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David Skeel suggests that a new chapter should be created in U.S. bankruptcy law to cover state governments. This is not without problems, however.  Skeel states that 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.”  He does not see this as a major hurdle, whereas I do. Whereas he, as a lawyer, is looking narrowly at bankruptcy and constitutional law, I am looking more long term at the trajectory of federalism succumbing to consolidation.

Skeel maintains that “(t)his 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.”  For a prototype, Skeel points to the municipal bankruptcy law that passed constitutional muster in 1937 and was “carefully drawn so as not to impinge upon the sovereignty of the State” such that the state “retains control of [the city’s] fiscal affairs.”  A U.S. court could not deprive a state of its control of its fiscal affairs.  So a judge could not order Illinois, whose 2011 deficit is at around $16 billion, to cut social programs or raise income taxes even more than it did in January of that year. The problem, as Skeel, notes, runs as follows: “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.”  So what could going to such a court do for a state other than act as political cover for what the state has already agreed to do?

Skeel’s proposal is open to abuse by state governments. This is evident from how he wants to apply municipal bankruptcy law. “In 1991, a court concluded that Bridgeport, Connecticut—which wasn’t anyone’s idea of a healthy city—had not demonstrated that it was insolvent, and rejected Bridgeport’s bankruptcy filing. To avoid this risk, without making bankruptcy too easy for states, Congress would do well to consider a somewhat softer entrance requirement if it enacts bankruptcy-for-states legislation. Current corporate bankruptcy does not require a showing of insolvency, and the new financial reforms allow regulators to take over large banks that are ‘in default or in danger of default.’ Although these reforms are in other ways deeply flawed, the “in default or danger of default” standard would work well for states.”  However, a political party holding power in a state government could use “in danger of default” to obviate payments to state pensioners that are mandated even by the state’s constitution for political expediency. In other words, providing an easy route for bankruptcy could enable a state to shrink from the obligations that come with its governmental sovereignty.

Although the states are semi-sovereign under the U.S. Constitution—the U.S. Government having the other “semi”—the matter of bankruptcy pertains to the portion of sovereignty that the states retain; a state's revenues, spending, and bonds are of the state--not the federal government. This is not to make a “states rights” argument; rather, it is to affirm that dual sovereignty is an essential attribute of modern federalism, for without two governmental systems enjoying sovereignty independent of each other, federalism quickly devolves into decentralization or consolidation. As an alternative to U.S. bankruptcy court, the American states might look at how the “PIGS” in the EU might proceed(1). For example, the U.S. could create a temporary emergency fund like that of the E.U. that troubled states could draw on. However, there is little appetite for that in Congress (and among the people), as we have bailout fatigue in the wake of Wall Street getting one and turning around with near record bonuses. In early January, 2011, Federal Reserve Chairman Bernanke testified before the U.S. Senate. A  few daring senators asked him if the Fed could or would bail out overleveraged states.  'No, and No," where the answers.  Of course, the Fed had been actively buying up t-bills to help the U.S. Government sustain its debt. It could be argued that the bias of the Fed toward the U.S. Government is a major lever pushing us further in the direction of a consolidated government and away from federalism. It could be argued that the Federal Reserve should either help both systems of government or neither.  As it is, the Fed demonstrates the bias of U.S.-level organizations in favor of the U.S.

Government relative to the state governments. Left without unlimited free money or the option of a bailout from Congress, the state governments in trouble do not have to succumb to a U.S. bankruptcy court that would somehow simultaneously rationalize or order the state's debt and yet not touch on the state's sovereignty.  As a sovereign republic with respect to its revenues, spending and debt, a state can organize its own bankruptcy. As simple as this sounds, it might be the most fitting with the federal system of governance that we formally have as a governing framework.

Alternatively, if states in trouble agree to a U.S. bankruptcy court process, I fear we risk relegating our own republics once again, wherein they function as appurtenances of the U.S. Government--little more than districts in effect.  While perhaps expedient now in unwinding a state’s ensnarled fiscal condition, effectively subsuming a state’s reorganization under the auspices of a federal court, even if the latter is essentially to function as a mediator without teeth for one of the parties (and how could this be fair?), pushes us one step further toward perfect consolidation.  At the very least, creating a new chapter in the U.S. bankruptcy law for the states would reinforce the modern connotation of “state” as “subordinate,” or second class, like adjunct faculty at a university. For the state governments to be able to recuperate sufficiently to be able to act as a check against abuses of power in the U.S. Government, those governments must act as sovereign republics in getting their fiscal houses back in order. It has been about 160 years since one of the American states went bankrupt, but as it has happened before without the aid of a U.S. bankruptcy court, it can happen again. One of our republics that is a constituent member of the union ought not be conflated with a bank whose reorganization should be managed because it is too big to fail. Relegating a republic into a sort of corporation would make the states akin to the early British colonies in North America that were referred to as plantations (the word is still technically part of the name of Rhode Island). In short, lest we take our eye off the ball concerning the long term viability of our public system of government, we will suffer in denegrating it as we pacify ourselves in the instant gratification that comes with following whatever is expedient at the moment.  It is precisely such expediency that has given rise to the unsustainable debt—both federal and state—in the United States. The fix should at least differ qualitatively from the cause, or the remedy will occasion further illness and distress.

Note:
1. PIGS stands for the E.U. states of Portugal, Ireland, Greece and Spain, all of which were in 2010 in precarious fiscal condition.

Source: David Skeel, “Give States a Way to Go Bankrupt,” The Weekly Standard, November 29, 2010, vol. 16, no. 11.
See: http://www.weeklystandard.com/articles/give-states-way-go-bankrupt_518378.html?page=1