Addressing the Coming Wave of State Insolvency

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Addressing the Coming Wave of State Insolvency

A growing number of governors are voicing concern about the damage inflicted on both the revenue and the expenditure sides of their states’ budgets by the COVID-19 pandemic. To allay these concerns, the $2 trillion Coronavirus Aid, Relief, and Economic Security (or CARES) Act provided $150 billion to state and local governments in addition to a $30 billion education fund, a $45 billion disaster relief fund, and other smaller programs.  But even these massive sums are proving inadequate to prevent the enormous disruptions caused by large-scale business shut-downs, plummeting tax revenues, and new healthcare and unemployment insurance expenses.  Moreover, this threat only grows with each day that states like New York, New Jersey, Illinois, and California delay fully reopening for business.

The situation is particularly dire for the many states that entered the current crisis with “preexisting conditions” that render them less able to cope with these challenges owing to repeated failures in addressing their budget issues.  That’s especially true for states with heavily underfunded public employee retirement benefits.  Many states that have offered generous retirement benefits to their employees have not funded these benefits in full, partly because the needed money has been spent elsewhere in the budget.  Accounting gimmicks, as well as high investment returns in the past decade, have kept overburdened states afloat. But just as economic catastrophe is driving debt-laden companies such as JC Penney, Neiman Marcus, and Hertz into bankruptcy, many states are being forced to confront similar burdens.

It is in this context that the idea of including states under Chapter 9 of the U.S. bankruptcy code, which allows cities, counties, and other municipalities to file for bankruptcy, has resurfaced.  This proposed expansion would allow state governments to file for bankruptcy. 

Although controversial, the idea of political jurisdictions filing for bankruptcy is far from radical.  In fact, since 1980, there have been a total of fifty-four Chapter 9 filings involving cities, counties, towns, and villages.

In theory, allowing states to go through the bankruptcy process would overcome today’s political obstacles and finally create the conditions for financially troubled states to rectify their unsustainable financial conditions.  

It this realistic?  Consider the facts. 

Ideally, insolvent states would try to right their fiscal conditions.  That means legislatures and governors would make the hard budget adjustments necessary for states to meet their obligations to the public, retirees, and bondholders...

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