Curmudgeon's Corner

When States & Cities Go Bankrupt

Posted by Al Campbell on Jan. 17, 2011

U.S., Wisconsin, Taxes, Political, Economy, Quality of Life

How will Congress deal with bankrupt cities and states?  There are a significant number of states and cities that are, in the real sense of the word, bankrupt.  They cannot pay their obligations with current revenue streams.  Among those obligations are public sector pension benefits that have been promised but which remain underfunded.

This will be a major issue as we course through the coming year or two.  If California, for example, were subject to the rules applied to businesses during financial audit, that state would almost certainly receive the “going concern” admonition as part of the final audit report.  That means simply that it is in serious trouble and that there are very real concerns about whether it can continue as a viable state given its current obligations as contrasted to its revenues and bank account balances.

We know that there are several cities in Michigan, as widely reported, that have petitioned that state for the right to declare bankruptcy.

What if cities and states were permitted to go through the bankruptcy process?  Those who have claims against such a state or city would petition the bankruptcy court for protection and would, in all likelihood, take pennies on the dollar in return for their claims.  That means that pension plan recipients would take less than they had expected in benefits.  That means that current labor agreements might be vacated by the courts.  Bankruptcy judges would pool available assets and determine the winners and losers or, more appropriately, the greater losers and the lesser losers.   That means that everything we have taken for granted would be subjected to the light of a new day.  Who would’ve imagined a decade ago that we could potentially see a state declared bankrupt?  Not many of us.

The ripple effect that would be created would take other entities down, as well if those entities were overly dependent upon the bankrupt state or community for its support.  State employees would probably see changes in their benefits and compensation.

The demand against the federal government to bail out these states and/or cities would be immense.  The debate would be deafening.  If we think we’ve seen a combative environment in Congress before, I suspect we might be redefining the term.

There is a limit to what level of taxation citizens can pay.  In the bulk of the suspect states and cities, taxes are already at all time high levels and the resulting revenues fall short.  The evidence is good that increased taxes do not result in the revenue expected leading to more tax increases that lead to lower realized revenue.

The goose that lays the golden eggs (that would be us citizens since governments do not produce anything) is very much threatened today.  If we see inflation rising (and we likely will), if we see gasoline prices rising (and we likely will), if we see more foreclosures rather than fewer foreclosures (and we likely will), there remains little alternative to the bankruptcy actions.

Those holding our government’s debt instruments will demand higher returns, if they are willing at all to advance more credit.  Our country is dangerously close to becoming a mirror image of Europe and we have made that happen all by ourselves.  As was said in a ‘Pogo’ comic strip long ago, we have met the enemy and he is us.

As our own Paul Ryan said recently, it is time for the adults to show up in Congress if we are to work our way through the coming troubled times.  And the adults are going to have no choice but to take serious action if we are to avoid, or even mitigate, the realities that appear to lie before us.