How to Let States File Bankruptcy

Allowing states to file bankruptcy raises a host of questions and issues. This article from the New York Times addresses some of them. One issue is that states are sovereign and could just refuse to honor particular contracts. But if they do, their bond ratings get lower, which costs them more money in the long run. Of course, filing a bankruptcy could lead to a really low bond rating. But, right now, there is no legal mechanism equivalent to declaring bankruptcy for a state.

David Skeel, a well-respected bankruptcy professor, opined that Congress should give states a way to go bankrupt. Professor Skeel seems to rather lightly dismiss the constitutional concerns:

Start with the issue of constitutionality. The main objection to
bankruptcy for states is that it would interfere with state
sovereignty-the Constitution's protections against federal meddling in
state affairs. The best known such barrier is the Tenth Amendment, but
the structure of the Constitution as a whole is designed to give the
states a great deal of independence. This concern is easily addressed.
So long as a state can't be thrown into bankruptcy against its will,
and bankruptcy doesn't usurp state lawmaking powers,
bankruptcy-for-states can easily be squared with the Constitution. But
the solution also creates a second concern. If the bankruptcy framework
treads gingerly on state prerogatives, as it must to be constitutional,
it may be exceedingly difficult for a bankruptcy court to impose the
aggressive measures a state needs to get its fiscal house in order.

He may be right about this, but it seems to me that sovereignty is a little more complex than that. But let’s say we get past sovereignty. How would it work?

We now have more than 70 years of experience with a special chapter of
the bankruptcy code-now called Chapter?9-which permits cities and other
municipal entities to file for bankruptcy. For decades, this chapter
did not get a great deal of use. But since the successful 1994 filing
for bankruptcy by Orange County, California, after the county's bets on
derivatives contracts went bad, municipal bankruptcy has become
increasingly common. Vallejo, California, is currently in bankruptcy,
and Harrisburg, Pennsylvania, is mulling it over. The experience of
these municipal bankruptcies shows how bankruptcy-for-states might
work, what its limitations are, and why we need it now.

Once concern I would have is the complexity of state finances to be handled in the bankruptcy court. The complexity of state bankruptcy seems that it would dwarf municipal bankruptcies. On the other hand, the GM bankruptcy was pretty complex in itself and there have been a lot of complex bankruptcies in recent years. Maybe this would be something a bankruptcy judge could handle.

I guess we will see if anything comes to fruition.