allowing states to file for bankruptcy would be a good idea.
The first proposition is right on the money: profligate states should not expect the feds to pay the accumulated bills for years, even decades, of excessive spending. Still ... why should we assume bankruptcy is the answer to possible state requests for bailouts?
[A]s with municipal bankruptcy, a new bankruptcy law would allow states in default or in danger of default to reorganize their finances free from their union contractual obligations. In such a reorganization, a state could propose to terminate some, all or none of its government employee union contracts and establish new compensation rates, work rules, etc. The new law could also allow states an opportunity to reform their bloated, broken and underfunded pension systems for current and future workers. The lucrative pay and benefits packages that government employee unions have received from obliging politicians over the years are perhaps the most significant hurdles for many states trying to restore fiscal health.The planted axiom is sound enough: union contracts are a problem for many of the nation's most troubled state and local governments. (Indeed--that's the premise of this website.) But contracts aren't the only problem. Keep in mind, we're talking only about states here. Local governments, which employ the bulk of public-sector workers, can already go bankrupt.
An additional benefit of a new voluntary bankruptcy law for states is that its mere existence may deter any state from ever availing itself of its provisions. If government employee union bosses know that they could have all their contracts annulled under federal bankruptcy law, either through a plan of reorganization voluntarily entered into by state leaders or by the voters through proposition, they may be far more accommodating with state governments to restructure government employee union workforces, pensions and work rules.
On average, more than half of state spending goes to Medicaid and K-12 school aid. While taxpayers will be exposed to mounting unfunded liabilities for pensions within the coming decade, rising current pension costs are not huge pieces of the current budget gaps in California or New York (although they pose a more immediate problem for Illinois and New Jersey). Moreover, as I pointed out in a Wall Street Journal op-ed earlier this week, state officials already have considerable power to challenge their unions, which enjoy collective bargaining rights pursuant to state laws, which can be changed. Once current contracts expire, typically within three years, a governor and Legislature can, on their own, "establish new compensation rates, work rules, etc."
Governors and legislators also have the legal power to completely restructure pension benefits for new hires, an option that is being pursued by a growing number of states. Many of the so-called pension "reform" plans enacted so far (like New York's) have been minimal or even objectionable (like Pennsylvania's), but more could be done; for example, Utah has shown the way with a promising hybrid approach that permanently fixes the tax-funded employer contribution at a level rate. As for current employees, many states have the legal ability to freeze pension benefits before more have accrued; at least one independent legal analysis suggests that this could be done even in Illinois, one of a handful of states with a strong constitutional provision (modeled on New York's) prohibiting any move to "diminish or impair" benefits.
Bush and Gingrich recognize that a state bankruptcy route could be constitutional only if voluntary, as is the case with the Chapter 9 bankruptcy provision for municipal governments. Further, they point out, a new state bankruptcy law would have to respect the sovereignty of the people of a state. "A state legislature acting by a majority vote, with the governor, would fit this test." they say.
Which leads to another question raised in my Journal piece: "if Gov. Jerry Brown and the California legislature are unwilling to rewrite their collective bargaining rules--signed into law by Mr. Brown himself, 33 years ago--why assume they would plead with a federal judge to do it for them?"
Bush and Gingrich have an answer for that:
... The new federal bankruptcy law should also allow those states that provide for the right of initiative, like California, to put the question to voters whether they support a reorganization of their state government under the U.S. Bankruptcy Code.They then dive into the deep, dark end of the constitutionality pool, suggesting that a bankruptcy proposition on the California ballot "could provide that a yes vote would trigger the cancellation of all state government employee union contracts."
In fact, the discretion of a federal judge in a state bankruptcy proceeding would be very limited. At the end of the day, a restructuring plan would still be guided by the preferences and priorities of elected officials. If California voters have the power to trigger cancellation of union contracts (and maybe they do), and if such a proposition could pass, then why isn't someone already circulating petitions? (Darrell Issa: call your office!) Which brings us back to where we started.
Like others who share their views on this issue, Bush and Gingrich seem to assume that bankruptcy will repeal politics. But as a practical matter, unions won't go away, bankruptcy or no bankruptcy. Nor will hundreds of thousands of individual employees and retirees, including non-union members, who are entitled to pension benefits by law and not just union contracts.
The messy descent into a hypothetical state government bankruptcy, perceived as targeting not only collective bargaining rights but pensioners and bondholders, would most likely set into a motion of a chain of events leading directly (just as the GM bankruptcy did) to the U.S. Capitol -- precisely what bankruptcy advocates want to avoid. Yes, states do need to rewrite if not repeal their collective bargaining statutes, and to reshape their pension obligations to make them more affordable. But it's unrealistic to assume that bankruptcy is the magic stun gun that will drop public employees to their knees--even in states not effectively run by unions.
As an example of why and how bankruptcy works, Bush and Gingrich cite Orange County, California, which filed for Chapter 9 bankruptcy in the early 1990s after some ill-advised derivatives transactions went sour. My colleague Nicole Gelinas, who has laid out her own arguments against state bankruptcy in the New York Post, had this observation on the Bush-Gingrich piece:
I wonder why they're mentioning Orange County rather than Vallejo. After all, Orange County went bankrupt to deal with a very specific cash-call / collateral issue, not to deal with long-term structural issues ... And yet -- they've got a wonderful, current, relevant example of a city in bankruptcy right now to deal with long-term structural issues -- Vallejo. Could it be because Vallejo, a small city with a cooperative city council and only two bondholders, has been in bankruptcy for three years, during which time its contracts governing wages and healthcare would have expired anyway? How long would it take for the state of California, with dozens of different bond structures, many types of debt ranging from tax secured to revenue, thousands of smaller issuers implicitly dependent on its credit, no cross-default provisions, hundreds of lawmakers who would not cede authority to a governor, and pension trusts that will not run out of cash-flow ability to pay for at least a decade even in terrible market scenarios, anyway, to enter and exit bankruptcy?
Bush and Gingrich barely mention the impact that the existence of a bankruptcy statute is likely to have on the municipal bond market. For what it's worth, here was my take in the Journal:
It's more likely that a state like California would pursue bankruptcy if powerful unions and other budget-dependent interest groups saw this as a way to deflect some of the pain to bondholders. California is one of the states that constitutionally guarantees its general obligation debt, and whose bondholders are now seemingly untouchable. That could change with a bankruptcy option.
Such an option would certainly rattle the bond market--which bankruptcy proponents see as a good thing. Yet this ignores the potential for collateral damage and disruption. While bond spreads might get wider for the most troubled states, the enactment of a state bankruptcy law is likely to raise the cost of borrowing for all municipal issuers.
Or, as Nicole explains more fully in this Boston Globe op-ed, "bond-market brinkmanship and bankruptcy threats can't save the states from themselves."
The bottom line: state bankruptcy promises no clear benefits and plenty of potentially negative unintended consequences. It's good that Bush and Gingrich are calling attention to the problems of states, and warning Washington to beware of bailout pressure. However, rather than focusing on bankruptcy as an all-purpose solution, it would be better for Congress to root out federal mandates and red tape that make it more difficult for states to save money and reform bloated programs. A good place to start: the proposal by Paul Ryan and Alice Rivlin to convert the federal share of Medicaid into a block grant for states.