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First GM, Now States? Pros and Cons of Bankruptcy

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Byline: Bernard Condon and Daniel Wagner Associated Press

NEW YORK Big companies like General Motors file for bankruptcy. Some cities do, too. And last year 1.5 million Americans did it.

But U.S. states aren't allowed. Now a few policymakers and pundits are debating whether it's time to give states a court-sanctioned way to shed their debts.

The idea galls critics. "Baloney" is what California Treasurer Bill Lockyer calls it, saying his state, which is already weighing painful tax hikes and spending cuts, doesn't need the option.

It seems clear some states can't afford their long-term promises to pay for pensions and retiree health care. Those swelling costs could force states to raise taxes and slash services like public transportation.

But is bankruptcy the right solution?

In bankruptcy court, a judge could force lenders and public workers to accept less than they are owed. Debt could drop overnight. Existing union contracts could be replaced with cheaper ones. In theory, states could regain their financial health.

But the risks are high. A state could be tied up in court for years as various sides squabble over a deal that might bring only scant relief in the end. Even discussing the idea could spook investors and rattle states' fragile finances. States need investors to buy their bonds, and demand was already dropping before talk of a bankruptcy option spread.

Fearing towns and cities may default, investors in November and December pulled a record $21 billion from funds that invest in municipal bonds

twice as much as they did at the depths of the 2008 credit crisis, the Investment Company Institute says. Those still buying are demanding higher interest payments to compensate for the risk.

Standard & Poor's, which determines how credit-worthy states are and assigns ratings, said last week that a bankruptcy law would cause it to review the way it judges states. Downgrades would force states to pay higher interest rates.

If investors started selling the bonds, that would force interest rates higher, too, adding to the cost of financing the bonds.

"The higher the interest rate a state has to pay, the more potholes

that can't be filled," says Marilyn Cohen of Envision Capital, a company that invests in bonds. …