A Path Is Sought for States to Escape Their Debt Burdens

The New York Times, January 20th, 2010

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.

Unlike cities, the states are barred from seeking protection in federal
bankruptcy court. Any effort to change that status would have to clear
high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible
way out may be bankruptcy, giving Illinois, for example, the opportunity
to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural
problems, like insolvent pension funds, that are diverting money from
essential public services like education and health care. Some members
of Congress fear that it is just a matter of time before a state seeks a
bailout, say bankruptcy lawyers who have been consulted by
Congressional aides.

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.

House Republicans, and Senators from both parties, have taken an
interest in the issue, with nudging from bankruptcy lawyers and a former
House speaker, Newt Gingrich,
who could be a Republican presidential candidate. It would be difficult
to get a bill through Congress, not only because of the constitutional
questions and the complexities of bankruptcy law, but also because of
fears that even talk of such a law could make the states’ problems
worse.

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