State bankruptcies? An odd and misplaced idea State bankruptcies? An odd and misplaced idea http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\bankruptcy-law-small.jpg May 5 2020 April 27 2020

State bankruptcies? An odd and misplaced idea

Suffering states aren't seeking this option and, under current law, can't anyway.
Published April 27 2020
My Content

In an aggressive case of political posturing, Senate Majority Leader Mitch McConnell has invoked the bankruptcy option for states suffering from devastating virus-related fallout to their economies. There’s only one problem—actually, there’s more than one—but the big one is that states legally can’t file for bankruptcy. Chapter 9 of the U.S. Bankruptcy Code, written into law in the Great Depression, only applies to local governments and political subdivisions of states—not states themselves.

Moreover, states retain some sovereignty within our republic as defined by the 10th Amendment to the Constitution. Because bankruptcy is a federal process, submitting states to it against their will or desire likely would be challenged on constitutional grounds. If states willingly pursued and supported a new state bankruptcy statute and a divided Congress and President Trump were to enact it, maybe the courts would uphold it. Maybe. But it would be shocking if states were to pursue such a remedy.

As it stands, no states have asked for such relief. State leaders likely understand their states would be worse off under a bankruptcy. Introducing the risk that state debts could be reduced/restructured in bankruptcy would increase costs of capital to all states—particularly lower-rated ones—harming the states, their taxpayers (and voters) more than helping them in the near term. 

States know how to make tough decisions

The reality is states don’t need bankruptcy. True, they face large immediate holes in their budgets and some have drastically underfunded pension plans. But pensions are not all immediately due and payable tomorrow. And unlike their brethren in the federal government, state executive and legislative branches are elected to make tough decisions on spending and taxation as they are bound to roughly balance their budgets annually. 

In times of emergency such as this virus crisis, states look to D.C. for emergency funding as the federal government can incur large deficits and borrow to the tune of trillions. But states understand they will have to cut spending and raise taxes to balance their budgets after the federal funds run dry. This is always the case. Thus, a lack of additional federal funding to states amid the coming double-digit percentage drops in tax revenues merely will cause sharp state spending cuts, personnel layoffs and/or tax increases, further complicating the economic recovery.

It helps that debt burdens in all 50 states as a percentage of their respective economies are a fraction of what we saw in Puerto Rico (where debt and pensions exceeded 100% of its annual output and income). No state is as over the barrel as was Puerto Rico when the federal government created an oversight and bankruptcy-like process for the island a few years ago. But recall, Puerto Rico is a territory, not a state, and our Constitution gives explicit unlimited authority to the federal government in the administration of its territories.

Partisanship does no one any favors in this crisis

In my opinion, McConnell’s comments represent a cynical attempt to minimize further federal aid to states in the next round of Covid-19 relief legislation, and arguably represent a re-emergence of extreme political division between “red” and “blue” states at a time of national emergency. That is not to suggest McConnell can’t say “enough is enough” on the massive federal spending. He is the Senate majority leader, after all. But his methods and, at times, those of the leadership on the other side of the aisle are now starting to resemble hyper-partisanship at a time of crisis. It was reassuring to see the cooperation and leadership that emerged in D.C. to pass the Coronavirus Aid, Relief and Economic Security (CARES) Act, but sad to see it lapse so quickly.

Tags Coronavirus . Fixed Income . Politics .
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