State Bankruptcy

Two articles crossed my desk (well, my Kindle and my iPhone) recently, both on how to manage bankruptcy of US states.

States are not allowed to declare bankruptcy. One of the challenges in managing state-level financial distress is ensuring that the state is able to meet its contractual obligations while maintaining services. Unlike a corporation, a state cannot simply declare bankruptcy, and does not go bankrupt when it breaks a covenant.

NYT article on movement towards resolving distressed US states. Notably, prospect of removing primacy of pensions and senior bondholders in restructuring:

What they're getting it is two-fold: 1) in bankruptcy, the debtor basically turns over his finances to the court for restructuring. A sovereign state can't do that - without sacrificing sovereignty. 2) For a a state to meet its contractual obligations and covenants, it would have to cut back on services first. This isn't sustainable. So, how does a state renegotiate its obligations and covenants if it can't enter bankruptcy?

Peter Orszag briefly touches on state default in this FT piece - regards it as alternately unlikely yet devastating should it occur:

So, I call trial balloon. We have an NYT piece full of chatter about the nature of the problem and some of the ideas about how to resolve it, but no real commitment. We have a former administration official, a financier and economist, talking more bluntly about the nature of the problem. I think we're being prepped. I think in 2011 we're going to see some movement towards regulation and possibly legislation to allow state and municipal governments to renegotiate at least some of their debt obligations.

This is huge. How does a government clear up its debt? More importantly at the state and muni level, how does one government do this without casting a pall on all others? I agree with Orszag that comparisons to Europe are overblown - by the order of magnitude if nothing else - but if one city or state oes bankrupt, it's certainly going to affect borrowing costs for others for years.

The challenge here is to provide a mechanism for resolving government distress without damaging the ability of governments to afford the carrying costs of their operations. All these nutters going on about how we can't keep borrowing have no idea about what life would be like if governments could not borrow at all. Let's hope none of his get to experience that.

http://www.nytimes.com/2011/01/21/business/economy/21bankruptcy.html

http://www.ft.com/cms/s/0/10612eec-24cc-11e0-a919-00144feab49a.html#axzz1Bnex2eOZ