Sorry: Letting states go bankrupt won’t solve anything — and would create new problems.
Former House Speaker Newt Gingrich started this talk in November, saying that he hoped the House would quickly create a state-bankruptcy law, “so that states like California and New York and Illinois that think they’re going to come to Washington for money can be told . . . you need to sit down with all your government-employee unions.” News reports suggest some Republicans in Congress are planning to create such a legal process.
Problem is, this “solution” ignores the real structures of state government.
Take New York, with its $78.4 billion in outstanding bond debt and estimated $81 billion in unfunded obligations for state-employee pensions and retiree health care. The idea seems to be that the Empire State would go “bankrupt,” figure that it can afford only, say, 80 percent of this number — and get a judge to lop off 20 percent.
Ha. The complications of the municipal-bond markets make this plan hopelessly naive.
For starters, states like New York run up “their” debt indirectly. They issue bonds through tens of thousands of separate legal entities. New York “state” doesn’t owe all of that $78.4 billion in debt — it owes only $3.5 billion in “general-obligation” debt.
Who owes the rest? The MTA, the Dormitory Authority, the Triborough Bridge & Tunnel Authority and so on. Legally, each is not a government but a “public-benefit corporation.” Each has its own board, its own rules and its own contractual agreements with creditors, from bondholders to unions. Each of those agreements offers creditors different protections.
The Transitional Finance Authority, for example, gets funds to pay off its bonds from New York City taxes that are collected by the state, which pays the TFA its share before sending any cash to the city.
Other “state” bondholders depend on things like car tolls to pay off their debt. If this money comes up short, the state in some cases promises to make up the difference; in other cases, bondholders already know that they will take the hit, through decades-old precedents that don’t need new federal interference.
So, if we let New York go “bankrupt,” does that mean that the TFA should go bankrupt? How ’bout the MTA? Should they all go bankrupt? Should a judge be able to take a big pile of money that the MTA, as a corporation working on behalf of the state, has committed to transit retirees and give it to, say, Dormitory Authority bondholders? Why would it be a good idea to shred existing contracts and laws? But if you don’t do that, then bankruptcy doesn’t really deal with “state” debt.
Another inconvenience: Under corporate law, many state entities already can go bankrupt. But state law prohibits the MTA from going bankrupt — and no federal judge can force New York’s Legislature to change this law, since it plainly doesn’t violate the US Constitution. Similarly, while a federal judge could freeze labor contracts during a cash crunch, such contracts expire every few years, anyway — and New York still would need to change its state laws to create better ones.
Nor can bankruptcy fix New York’s pension and health-benefit obligations. The state Constitution says that Albany can’t cut the benefits it has promised an employee. No bankruptcy judge can change New York’s Constitution.
OK, perhaps some activist judge could prevail in ditching the rule of law and precedent — and get the state legislature and the US Supreme Court to go along. But even if such an approach were a good idea, it would take years to sort out in courts, hardly fixing practical problems in the meantime.
While Congress may intend the bankruptcy idea to avoid a bailout of struggling states, all the talk might bring us closer to just that. Muni bondholders, worried about states’ finances, might be panicked by fears that lawmakers will change the rules mid-game. And if bondholders think that Washington wants a “state” to go bankrupt, they won’t lend to any of that state’s related corporations — leaving borrowers from the MTA to local school districts in a crunch.
If it came to a debt crisis, no GOP congressman from California — or New Jersey or Illinois or New York — would vote to let his state hang. Nor would national party leaders determine that states are the place to take a real stand against bailouts, when AIG and Goldman Sachs weren’t.
Asked if states can get out of this mess without help from Washington, banker Felix Rohatyn, who helped Gov, Hugh Carey rescue New York City from bankruptcy 35 years ago, said, “Maybe a miracle can happen, and though I’m hopeful, it doesn’t seem this is one of them.”
The “bad states” aren’t abstract notions. They’re 26 percent of the nation’s population — people who, in a muni crisis, would experience not the enlightened reforms they need but brutal and immediate service cuts.
States’ problems aren’t pretty. The solutions may be messy. But bankruptcy wouldn’t be a messy answer; it would be no answer at all.
Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal.