NEW YORK Big companies such as General Motors file for bankruptcy. Some cities do, too. And last year, 1.5 million Americans did it.
But U.S. states arent allowed. Now a few policymakers and pundits are debating whether its time to give states a court-sanctioned way to shed their debts.
The idea galls critics. Baloney is what California Treasurer Bill Lockyer calls it, saying his state, which is already weighing painful tax hikes and spending cuts, doesnt need the option.
It seems clear that some states cant afford their long-term promises to pay for pensions and retiree health care. Those swelling costs could force states to raise taxes and slash services such as public transportation.
But is bankruptcy the right solution?
In bankruptcy court, a judge could force lenders and public workers to accept less than they are owed. Debt could drop overnight. Existing union contracts could be replaced with cheaper ones. In theory, states could regain their financial health.
But the risks are high. A state could be tied up in court for years as various sides squabble over a deal that might bring only scant relief in the end. Even discussing the idea could spook investors and rattle states fragile finances. States need investors to buy their bonds, and demand was already dropping before talk of a bankruptcy option spread.
Fearing that towns and cities may default, investors in November and December pulled a record $21 billion from funds that invest in municipal bonds twice as much as they did at the depths of the 2008 credit crisis, the Investment Company Institute says. Those still buying are demanding higher interest payments to compensate for the risk.
Standard & Poors, which determines how credit-worthy states are and assigns ratings, said last week that a bankruptcy law would cause it to review the way it judges states. Downgrades would force states to pay higher interest rates.
If investors started selling the bonds, that would force interest rates higher, too, adding to the cost of financing the bonds.
The higher the interest rate a state has to pay, the more potholes that cant be filled, says Marilyn Cohen of Envision Capital, a company that invests in bonds. Theres a whole chain reaction.
Some also question whether allowing states to go bankrupt would be wise economic policy in the long run. When a company or family cuts its debt through bankruptcy, it risks encouraging others to do the same, notes Dean Maki, chief U.S. economist at Barclays Capital. With states, the danger is greater.
Theres only 50 of them, so if you allow one to file, people will say, Why does that state get to escape their debt and not others? Maki says. Are you encouraging poor behavior?
Bankruptcy talk may already be taking a toll on public finances. Matt Fabian of Municipal Market Advisors says states, cities and towns are avoiding issuing new debt, partly because they fear a bankruptcy option.
States combined deficits for next fiscal year are a projected $125 billion, says Iris Lav of the liberal Center on Budget and Policy Priorities. And they havent put enough money away to cover pensions due in coming decades. Estimates for the collective pension shortfall range from $500 billion to $3 trillion.
State tax revenues are starting to recover as the economy improves and as states raise taxes. Revenue rose 6.9 percent in the October-December quarter, based on early data from 41 states, according to a report from the Nelson A. Rockefeller Institute released Tuesday. That would be the fastest increase in more than four years.
Still, most states face brutal budget squeezes. Tax revenue remains just below pre-recession levels, the report says.
Theres increasing recognition that something has to give, says Robert Ward, head of government finance research at the institute. Are state taxes going to go up dramatically? Not in most places. Are services going to be slashed? Not in most. There are really only a few escape valves.
Two possible targets are bond investors and public workers.
Backers such as former House Speaker Newt Gingrich say states need the threat of a court-approved bankruptcy option to wrest concessions from bondholders and unions.
Unions would face a much more dire outcome in bankruptcy court than they would if they renegotiated, says Patrick Gleason of the Americans for Tax Reform, a conservative group pushing for such a law.
Also propelling the idea is fear that states may eventually approach Washington for a taxpayer bailout like the one for Wall Street.
Sen. Mark Kirk, R-Ill., thinks a bankruptcy option would keep states from seeking federal aid, a spokeswoman says. House Judiciary Committee Chairman Lamar Smith, R-Texas, says his panel will hold a hearing on the issue later this month. Unlike the case with cities and towns, there is no law allowing states to seek bankruptcy protection in federal courts.
A few states have moved to fix their finances. Lawmakers in Illinois, for instance, voted to raise personal income tax 66 percent, along with spending cuts. The state still faces a $15 billion deficit.