Apr 28, 2020 - Politics & Policy

Inside the idea of state bankruptcy

Illustration: Sarah Grillo/Axios

States are facing their biggest fiscal crisis since the Great Depression, with revenues plunging as obligations soar. Senate Majority Leader Mitch McConnell suggested that state bankruptcy filings should be considered as an alternative to further federal bailouts.

Reality check: States cannot currently file for bankruptcy, unlike cities and towns.

McConnell said last week he's "in favor of allowing states to use the bankruptcy route," but hasn't proposed legislation to enable it. Yesterday he said he'd also consider additional federal aid to states and cities, but only in exchange for business liability waivers.

President Trump tweeted that he's "open to discussing anything," but only in the context of a partisan argument about how only "Democrat run and managed" states want federal help (which is not true).

  • Bankruptcy, were it legal, wouldn't even help states get through this crisis.
  • Bankruptcy is about an inability to repay debts. The states' current predicament is centered on an inability to fund their essential services.

Debt default is not really a viable alternative for states.

  • Debt service payments don't make up enough of states' budgets to make default worthwhile.
  • Interest payments tend to account for about 5% of a state's total budget. When Arkansas defaulted on its bonds in 1933, by contrast — the only time that a state has defaulted in the past century — debt service payments were more than half its total budget.
  • In the event of a default, bondholders would sue the state and almost certainly get a court judgment allowing them to collect.

Between the lines: Many Republican lawmakers tend to like the idea of state bankruptcy because it's the only way to forcibly renegotiate contracts and pension agreements entered into with public-sector unions. But, again, it's not currently legal.

The big picture: Most states must balance their budgets, including for the fiscal year scheduled to end on June 30 (except for New Jersey, which just moved it back to September).

  • All states but Vermont have balanced budget requirements, although not all such requirements are enshrined in the state constitution.

What to watch: If federal aid does not arrive, states will have to make extremely painful budget cuts, or violate their balanced-budget rules, or both.

The bottom line: States urgently need cash. The federal government is best placed to provide it.

Editor's note: This story has been corrected to state that Arkansas (not Alabama) defaulted on its bonds in 1933.

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