Budget-Strapped States Might Prefer To Be Bankrupt

Host Liane Hansen talks with law professor David Skeel about a proposal that would allow states to declare bankruptcy as a way to handle overwhelming debt.

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LIANE HANSEN, host:

As we've heard, state governments typically have two options when faced with major budget shortfalls: raise taxes or reduce spending. Now, there's a proposal to give states a third choice: declare bankruptcy. By law, states cannot seek bankruptcy protection in federal court. They're considered sovereign and independent. To change that requires changes to the U.S. Constitution.

Advocates of bankruptcy would allow states to limit their pension obligations and consider bankruptcy a suitable alternative to a federal bailout.

David Skeel wrote the opinion page "Give the States a Way to go Bankrupt" for the Weekly Standard. Skeel is a professor of corporate law at the University of Pennsylvania and is in the studio of the Wharton Business School at the University of Pennsylvania. Welcome to the program.

Professor DAVID SKEEL (Corporate Law, University of Pennsylvania): Oh, thanks so much for having me.

HANSEN: Explain how this would work. I mean, how would a state like California in financial distress declare bankruptcy?

Mr. SKEEL: Well, we already have a roadmap for how this would work. It's already accepted for cities and other municipalities to file for bankruptcy. So, really what I'm suggesting is simply that we enact a very similar set of laws for states. And the key to the way this law would need to be structured is it couldn't be involuntary - we couldn't have a law that allowed creditors to throw the state into bankruptcy because of those state sovereignty concerns you've already mentioned.

It also couldn't interfere directly with governmental decision making. But other than that, a state could file for bankruptcy pretty much the way an ordinary corporation files for bankruptcy.

HANSEN: The National Governors Association in a written statement said: The mere existence of a law allowing states to declare bankruptcy only serves to increase interest rates, raise the costs of state government and create more volatility in the financial markets. How do you respond to the association?

Mr. SKEEL: Well, I certainly understand their concerns but it seems to me that they are significantly exaggerating the likely bond market effect. Historically, when you look at other analogous situations, such as when countries have run into financial trouble, the reality is that the bond market doesn't overreact, that the bond market knows which states are the troubled ones and which ones it doesn't need to worry about.

And even with the troubled ones, often they can borrow relatively quickly after any credit crisis event.

HANSEN: Eric Cantor, the House majority leader, has said he wasn't going to bring a bill like this forward. So, is there enough political will, do you think, to even move this proposal forward?

Mr. SKEEL: Well, that's the $64,000 question right now. If you look at the most recent polls, they give some reason for doubt about that, that we're not there right now. I think the odds that the Senate and the House and the president are going to be on board are still a little bit long, but I'm optimistic that this will at least get a serious hearing. Whether it will in fact be enacted, obviously, it's way too early to tell.

HANSEN: David Skeel's piece, "Give the States a Way to Go Bankrupt," appears in the Weekly Standard, and he's the author of "The New Financial Deal." Skeel is a professor of corporate law at the University of Pennsylvania. He's in the studio at the Wharton Business School in Philadelphia. Thank you very much.

Mr. SKEEL: Oh, thank you.

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