Enabling State Bankruptcy Gathers Support - Yikes!

Last Updated Jan 21, 2011 12:05 PM EST

A few days ago I wrote about a proposal by former House Speaker Newt Gingrich to change the federal law so that states could petition for bankruptcy. The idea seemed sort of wacky -- allowing state legislators to back out of promises that they had made to workers, by contaminating the financial position of a whole state until the end of time. But The New York Times today reports that the idea is gaining momentum (although perhaps not credibility -- yet).

Under current legislation municipalities and state agencies can petition for bankruptcy in federal court, but states cannot. (Moreover, "Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign," reports the Times.)

As noted, Newt Gingrich is promoting the idea nonetheless, giving his presidential aspirations some well-timed publicity, as are Republicans in the House and Senate, and, of course, bankruptcy lawyers, for whom such revisions of the laws would create an entire new career path. (Here's an article advocating state bankruptcy from a professor at the University of Pennsylvania law school.)

This issue is getting so much attention because of the depth of the recession: many states today have large, even overwhelming, deficits in the current budgets -- problems that by law must be solved right away. Good fiscal sense dictates the same thing -- don't spend what you don't have. Accordingly states are raising their taxes and cutting back the services they provide. No one is in favor of having fewer firemen or school teachers, but states and cities have to adjust.

The second part of the issue, which the bankruptcy proposals are more directly aimed at, are not immediate financial crises, but rather problems that will emerge over many years with the states' pension funds. Yes, when you measure their shortfalls today, the numbers are huge, but it's not money that's all due at once. It's a big, unpleasant effort, but pension plans can be repaired over time with adjustments to the contributions employers and employees make, and the benefits people receive.

The most potent measure is reducing the benefits to the current population of retirees, and people working for cities and states today. (Public workers are more than 10 percent of the U.S. labor force.) But there's a legal problem there, too, in that in negotiating such rollbacks, states would have to break the contracts they have already promised, which goes against the U.S. constitution and state constitutions. A few bold states, such as Colorado, Minnesota and South Dakota, have stepped up and reduced benefits.

There is no ready-made way out of the large pension deficits, certainly not bankruptcy. It has to be done as a collective effort, involving everyone in those states that have these problems. Much of the problem started in the dot-com boom, when for a short time state pension funds became generously funded, and legislators both increased workers' benefits and reduced states' contributions. And yes, workers and their unions did not turn down the offer of higher retirement pay. (There's also an element of the Aesop's fable "The Ant and The Grasshopper" in this -- many states did not promise the future away and don't face such deficits.)

The hard work needs to be accomplished among the state workers, their unions, and the legislators who shaped the pension plans. Allowing state bankruptcy on pension grounds would turn the whole issue over to federal judges, who would decide what benefits are preserved and cut, and how large contributions should be. (Actually I'm surprised to hear Newt Gingrich, Mr. Small Government, advocating that what is a local issue should turned over to what would become a new branch of the federal superstructure.) And let's face it, folks, a federal bailout would result.

State legislatures need to look hard at what they have created, and repair what they have done, rather than dump the problem into the lap of the federal courts, and ultimately, U.S. taxpayers.