States Should Not Receive Bankruptcy Protection

Tom Brenner/Reuters

There are a couple of good reasons for this.

Mitch McConnell believes he has hit upon a solution for states that are upside-down on their pension obligations and other financial commitments: “I would certainly be in favor of allowing states to use the bankruptcy route,” he told Hugh Hewitt on Wednesday. “It’s saved some cities, and there’s no good reason for it not to be available.”

There are a couple of good reasons for denying the states bankruptcy protection. One is the fact that there is no such thing as state-bankruptcy law in the United States. A second reason, related to the first, is the Constitution.

In the United States, we have a bankruptcy law for individuals, another one for businesses, and yet another one for municipalities and their subordinate agencies. We do not have a bankruptcy law for the states or for the federal government, for the same reason: They are sovereigns. ...

[...]

... Sovereigns don’t go bankrupt. Sovereigns default.

And that is what is likely to happen with the pension crisis, at least as far as states’ creditors are concerned. It is what should happen. It will be unpopular: Unlike many other financial instruments, municipal bonds are held mostly by households, not by financial institutions.

We may temporarily put off the reckoning through such maneuvers as the Fed’s backstopping the municipal-bond market, as it currently is. There is a reasonable case for short-term measures for the duration of the epidemic. But we should not use the coronavirus as an excuse to federalize the consequences of culpably irresponsible and fundamentally dishonest governance at the state and local level. Federalizing those problems does not make them go away — the liabilities remain, and somebody has to pay. The U.S. government is not a magical money machine that can exnihilate resources into existence with no economic consequence.

If we want debt markets to work, then investors have to pay the price for bad investments. (Lending money to an organization run by Bill de Blasio is a bad decision.) Making creditors take a painful haircut creates incentives to discourage such willy-nilly lending and profligate spending in the future. The more it hurts, the better. It is going to hurt a lot and already is hurting some, which is why investors have been running away from municipal debt. ...

Read the full op-ed from Kevin D. Williamson HERE.

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