State bankruptcy floated as option on Hill

With states large and small (hello, Nevada) squeezed by the recession and facing budget holes exceeding a collective $125 billion in the next fiscal year, a few conservatives are floating the idea of rewriting federal law to allow states to declare bankruptcy.

Former U.S. House speaker Newt Gingrich, a possible presidential candidate, has been pushing the concept as an alternative to further federal “bailouts” of the states like the fiscal stabilization funds contained in the $787 billion economic stimulus law passed in 2009. This week he and former Florida Governor Jeb Bush outlined a plan in the Los Angeles Times.

“The new Congress has the opportunity to prepare a fair, orderly, predictable and lawful approach to help struggling state governments address their financial challenges without resorting to wasteful bailouts,” the Republicans wrote. “This approach begins with a new chapter in the federal Bankruptcy Code that provides for voluntary bankruptcy by states, a proven option already available to all cities and towns across America.”

While the law would allow states to restructure their debts, the details are sure to be thorny and highly controversial. As proposed, a state in bankruptcy reorganization could terminate its public employee contracts and establish new work rules.

Further, “The new law could also allow states an opportunity to reform their bloated, broken and underfunded pension systems for current and future workers,” Gingrich and Bush wrote.

So far the idea has gotten a mixed reception on Capitol Hill, and was rejected outright by the National Governors Association. Much as an individual can be tainted by the stigma of bankruptcy, so would a state, with the fallout much more pronounced.

“The nation’s governors strongly oppose federal proposals to provide states with bankruptcy protection,” said Washington Gov. Chris Gregoire , the NGA chairwoman, and vice chair Dave Heineman, the governor of Nebraska

“Allowing states to declare bankruptcy is not an authority state leaders have asked for nor would they use,” the governors 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 financial markets.”

Similarly the Center for Budget and Policy Priorities in a Jan. 20 report said bankruptcy would potentially enable states to default on their bonds. “Such a provision could do considerable damage, and the necessity for it has not been proven,” it said.

Nonetheless, Gingrich has predicted legislation will be introduced in Congress. Rep. Patrick McHenry, R-N.C. the chairman of a House oversight subcommittee, has said he plans to hold hearings.

“We’re exploring that as a responsible option,” Sen. John Cornyn, R-Texas, told reporters this week.

Sen. John Ensign, R-Nev., says he favors the idea.

“I think it is exactly the right way to go,” he said. “Cities and counties can do that now but states are not allowed to do that. Some of these states are actually heading for bankruptcy and you want them to be able to reorganize. I know there will be bills worked on this in both the House and the Senate.”

Rep. Eric Cantor, R-Va., the House majority leader, said he would oppose the bankruptcy option.

“State governments have at their disposal the requisite tools to address their fiscal ills,” he said, according to an account in Politico. “They’ve got the ability obviously to adjust levels of spending as well as revenues at the state level.”

One thing that has become most clear, however, is that Republicans have little if no appetite to send more money to the states. Senate Republican leader Mitch McConnell, R-Ky., was noncommittal on the bankruptcy idea but stressed, "There will be no bailouts, I can tell you that. No bailouts.”

Similarly, Ensign introduced legislation this week “to prohibit taxpayer bailouts of fiscally irresponsible state and local governments.”

A copy of the bill was not immediately available. Ensign aides said it would prohibit federal money to be spent on state and local obligations if a credit rating agency determines a state or city is likely to default.

Nevada Gov. Brian Sandoval, who faces a two-year budget gap of at least $1 billion, traveled to Washington last fall to feel out Senate Majority Leader Harry Reid on the prospects of the state getting some relief to pay for its growing Medicaid caseload and for interest payments on money borrowed from Uncle Sam to pay unemployment benefits.

Reid said he would if he could but he doubted Republicans would go along.

Reid on Friday did not comment on the proposal to allow states to declare bankruptcy.