A bankrupt option: states should not be allowed to file for bankruptcy.

• Author: de Rugy, Veronique
• Position: Column

THE 50 STATES, as we have seen recently in Wisconsin and elsewhere, are in serious fiscal trouble. Total state debt is estimated at more than $1 trillion, and that doesn't include another $3 trillion in unfunded liabilities from pensions and other obligations. We can afford neither a federal bailout of this sum nor the precedent it would set. But how about giving states the option of filing for bankruptcy, as municipalities can do via Chapter 9?

University of Pennsylvania law professor David Skeel, a specialist in corporate finance and bankruptcy, thinks that's a good idea. Writing in The Weekly Standard last November, he argued that a procedure for bankruptcy could instantly reduce states' bond debt and chop the fat out of bloated contracts with public employees by allowing states in default or in danger of default to reorganize their finances free from their contractual obligations. In January former House Speaker Newt Gingrich and former Florida Gov. Jeb Bush endorsed the concept in the Los Angeles Times, arguing that a new law could give states a chance to reform their unaffordable and underfunded pension systems. In "a voluntary bankruptcy scenario" they wrote, "states, like municipalities, will have every incentive to file a reorganization plan that protects state bondholder claims and their ultimate recovery."

Critics contend that bankruptcy will only make states' problems worse by jeopardizing their ability to borrow and finance their debt. Paul Maco, who was head of the Securities and Exchange Commission's Office of Municipal Securities during the Clinton administration, told The New York Times that even introducing a state bankruptcy bill could precipitate "some kind of market penalty. "As the Times summarized Maco's argument, that penalty "might be higher borrowing costs for a state and downward pressure on the value of its bonds. Individual bondholders would not realize any losses unless they sold.... A deeply troubled state could eventually be priced out of the capital markets. "According to Reuters, the ratings agency Standard & Poor's believes that the potential "market penalty" for bankruptcy would be so large that states would be discouraged from even considering the option. Bush and Gingrich responded to that argument by saying states would "consider their long-term lending potential and credit worthiness" in restructuring, thus minimizing the costs.

Unlike some critics of state bankruptcy, I think state borrowing should...