For Tottering States, Bankruptcy Could Be The Answer (How To Defeat The Public Union Mafia Alert)

Townhall ^ | 11/29/2010 | Michael Barone

[goldstategop]

We won't be able to say we weren't warned. Continued huge federal budget deficits will eventually mean huge increases in government borrowing costs, Erskine Bowles, co-chairman of Barack Obama's deficit reduction commission, predicted this month. "The markets will come. They will be swift, and they will be severe, and this country will never be the same."

Bowles is talking about what the business press calls bond market vigilantes. People with capital are currently willing to loan money to the federal government, by buying U.S. bonds at low interest rates. That's because interest rates are generally low and because Treasury bonds are regarded as the safest investment in the world.

But what if they aren't? What if investors suddenly perceive a higher risk and demand a higher return? That's what Bowles is talking about, and there are signs it may be starting to happen. The Federal Reserve's second round of quantitative easing -- QE2 -- was intended to lower the interest rate on long-term bonds. Instead, the rate has been going up.

The federal government still seems a long way from the disaster Bowles envisions. But some state governments aren't.

California Gov. Arnold Schwarzenegger came to Washington earlier this year to get $7 billion for his state government, which resorted to paying off vendors with scrip and delaying state income tax refunds. Illinois seems to be in even worse shape. A recent credit rating showed it weaker than Iceland and only slightly stronger than Iraq.

It's no mystery why these state governments -- and those of New York and New Jersey, as well -- are in such bad fiscal shape. These are the parts of America where the public employee unions have been calling the shots, insisting on expanded payrolls, ever higher pay, hugely generous fringe benefits and utterly unsustainable pension promises.

The prospect is that the bond market will quit financing California and Illinois long before the federal government. It may already be happening. Earlier this month, California could sell only $6 billion of $10 billion revenue anticipation notes it put on the market.

Individual investors have been selling off state and local municipal bonds this month. Meredith Whitney, the financial expert who first spotted Citigroup's overexposure to mortgage-backed securities, is now predicting a sell-off in the municipal bond market.

So it's entirely possible that some state government -- California and Illinois, facing $25 billion and $15 billion deficits, are likely suspects -- will be coming to Washington some time in the next two years in search of a bailout. The Obama administration may be sympathetic. It's channeled stimulus money to states and TARP money to General Motors and Chrysler in large part to bail out its labor union allies.

But the Republican House is not likely to share that view, and it's hard to see how tapped-out state governments can get 60 votes in a 53-47 Democratic Senate.

How to avoid this scenario? University of Pennsylvania law professor David Skeel, writing in The Weekly Standard, suggests that Congress pass a law allowing states to go bankrupt.

Skeel, a bankruptcy expert, notes that a Depression-era statute allows local governments to go into bankruptcy. Some have done so: Orange County, Calif., in 1994, Vallejo, Calif., in 2008. Others -- perhaps a dozen small municipalities in Michigan -- are headed that way.

A state bankruptcy law would not let creditors thrust a state into bankruptcy -- that would violate state sovereignty. But it would allow a state government going into bankruptcy to force a "cram down," imposing a haircut on bondholders, and to rewrite its union contracts.

The threat of bankruptcy would put a powerful weapon in the hands of governors and legislatures: They can tell their unions that they have to accept cuts now or face a much more dire fate in bankruptcy court.

It's not clear that governors like California's Jerry Brown, who first authorized public employee unions in the 1970s, or Illinois's Pat Quinn will be eager to use such a threat against unions, which have been the Democratic Party's longtime allies and financiers.

But the bond market could force their hand and seems already to be pushing in that direction. And, as Bowles notes, when the markets come, they will be swift and severe.

The policy arguments for a bailout of California or Illinois public employee union members are incredibly weak. If Congress allows state bankruptcies, it might prevent a crisis that is plainly looming.

[goldstategop]

Blue State America faces huge budget deficits and a political culture were its held hostage by the public union mafia. How to break the logjam? Michael Barone proposes that Congress should pass a law allowing states to pursue bankruptcy, cut spending and rewrite public union contracts. At least this might save them from going under like the Titanic. One thing is for sure: bailouts will only delay the changes needed to get them back on the road to sound fiscal health. Its worth considering.

[curiosity]

Great idea, but I don't know how we could get a provision in the code for state bankruptcy through the Senate.

But then there's a key question: what happens when states run out of money and there's no bailout from the Feds? Without the possibility of bankruptcy, I can't see a way out.

[bruinbirdman]

"How To Defeat The Public Union Mafia Alert "

There is a CA city that went bust. I suppose its in state receivership. In any case, 90% of its current income goes to service pension obligations.

Familiar with this? Not Bell(flower).

yitbos

[goldstategop]

Orange County went bankrupt in 1994. That was the largest US bankruptcy on record. And absolving CA of much of its debt is going to be needed to put its fiscal house back in order.

[RobbyS]

Since Reagan fired the air traffic controllers, the public employee unions have managed to use their purses—filled with public funds — to claw their way into virtual control of some governments. This is an intolerable situation. It is one thing to let private sector unions to have a seat at the table, quite another to have nion of “public servants” to have such a place. Already the “permanent government” prohibits any meaningful restraints on policy change. Noe they have the power to bust the budget.

[goldstategop]

Agreed. The Republican-led House is not going to provide taxpayer bailouts for Blue States and the only avenue left is bankruptcy.

[rdcbn]

The union compensation packages are unsustainable. Unions have two options.

The first is to renegotiate a compensation package that is sustainable.

The second is to have the states go into bankruptcy, lose most of the benefits as unsecured creditors and have a revised compensation package imposed upon item at time of economic crisis where they will receive bad publicity and little sympathy.

They will choose the second option

[goldstategop]

The larger question is who does government serve: the taxpayers or the unions? That’s going to come up if and when Congress is asked to address the issue.

[goldstategop]

The unions can either agree to more realistic retirement benefits or see their members get nothing.

Given that choice, they will choose option 1.

[monocle]

Moral of story: Do not invest in blue state debt instruments.

[RobbyS]

The irony is that most civil servants if asked would give back part of their salaries to solve the budget crunch. The exceptions would be those, especially in DC, who think their jobs meaningless but have no other options.

[goldstategop]

The bond markets aren’t investing. CA and NY are stone cold broke. They have no way out and while Andrew Cuomo wants to cut spending, good luck getting it past the Assembly Democrats in Albany.

[USNBandit]

San Diego?

[goldstategop]

I think you’re thinking of Vallejo, CA, which filed for bankruptcy to void union contracts that had it paying for pensions for which no money was ever set aside. San Diego, CA is also facing bankruptcy on accounting of ballooning pension costs for which again, no money has been set aside.

And in the state of CA, there is a huge state pension IOU - unfunded liability for which no money was ever set aside to pay for it. Its a mess.

[nathanbedford]

I think you are right, the unions will choose to drive the states into bankruptcy because that way the leadership of the unions will not have to explain why they traded away their members' pensions they can simply blame it on the Republicans and the courts.

The Republicans, for their part, face a political problem: if they oppose bailing out the states they will be accused of heartlessness again and could be held responsible for the fallout damage which cannot now be calculated. It is impossible to say how bad the ripple effect would be from the implosion of an economy the size of California's.

Therefore, Republicans must define the equation as a choice between those states which have been responsible and those states which have been irresponsible and ask why responsible states should be taxed for irresponsible states which pandered to public-interest unions to win elections for Democrats. Even more effective, Republicans must structure the argument as a choice between public interest union pensions and Social Security.

[bruinbirdman]

"Prichard, Alabama officials are trying to do something that has never been done anywhere in the United States: Reduce vested pension benefits through municipal bankruptcy."

yitbos

[goldstategop]

No one begrudges those who have served our country and no one wants to take away their retirement benefits from them. That’s a non-issue. By the same token, if we’re going to save those pensions, we have to make sure we can pay for them. And if we can’t, then people who were counting on receiving them in their golden years will be left with nothing. That is just not acceptable. And pension reform is already happening, whether the unions like it or not.

[Tzimisce]

It’s a great idea.

The problem is left wing judges won’t let Union contracts be re-negotiated.

[goldstategop]

Judges can’t order the government to raise taxes. That would be the only realistic way to pay for existing pension benefits. Ain’t gonna happen.

[Tzimisce]

Judges can’t order the government to raise taxes. That would be the only realistic way to pay for existing pension benefits. Ain’t gonna happen.

I believe states have sued for bankruptcy before only to have judges tell them they can not renegotiate Union contracts.

But let's assume judges haven't. There is nothing stopping them from doing it now.