Bankruptcy for States?

Troubled by crushing debt? Overwhelmed by pensions and post-retiree health care costs? Unable to bargain with public sector unions? Well, there may be a new solution on the horizon, bankruptcy for states.

We have written plenty about Chapter 9, the Federal law that governs municipal bankruptcy. In order to preserve the balance of power between the Federal government and the states, Chapter 9 allows states to act as gatekeepers: they can permit municipalities to file without restriction, limit filing to certain types of local governments, place hurdles, or outright prohibit filing altogether. Right now 19 states permit their municipalities to file, so a new Federal law permitting states to file would create a situation in which 30 states that currently prohibit municipal bankruptcy would enjoy the right to file.

Of course this proposal raises Constitutional issues. One observer says that so long as state bankruptcy would be treated as municipal bankruptcy-that the governing body could not be forced into a filing and the courts could not dictate tax increases or service cuts-then it would be permissible. But states would quickly run into the "insolvency test" in which the courts would be able to dismiss a filing if it were determined that tax hikes or service cuts and efficiencies could be achieved. Difficult to do for a City like Pittsburgh with a $400 million plus budget; even harder to do for a state like Pennsylvania with a $28 billion budget. If the courts dismissed state filings based on that test, then it would be back to square one of negotiating and cutting outside the oversight of the judge.