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Feds considering letting the states go bankrupt?

by John Stephenson / /

Someone once told me that if you fail to cure the disease, you'll only get sicker and the remedies more painful. Unfortunately for taxpayers, the states are unable or unwilling to reduce spending, the disease that is plaguing their budgets, so Congress soon may have to consider a very painful remedy: bankruptcy for the states.

Today's New York Times (in a front page, above the fold story) features an article that tells us how policymakers are quietly exploring the possibility of creating a special, new bankruptcy code for the states. Currently, states cannot declare bankruptcy, but cities can and have done so for years. Like for private companies, bankruptcy would allow states to get out from the massive costs, unpaid bills, and obligations that are crippling the states. The concept is gaining traction because policymakers do not see easy solutions to the states' fiscal mess. The problem has been that politicians have been unwilling to significantly reduce spending. Public sector unions have challenged efforts to reduce the size of state workforces or rewrite their labor contracts. Additionally, constitutional provisions and statutes prevent states from adjusting generous pension or health benefits.

State bankruptcy faces tremendous hurdles. There are significant constitional issues to be resolved. While David Skeel, a bankruptcy law expert, believes that the constitional issues can be addressed, law professor Kenneth Anderson urges caution in giving such awesome power over a sovereign to a judge. As the New York Times article points out, massive bankruptcies could roil the usually quiet and safe municipal bond markets, which could impact the economic recovery.

The New York Times alludes to the idea that this may be a negotiating position or a starting point for dialog about resolving the fiscal mess in the states. Rest assured, there will be a lot more dialog about this issue.