State Bankruptcy Proposal Criticized by Both Parties at Hearing

Republicans and Democrats in the U.S. House criticized a proposal to allow states to file for bankruptcy to escape their debts, calling it an unnecessary intrusion into local affairs that could roil the bond market.

Republican Representative Lamar Smith of Texas, chairman of the House Judiciary Committee, said in Washington today that allowing bankruptcy filings could encourage profligate borrowing and penalize even sound states with higher interest costs. Former House Speaker Newt Gingrich, a potential presidential candidate in 2012, has advanced the idea.

“States currently have ways to put their fiscal houses in order,” Smith said during a hearing of a subcommittee of the Judiciary Committee. “Congress should not hinder restructuring efforts at the state level by passing laws that make it more expensive for states to access capital in the bond market during a recession.”

Suggestions that states should be allowed to file for bankruptcy, as cities can, have drawn criticism from federal lawmakers in both parties, state officials and public-employee unions, whose contracts might be jeopardized in a filing. Municipal-bond analysts have also expressed concern that a change may rattle the $2.86 trillion debt market by casting doubt upon the safety of the securities.

Photographer: Mark Wilson/Getty Images

Republicans and Democrats in the U.S. House criticized a proposal to allow states to file for bankruptcy to escape their debts, calling it an unnecessary intrusion into local affairs that could roil the bond market. Close

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Photographer: Mark Wilson/Getty Images

Republicans and Democrats in the U.S. House criticized a proposal to allow states to file for bankruptcy to escape their debts, calling it an unnecessary intrusion into local affairs that could roil the bond market.

‘Useless’ Idea

Representative John Conyers, a Democrat from Michigan, said it is a “useless” idea. Democrat Hank Johnson, a Georgia Democrat, also said it was an unnecessary step that’s motivated by opposition to public-employee unions, a major source of campaign contributions for Democrats.

“State bankruptcy may be a solution in search of a problem,” Johnson said.

U.S. states are forecasting a collective $125 billion in budget deficits for the next fiscal year, according to a study by the Washington-based Center on Budget & Policy Priorities. Investment losses suffered during the financial crisis left a more-than $1 trillion hole in pension funds, according to the Pew Center on the States in Washington.

While Republicans are drawing a line against a financial rescue, governors have said they aren’t seeking one and are scaling back spending or raising taxes to cover their gaps.

States were left out of a Depression-era law that lets municipalities reorganize their finances under Chapter 9 of the bankruptcy code, a provision that has largely been used by small sewer and utility districts. Since Vallejo, California, a 115,000-person town, filed for bankruptcy in early 2008, no city of that size has followed its lead.

Market Turmoil

The skepticism about allowing states to seek protection from creditors was echoed by experts invited to speak before the subcommittee.

“Legislating state bankruptcy would disrupt the current municipal bond market and undermine investor confidence,” Matt Fabian, a managing director of Concord, Massachusetts-based Municipal Market Advisors, said in remarks prepared for delivery.

The hearing today was the second congressional forum in as many weeks where experts advised representatives against letting states file for bankruptcy. At a separate House hearing on Feb. 9, analysts from the New York-based Manhattan Institute for Policy Research and the Center on Budget & Policy Priorities, groups with differing political viewpoints, said it would do more harm than good.

Representative Howard Coble, a Republican from North Carolina, also said the idea would cause more problems.

“I see all sorts of snakes coming out of that can,” he said.

Signs of Hope

There some signs that states are beginning to emerge from the worst effects of the recession. U.S. state tax collections headed for their biggest jump in more than four years during the last three months of 2010, the fourth-straight increase, according to a study this month from the Nelson A. Rockefeller Institute of Government in Albany, New York.

James Spiotto, a bankruptcy attorney with Chapman and Cutler LLP in Chicago, told the subcommittee today that any move to allow bankruptcy would be fraught with practical and legal challenges, including potential conflicts with the state’s sovereignty.

“While the creation of a vehicle for state bankruptcy may initially appear as an attractive solution to a difficult problem, upon careful consideration, its problems outweigh its benefits,” Spiotto said in remarks prepared for delivery.

To contact the reporter on this story: William Selway in Washington at wselway@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net.

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