State Bankruptcy Prediction

There seems to be discussion in Washington about creating a legal framework for state bankruptcies.  My guess is that any law that might be passed will simply be a Trojan Horse.

A lot of people (including myself) would like the idea of the tough provisions applied to individuals who are bankrupt being applied to states.  Unfortunately, it is wildly unlikely that this is actually what we will get.  Any such law would likely just be a bailout program renamed "bankruptcy" to make it more palatable to the public, a transfer of obligations from state to federal taxpayers without any real imposition of discipline or cleanup of long-term obligations like pensions.  Heck, this is exactly what happened at GM, and that was just a private company.

Some might assume that a Republican House would be loathe to support bailout provisions for California, but two thoughts come to mind.

First, California, despite being a blue state, has plenty of red Congresspersons who will scream support for a bailout (for a parallel, think ethanol or farm subsidies, where grain state Republicans are among the first to break ranks with their brethren to support government interventionism).

Second, it is not clear that the Administration even needs the Congress any more to dish out money.  It has found so many extra-Constitutional ways to appropriate money without actually having to go to Congress (e.g. use of TARP funds for about anything, use of the Federal Reserve, etc.) that it should be no problem to do this without the House.  Take just one idea -- Imagine California issues a $100 billion in 0.0000005% 100-year bonds that the Fed then buys at face value with printed money (as they have been buying US securities).  Instant bailout, no Congress.


  1. Dave:

    When the time comes to implement the bogus "bankruptcy" you describe, dissenters will also be threatened with another "collapse of the financial system" which will send us deeper into recession.

  2. Noah:

    The elite will bypass Congress and use the Federal Reserve to bail out the states which aren't really bankrupt on a cash flow basis. The challenge is long term pension obligations. A bailout might be palatable if all, repeat all, existing pension obligations were immediately converted to 401Ks.

    With public employees - local, state, and Federal - in 401Ks, then both private and public employees are in the same retirement boat the health of the private economy. The other advantages are 1) current employees saving for their own retirement and 2) elected officials can no longer buy short term labor peace with promises of future benefits.

  3. me:

    All too likely. It is a bit odd - as a country, we have an "aw, shugs" mentality when it comes to anything happening in DC, but I had expected more of an uproar at "they're devaluing our money". I mean, the fun has to stop somewhere, doesn't it?

  4. Bearster:

    The Fed is beholden to the banks, not the states or cities. My bet is that the Fed won't buy municipal bonds.

  5. eCurmudgeon:


    Starting with a requirement that any state declaring bankruptcy immediately loses its statehood status, and reverts back to being a territory. After suitable financial re-organization and cleanup, the territory can once again apply for statehood (or, in the case of California, multiple states: "Southern California", "California" and "Cascadia").

  6. Orion:

    eCurmudgeon-very clever. I like that. Would that open the door for solvent economically successful territories to become states? And it so, is that good or bad? I tend to think good truth be told. Heck, let's allow some Asian powerhouse economies to become states if they want to-think Singapore or South Korea (admittedly fanciful thinking).

  7. Evil Red Scandi:

    @eCurmudgeon & Orion - Thank you for the awesome this morning.

  8. jt:

    The Fed is statutorily prohibited from buying anything but extremely short-term state paper. It would take Congress to relax that restriction. That being said, I agree that the executive would try to find a way outside of Congress to bail out California, but I think it would also come with a steep political cost.

    The interesting issue is that Cali is far from bankrupt. It can easily cover its interest payments with revenue, the issue is that it does not want to cut spending even as its debt burden increases. Even a slight effort to reinforce the priority of debt payment over spending would probably boost its rating and allow it to roll its short term debt for years.

  9. Max Lybbert:

    I'm not entirely clear on the provisions for local government bankruptcies, but I've expected any State bankruptcy laws to be based those.

  10. Dan:

    If California is bailed out in the next two years (P>60%) it will be via TARP and not the Fed. Scenario - California issues new class of bonds. TARP declares them Troubled Assets at issue and purchases them via what the British call a QuANGO - Quasi-non-governmental organization which then issues its own debt to fund the purchase, which will carry the same sort of implied guarantee that caused the whole Fannie/Freddy mess.
    So with a few pen strokes and the creation of a few new agencies, the State of Califonia has effectively issued it's own debt with the full face and Credit of the United States Government.

  11. Jay:

    I don't see the Fed purchasing the type of bond you described, but I do think a scenario with the same motivation will likely be carried out. @Noah - great idea about converting pensions.

  12. Mark:

    I know there is no official bankrupsy buy can't states default on their bond debt?

    This seems low, but it looks like CA has 168 billion in outstanding bond debt

    Defaulting would save 8.5 billion per year.

    What states can not do is re-negotiate contracts and pensions. But if the state has no money, what will they have to do. They will pay less and book the debt as owed money. Some judges will get involved and try to force the state to pay per the constituency in front of the particular judge, and possibly force tax increases, but when the money doesn't appear then what?

    There would be a de facto bankruptcy even without the bankruptcy law.

  13. Not Sure:

    Re: California- It looks like the politicians are starting to eat their own there:

    California cities race to shield funds from state



  14. Mesa Econoguy:

    There is no current procedure for state bankruptcy, but they're starting to talk about it:

    There are significant ripple effects to state bankruptcy.

  15. MJ:


    Probably this.

  16. LoneSnark:

    I have yet to have anyone say otherwise. If the legislature of California passed a law ordering state agencies to stop paying on the debt or the pensions or any other debt instrument and the governor signs it, then what? What article in the California constitution could be used to overturn such a law? What about in other states?

    I know of none. Debt repudiation does not happen because it is impossible to get such a bill through the legislature, but such a bill would be law and there would be nothing anyone short of the Congress could do about it, I believe.

  17. tehag:

    The only sensible condition for a state declaring bankruptcy is reversion to territorial status and surrender of representation in Congress.

  18. Mark:


    Federal Law prevents states from cutting back on pension obligations. But again, if there is zero money to pay, then what? Hold the state in contempt? Lefty judges will try to force redistribution, but when one judge tries to force payment to one Union group, and another to another Union group, and a third tries to force schools to stay open with the same funds, it will be more than a mess.

  19. mahtso:

    Mark, in re bond default vs. pensions:

    Hugh Hewitt's blog was showing that the state's would not want to default b/c that would screw up credit ratings; instead the approach would be to get the law changed so they can breach contracts/pensions

  20. chuck martel:

    In the case of California, it's not just the state, it's counties and municipalities as well. Since those entities cannot get out of their pension obligations, they will have to be dissolved and replaced with other political units. Los Angeles County could be replaced by Arcadia Borough and Venice Parish, for instance. California itself would probably be better off as two or even more states, Humboldt County and Los Angeles County don't have much in common. Adjoining cities could combine and divide into new forms with new governments and new obligations. It might be the only practical way out.

  21. Jeff:

    @chuck -- The last thing we need is California voters having MORE senators. Do you really want to see Sen. Maxine Waters?

  22. IgotBupkis, President, United Anarchist Society:

    I would cite for you that one tension nominally threatening the EU is the fact that the solvent and responsible states, like Germany, are getting tired of bailing out the insolvent and irresponsible ones, like Greece and the rest of the Mediterraneans.

    It may well be that this issue breaks up the EU as a concept.

    So, too, may this be the issue which breaks up the USA as a concept, as the solvent states refuse to bail out the insolvent states.

    The grasshopper and the ant, folks.

  23. tehag:

    Perhaps Coyote can comment on how a state with hefty taxation is in the deepest debt. Most alcoholics I have know don't have wine cellars. They're cheap, not rich.

  24. enoriverbend:

    "Perhaps Coyote can comment on how a state with hefty taxation is in the deepest debt."

    In the same way that a MBA banker is just as capable of living on 125% of his income as the janitor.