My friend Stephen Lubben had a characteristically interesting post on the bankruptcy-for-states debate in his Dealbook column yesterday. Stephen pointed out that the advocates for a bankruptcy chapter for states are overwhelmingly Republican, and concluded that this bodes ill for the prospects of enactment.
It seems to me that more Democrats should support the legislation—especially those who are concerned to protect public employee unions. Although they fear the legislation would simply be used to whack unions, in reality union contracts are already under great pressure, even without bankruptcy. The virtue of bankruptcy—at least as an option in the direst circumstances—is that it would bring everyone to the table, and ensure that everyone made sacrifices as necessary.
Which brings me to the bond markets. Republicans definitely aren’t united in favor of legislation at this point. My sense is that many who oppose a bankruptcy option—such as Eric Cantor—have bond traders whispering in their ears. The standard refrain is that a bankruptcy option would be devastating to the bond markets, and would create chaos for all states, even the financial stable ones. It’s possible that a state bankruptcy option would have adverse effects on the bond markets, but I think the effects are greatly overstated. The markets are very good at distinguishing between troubled borrowers and healthier ones; and even troubled borrowers often can quickly return to the markets after a rough patch. (On the international stage, Argentina has shown how this can be done—almost too easily).
Moreover, bankruptcy is much less destructive than a complete default by a state on its bonds, which is a real possibility with a couple of the most troubled states. In bankruptcy, the bonds could be trimmed a little, along with the state’s other obligations.
Hopefully, no state would need to use a bankruptcy option. But if worst came to worst, having the option seems a lot better than not.