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Feds Trying to Let Illinois Go Bankrupt

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Elevating jigs

I know that treating the Constitution like it was some kind of, ahem, law is not particularly in vogue right now, but let’s think about this one for a minute:

Policymakers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

So sovereign states would go to a court that would have to be empowered to dictate their current and future asset allocation.  It’s OK, it’s a just a hurdle, right?

Naturally the bond markets are having a shit fit even at the mention of this, which strikes me as kind of silly considering if you’re into bond trading chances are you can do math, at least at the level where it’s fairly obvious some kind of default is coming with most states.

Still, there is some precedent:

The story began, as so many do, with the best of intentions. In 1927, the state of Arkansas took responsibility for $54.8 million in debt sold by hundreds of road districts to prevent its default.

Combined with the state’s own $84 million in highway-system bonds and $7.2 million in toll-bridge securities, the assumption of district bonds pushed Arkansas’ debt to $146 million. Coupons on the bonds were as much as 5 percent.

Fast forward to March 1933 in the depths of the Great Depression — not Senator Reaves’s best of circumstances. The Arkansas General Assembly passed the Ellis Refunding Act, which sought to exchange all outstanding highway debt for state bonds carrying a 3 percent coupon, maturing in 25 years.

“Interest on highway and toll-bridge bonds, amounting to $770,500, due March 1, is in default, and this fact spurred the Governor in his demand for a refunding program that would yield revenue sufficient to meet any emergency and insure stability to outstanding obligations,” the New York Times reported.

Actually, this wasn’t the first state default.  Still, read the piece.  Basically what happened was the bondholders got an injunction against using gas or automobile taxes for anything but highway maintenance, and Arkansas cut a deal with the bondholders where they raised the taxes and eventually paid off the bonds (but not without nearly defaulting several more times).

The issue is that back then Arkansas guaranteed the debt with a specified revenue stream (gas and auto taxes).  Now they’re all general obligation, meaning they’re backed with the full faith and credit/taxing authority of the issuing state.  This could mean there’s no recourse, or it could mean that some random federal judge could use the power of injunction to determine what things a state could legally pay for before paying off its debt, even without bankruptcy.  The state would still be sovereign in a de jure federalist sense, but as a bond issuer who has entered into default they’d be like any corporation that did the same.

So unless I completely misinterpreted GO bonds (which is a definite possibility) the goal of creating a mechanism for bankruptcy would be more about codifying what happens in this situation instead of leaving it entirely up to the whims of whatever judge gets this turd dropped at his/her doorstep than it is a federal power grab.  That said, it would still be a massive federal power grab, because granting states the ability to declare bankruptcy means they give up their sovereignty regardless of whether they ever use this ability, as federal sovereignty is a necessary premise of the ability even existing.

Obviously, any lawyer input on this would be greatly appreciated.

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