just talk of the state bankruptcy of state bankruptcy would send bondholders into a panic, and dry up new bond sales. New York State Comptroller Thomas P. DiNapoli explains:
“Just the availability of a bankruptcy option and the potential bond default could severely damage state credit ratings and destroy the trust of bondholders.”
Bingo.
My great friend and broker tells me that right now is a great time to buy bonds, as the “headline fear” of defaults is so high, and as a result the rates I can get are high. But, I tell him that we haven’t seen anything yet, and I’m going to wait until the shit hits the fan. I don’t yet see the blood in the streets.
What do you think will happen?
Source: Reuters
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Yesterday we wrote on how policy makers in Washington, D.C. are oh-so-quietly discussing how to allow states to declare bankruptcy. It’s not quiet any longer. First the New York Times broke the story, and now media outlets are picking it up.
Here’s a Fox News clip of Shepard Smith interviewing Jordan Goodman about the possibility. Yeah, Shep is an idiot, but the guest is worth a listen.
How real is this? I think very real. The idea has the backing of congressional republicans. Below is clip from the Keith Olbermann show (Keith is gone, as of last night, thank God) earlier this week, where the guest host rails on the GOP for this scheme.
The debate is going to break down between the left and the right, because if a state declares bankruptcy, the existing contracts with unions are up for renegotiation, and union members, working and retired, are going to feel the brunt of the pain. This won’t sit well with the democrats, as the unions and the democrat party are one and the same. Their alternative will instead favor bailouts from Washington.
Considering the money that is paid to unions in wages, benefits and especially pension plans is the number one reason the states are in the red, that’s just fine and dandy with me.
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We know that states are not allowed to declare bankruptcy like cities and counties can. And since they can’t print money like the federal government, they must find ways out of their financial mismanagement by cutting spending and raising revenue.
Maybe.
The New York Times today said that “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.”
I understand why they are working quietly, “behind the scenes.” Word that something along this line could actually move forward would wreck havoc the bond market, especially when someone understands that a surprise could be in store for holders of those “ultra safe” state General Obligation bonds (see end of this story).
Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.
“All of a sudden, there’s a whole new risk factor,” said Paul S. Maco, a partner at the firm Vinson & Elkins who was head of the Securities and Exchange Commission’s Office of Municipal Securities during the Clinton administration.
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.
The possibility of this previously unthinkable option is higher now, given the new conservative congress. States know how difficult it would be to get a bailout from Washington, D.C. in this climate. In fact, it was republican Newt Gingrich who got the conversation going:
Discussion of a new bankruptcy option for the states appears to have taken off in November, after Mr. Gingrich gave a speech about the country’s big challenges, including government debt and an uncompetitive labor market.
“We just have to be honest and clear about this, and I also hope the House Republicans are going to move a bill in the first month or so of their tenure to create a venue for state bankruptcy,” he said.
But what about the constitutional issues that would no doubt arise?
A few weeks later, David A. Skeel, a law professor at the University of Pennsylvania, published an article, “Give States a Way to Go Bankrupt,” in The Weekly Standard. It said thorny constitutional questions were “easily addressed” by making sure states could not be forced into bankruptcy or that federal judges could usurp states’ lawmaking powers.
“I have never had anything I’ve written get as much attention as that piece,” said Mr. Skeel, who said he had since been contacted by Republicans and Democrats whom he declined to name.
Mr. Skeel said it was possible to envision how bankruptcy for states might work by looking at the existing law for local governments. Called Chapter 9, it gives distressed municipalities a period of debt-collection relief, which they can use to restructure their obligations with the help of a bankruptcy judge.
Unfunded pensions become unsecured debts in municipal bankruptcy and may be reduced. And the law makes it easier for a bankrupt city to tear up its labor contracts than for a bankrupt company, said James E. Spiotto, head of the bankruptcy practice at Chapman & Cutler in Chicago.
And, we finally get to the issue of General Obligation bonds — bonds that we are told must be paid by states. Here’s what the law professor says about them:
The biggest surprise may await the holders of a state’s general obligation bonds. Though widely considered the strongest credit of any government, they can be treated as unsecured credits, subject to reduction, under Chapter 9.
“Subject to reduction.” I think we are going to be hearing this term thrown about quite a bit over the next few years.
Source: New York Times (yahoo)
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“The unions don’t want any accountability, they put incompetent adults ahead of children.”
That’s a quote from from former Los Angeles Mayor Richard Riordan, in an interview with Reason.tv’s Tim Cavanaugh.
He tells Cavanaugh that while he has been quite a critic of current L.A. Mayor Antonio Villaraigos, he’s become a fan ever since he “dropped the atomic bomb” on the unions by saying publicly that they are in the way of educational reform.
Riordan is encouraged that although Sacramento is still overwhelmingly controlled by the unions, there’s a break in the ice and increased public awareness of the problem, especially with Villaraigos blaming the unions for our failed education system.
He goes on to discuss state and local budget crises, one upping Meredith Whitney an her call for 100 cities to go bankrupt, with this quote:
“Throughout the country, 90 percent of cities and states are going to go bankrupt within the next five years, many of them sooner.”
Ouch.
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