Mitch McConnell believes he has hit upon a solution for states that are upside-down on their pension obligations and other financial commitments: “I would certainly be in favor of allowing states to use the bankruptcy route,” he told Hugh Hewitt on Wednesday. “It’s saved some cities, and there’s no good reason for it not to be available.”
There are a couple of good reasons for denying the states bankruptcy protection. One is the fact that there is no such thing as state-bankruptcy law in the United States. A second reason, related to the first, is the Constitution.
In the United States, we have a bankruptcy law for individuals, another one for businesses, and yet another one for municipalities and their subordinate agencies. We do not have a bankruptcy law for the states or for the federal government, for the same reason: They are sovereigns.
The several states are not administrative subdivisions of the federal government. They are powers in their own right, superseded by the U.S. government only in certain matters that involve more than one state: Washington can declare war or write immigration law, but it cannot tell Austin how to run the Texas Rangers or Sacramento how to prioritize its finances.
Because bankruptcy law is federal law, putting states into bankruptcy reorganization would upend our basic constitutional arrangement, making state governments answerable to federal bankruptcy judges and, behind them, to Congress. The people in Illinois are, for their sins, represented by the elected officials of Illinois in matters pertaining to Illinois.
Republicans often talk about the public-pension fiasco as though it were a uniquely Democratic problem — Hewitt listed California, Illinois, and Connecticut as states with such troubles. But Senator McConnell’s home state of Kentucky is no less troubled. Oklahoma has substantial unfunded liabilities in its pension system. At the municipal level, Chicago has pension troubles, but so does Dallas.
Badly managed cities and states hope to use the coronavirus epidemic as a pretext for federal bailouts. This is a cynical and shameful ploy: These problems have been decades in the making as states systematically underfund their pension systems. Why do they do that? It is a way to increase compensation for a politically powerful group — government employees — without raising taxes to pay for those benefits, or even to put them on the budget in a halfway honest fashion. (The numbers government budget-writers use to calculate their pension liabilities are fanciful, as obvious an exercise in book-cooking as you will find.) One interest group gets promised benefits in the future, and another gets benefits in the here and now that are paid out of the money that should have been used to fund those pension liabilities. It is a way of spending the same money twice, in effect.
Sovereigns don’t go bankrupt. Sovereigns default.
And that is what is likely to happen with the pension crisis, at least as far as states’ creditors are concerned. It is what should happen. It will be unpopular: Unlike many other financial instruments, municipal bonds are held mostly by households, not by financial institutions.
We may temporarily put off the reckoning through such maneuvers as the Fed’s backstopping the municipal-bond market, as it currently is. There is a reasonable case for short-term measures for the duration of the epidemic. But we should not use the coronavirus as an excuse to federalize the consequences of culpably irresponsible and fundamentally dishonest governance at the state and local level. Federalizing those problems does not make them go away — the liabilities remain, and somebody has to pay. The U.S. government is not a magical money machine that can exnihilate resources into existence with no economic consequence.
If we want debt markets to work, then investors have to pay the price for bad investments. (Lending money to an organization run by Bill de Blasio is a bad decision.) Making creditors take a painful haircut creates incentives to discourage such willy-nilly lending and profligate spending in the future. The more it hurts, the better. It is going to hurt a lot and already is hurting some, which is why investors have been running away from municipal debt.
Government debt should in this respect be treated like any other debt — and we should change the law to strip municipal bonds of their tax-free status, which creates a subsidy for debt.
The problem is that creditors are not the only parties to whom state governments owe something. They also owe their retirees and future retirees the promised benefits. Beyond the ordinary moral obligation to keep their promises, many states cannot as a legal matter reduce promised pension benefits, which are protected by statutory or constitutional provisions.
Eventually, the political problem becomes a math problem, with the states obligated to spend more money than they have or can borrow. Even the Supreme Court of Oklahoma cannot produce blood from a stone.
The most likely way forward — the only plausible way forward short of gutting the Constitution — is for states to engage in a long, painful, disruptive negotiation with their creditors, their pensioners, and other interested parties. There will be endless lawsuits, unpopular budget cuts, unpopular tax hikes, and much else that is designed to make no one happy except for the lawyers. (The lawyers always get paid.) But these are the decisions the democratically elected representatives of the people of the several states have made, and they will have to live with them.
Call me an optimist, but: The more it hurts, the less likely they are to repeat the error.