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Wall Street Journal


State Bankruptcy Is a Bad Idea

January 24, 2011

By E. J. McMahon

Politicians already have the power to tame public unions without roiling municipal bond markets. They merely have to use it.

As states struggle with enormous deficits and exploding pension costs, some analysts are urging Congress to enact a law enabling states to declare bankruptcy the way municipalities can under Chapter 9 of the federal bankruptcy code. This is a bad idea. A state bankruptcy provision could create more problems than it solves.

Bankruptcy proponents understandably worry that states such as California and Illinois are so deep in the hole they may end up petitioning Congress for federal relief. To forestall this possibility, the argument goes, even the threat of bankruptcy would give governors and legislators a powerful new weapon for forcing concessions from recalcitrant public employee unions.

Yet state officials committed to cutting costs already have options for putting the squeeze on their unions. One is the threat of mass layoffs, which most governors can impose unilaterally. Governors and legislators also can prospectively freeze wages or even cut them through involuntary furloughs, as California and several other states did over the past two years.

True, management (i.e., taxpayers) often starts from a weak position in contract talks with government unions. But governors and legislators have the power to change that, too—because the bargaining rights of state and local government unions are primarily a matter of state law.

By reopening their collective bargaining statutes, state officials can narrow the terms of future negotiations—restricting compulsory arbitration, say, or taking retiree health insurance off the table and making it a management prerogative. They can also pressure unions by revoking privileges such as the employer-collected dues checkoff. They can even eliminate future union contracts.

This is not as unlikely as it may sound. At least 18 states already outlaw collective bargaining with some categories of government employees; Virginia and North Carolina prohibit it for all public workers. Two newly elected Republican governors, Scott Walker in Wisconsin and John Kasich in Ohio, have threatened to dismantle their state bargaining statutes if unions fail to make concessions.

For constitutional reasons, any federal law enabling state bankruptcy would have to be voluntary, meaning states would have to invite federal judges to play tough with their unions. But if Gov. Jerry Brown and the California legislature are unwilling to rewrite their collective bargaining rules—signed into law by Mr. Brown himself, 33 years ago—why assume they would plead with a federal judge to do it for them?

It’s more likely that a state like California would pursue bankruptcy if powerful unions and other budget-dependent interest groups saw this as a way to deflect some of the pain to bondholders. California is one of the states that constitutionally guarantees its general obligation debt, and whose bondholders are now seemingly untouchable. That could change with a bankruptcy option.

Such an option would certainly rattle the bond market—which bankruptcy proponents see as a good thing. Yet this ignores the potential for collateral damage and disruption. While bond spreads might get wider for the most troubled states, the enactment of a state bankruptcy law is likely to raise the cost of borrowing for all municipal issuers.

Much of the talk about state bankruptcy has centered on the solvency threat posed by unfunded public pension liabilities of as much as $3 trillion, according to an estimate by Joshua Rauh of Northwestern University. This is truly a significant concern, complicated in some cases by state constitutions that make it impossible to claw back unaffordable benefits for current workers.

However, while most public pension liabilities are pooled in statewide, off-budget trust funds, they largely reflect the cost of retirement benefits promised to teachers, cops and firefighters—who mainly work for municipalities, not state governments. This raises another complication: Could a judge in a state bankruptcy proceeding interfere with the pension obligations of localities?

A growing number of states are finally starting to get serious about pension reform. New Jersey Gov. Chris Christie, who confronts one of the nation’s worst pension underfunding problems, is using the prospect of insolvency to push for significant pension reductions. Bankruptcy could complicate this task. If Mr. Christie somehow persuaded a Democrat-dominated state legislature to join him in asking a federal judge to reduce pensions, New Jersey’s unions might be that much quicker to seek a federal bailout.

The focus of state bankruptcy advocates on employee compensation costs is somewhat misplaced. More than half of all state expenditures go to Medicaid, K-12 public school aid and other transfer payments. These are the areas—not current pension bills or debt service—that have been the prime source of unsustainable and unaffordable spending growth in state budgets.

The biggest state budget gaps will never be closed until politicians use the tools they already have to challenge the overweening power of public employee unions. Meanwhile, Washington can help by lifting some of the burdens it imposes on the states. Converting Medicaid into a block grant, for example, would remove one big excuse governors now have for failing to do more to control their health-care costs. By giving states more flexibility to deal with this program and other federal mandates, Congress will have greater justification for telling governors to fix their own problems.

Original Source:



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