They argue that states should be able to voluntarily file for bankruptcy, just as municipal governments at present can reorganize under Chapter 9 of the bankruptcy code. Their plan would not allow states to be forced into bankruptcy like an insolvent corporation because states are sovereign under the Constitution.
In an op-ed piece in the Los Angeles Times last week, the two Republicans argued that the “mere existence” of the bankruptcy option might prevent states from ever having to go bankrupt because it would be such a powerful weapon against unions.
“If government employee union bosses know that they could have all their contracts annulled [through bankruptcy], they may be far more accommodating,” they wrote.
But state legislators and many analysts say such drastic measures would be unwise and unnecessary because states already can periodically revise their union contracts and have taxing powers and other powerful tools that well-run states with political resolve have used to balance their budgets.
Moreover, a large share of states’ budget problems involve burgeoning spending on Medicaid, unemployment, and other federally mandated programs, and do not stem from employee contracts, they say.
“Letting states go bankrupt won’t solve anything, and would create new problems,” said Nicole Gelinas of the Manhattan Institute. “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 midgame” and the resulting market turmoil could drive some hard-pressed governments to the brink of bankruptcy, she said.
Issuance of municipal bonds dropped 66 percent last month partially in reaction to adverse publicity about bankruptcy as well as the end of the federally subsidized Build America Bonds program.
The talk about bankruptcy particularly spooked small investors, who pulled their money out of municipal bond mutual funds at record rates, according to the Bond Buyer newspaper.
Brian Gardner, Washington analyst at Keefe, Bruyette & Woods, doubts that the bankruptcy proposal will go far in Congress because it raises knotty legal and constitutional questions and has the potential to cause further adverse market reactions.