Lawmakers Resist Bankruptcy for US States: Muni Bloodbath Awaits

02-15-2011 • CNBC.com

"While bankruptcy for states may seem like an attractive alternative to state bail-outs, there are constitutional and policy concerns with this approach," Lamar Smith, chairman of the House Judiciary Committee said at a sub-committee hearing on the matter on Monday. US states are struggling with years of budget deficits related to the recession while the financial crisis has exacerbated gaps in their pension systems. This combination has led to concern that the most strained states will seek bail-outs. Joshua Rauh, associate professor of finance at Kellogg School of Management at Northwestern University, referred to unfunded pension liabilities as "hidden debt" that "will eventually force states and localities to choose among the unpalatable options of cutting services, raising taxes, attempting to reduce benefits owed to public employees, defaulting on other obligations or seeking a federal bail-out." Some Republican lawmakers want to introduce legislation that would allow states to go bankrupt instead. Mr Smith said that he was unsure whether Congress has the constitutional authority to allow states to seek bankruptcy relief. Under the US system of federalism, states are co-sovereigns.