All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident. -Arthur Schopenhauer.

 

By: Mark Glennon*

For Illinois or another state to formally go bankrupt, the United States Congress would have to pass legislation.

Would they? I think so. In fact, bipartisan support is reasonably foreseeable and, ultimately, that legislation is unavoidable, which will trump any debate.

The legal question whether Congress could extend bankruptcy to states was addressed in my earlier article so I won’t rehash that here, except to say I think David Skeel is right. He’s a law professor at the University of Pennsylvania who also serves on Puerto Rico’s oversight board in its bankruptcy-like proceeding authorized by Congress under PROMESA. He wrote firmly that the “constitutionality of bankruptcy-for-states is beyond serious dispute.”

In Congress, reasons will vary for initial political hostility to bankruptcy-for-states.

Some conservatives view state bankruptcy as a form of bailout and will be particularly averse to helping Illinois, which they understandably think deserves its fate. Others may view it as federal intrusion on state sovereignty, which is also what the constitutional objection is about.

But bankruptcy is really the anti-bailout alternative, and turning Illinois around is important to the national economy. We are now a drag on the national economy despite assets that should make us a powerhouse of jobs and production. Illinois GDP has lagged the nation’s significantly for ten years. A federal bailout is happening automatically, at least in a small sense, in the form of food stamps, housing assistance, Medicaid and similar programs. A fresh start for Illinois would reduce its federal tab for those costs and grow Illinois’ tax base for federal revenue.

Respecting state sovereignty, remember Congress would only be offering states the option of using bankruptcy, just as it has already done for municipalities; nothing would be forced on states.

The left will fear the power of bankruptcy to reduce pension payments, but it’s essential to remember the Bankruptcy Code would not be expanded “as is” to states. Changes would be made on which all sides should find common ground.

One such change should allow for progressivity or means testing in some form for any pension cuts. That is, the fat cats should be reduced proportionately more than smaller pensioners who truly need their annuity. The Bankruptcy Code currently treats all unsecured creditors uniformly, including unfunded pension liabilities.

Another possible change that progressives might like is statutory recognition of the concept of “service insolvency.” That’s the idea that failing to provide basic services should count in the initial determination whether a government qualifies for bankruptcy.

The left wouldn’t like how collective bargaining agreements can be terminated along with all other contracts bankrupt parties don’t like. But remember that state policy on collective bargaining and other labor matters is not dictated by bankruptcy. A bankrupt government can opt to keep or renegotiate whatever labor contracts it has.

The municipal bond industry will object fiercely since unsecured debt could be reduced. They’ve already focused on the issue, having earlier sponsored a national ad campaign opposing PROMESA, fearing it would set a precedent for states.

But progressives and free marketeers alike should shed no tears for existing bondholders. They took the risk that bankruptcy law could be changed to impact them.

All will fear higher future borrowing costs. That’s legitimate but finite. Once a bankruptcy proceeding is underway, new lenders get special protection to assure normal operation and, assuming a successful bankruptcy, a clean balance sheet and better credit ratings result. The key will be to line up support for federal legislation as best as possible behind the scenes and move very quickly once it’s proposed.

Won’t all states suffer higher borrowing costs because of the additional risk? In the very long run they will be forced to borrow less to assure the markets of no risk of getting near bankruptcy. Is that such a bad result?

Stop here and assume everything I’ve said so far is wrong. Assume still further reasons why bankruptcy is a bad option — it will be fraught with unknowns and is inherently unfair to those to whom promises were made, which is true.

None of that will matter because it will become evident there’s no alternative. This isn’t about whether bankruptcy is a good option. It’s about whether it’s the only option.

Look no further than pensions to see why. The Illinois Supreme Court has made crystal clear that, under the Illinois Constitution, pension promises can’t be cut for services already rendered, which are Illinois’ $130 billion liability (using silly, official numbers). That leaves only two means to do that — bankruptcy or a state constitutional amendment deleting the pension protection clause. But the amendment might not work anyway because of issues under the United States Constitution, and it would take years to put through even if the General Assembly acted to put it to a public vote, which it has shown no interest in doing.

And the unfunded pension obligations are insurmountable in themselves. That’s why no serious proposal by anybody in the current budget debate has pretended to address those liabilities. They all propose continued annual contributions to the pensions that underfund them, growing the pension debt each year.

Meanwhile, despite that underfunding, Illinois’ death spiral worsens. The tax base shrinks, state revenue drops, people and employers flee and services are cut.

Bankruptcy for Puerto Rico was initially scorned, but PROMESA ended up with bipartisan support, passing 297-127 in the House and 68-30 in the Senate.

One part of their experience is worth particular note. Lawsuits by creditors were stayed — basically, put on hold — under PROMESA. That stay expired on May 1 and a torrent of lawsuits began on May 2, forcing Puerto Rico to file its bankruptcy-like proceeding the very next day. It’s difficult to see how Illinois can avoid a similar wave of lawsuits at some point, and only an organized insolvency proceeding — bankruptcy — can fairly manage and prioritize an overwhelming number of claims.

The sooner we pass through the stages of ridicule and violent opposition, as Schopenhauer called them in that quote above, the less painful this will be for everybody.

*Mark Glennon is founder of Wirepoints. Opinions expressed are his own.

 

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32 Comments on "Would Congress Authorize Bankruptcy for Illinois and Other States? Yes, Inevitably. – Wirepoints Original"

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nixit

Mark – I miss the ability to comment on other articles. But regarding “The Wemstroms: Illinois needs a modern tax system”, you’ll be not surprised to know Chuck Wemstrom is a former delegate for the CTU. And apparently it takes 2 people to write this column…weekly, as far as I can tell. Each one more enlightening and maddeningly naive than the last.

nixit

Actually, they are both former CPS teachers (nee Pat Breitzer Westrom). I imagine their combined $100K pension travels well in the Mount Carroll lecture circuit. Not bad for 27 years of service each.

RHondo

If the same policies are followed after bnkrptcy as before then nothing gained but a great deal lost. I have absolutely no confidence in the political system managing this type of situation. When you talk about fulfilling ‘basic’ service one has to be very careful as to the definition of ‘basic’. Most states and municipalities have expanded their budget way past what is truly ‘basic’. All of these states and municipalities need to have capped budgets and debt as a percent of revenue…..and it needs to be ‘hard’ to get around.

Tough Loive

I LOVE to see Public Sector pensions reduced (in a Bankruptcy proceeding) to a level that could be purchased with the sum of employee contributions plus Taxpayer contributions no greater that what THEY typically get in retirement security from their employers.

My guess is that there would be a 1/2 to 2/3 reduction for non-safety workers and a 2/3 to 3/4 reductions for Safety workers.

Rick

I didn’t know Ponzi schemes can legally declare bankruptcy? In IL bankruptcy will not eliminate the Ponzi scheme structural nature of how resources are managed, it will just reset the clock. After the BK the state will continue to budget based only on next years cash flow and not consider the present value of long term debt. They will continue the unfeasible promises, the constitution wont change its pension clause, and defined benefit systems will continue, etc. The can will still resume being kicked after the dust settles, just starting from zero instead of negative 130 billion.

Tough Loive

It would be a ONE-TIME opportunity to set the State on the right path. …… by ENDING ALL DB pensions and replacing them (for their Future service of all workers) with Social Security plus a DC (401K-style) Plan with a %-of-pay “match” comparable to what Private Sector workers typically get from their employers …3% of pay.

Rick

Getting all that would take more than a bankruptcy though. There are just too many crooked things that need fixing like final year salary bumps, government paying 7% of the 9% the employee was supposed to pay, cops routinely taking a year off for disability as though it were an expected benefit, vacation time banking, the pension clause, and many more perks at the taxpayer expense. Not to mention people retiring at 50. COLA increases, health insurance till death, etc. Bankruptcy does nothing to stop the largess of government sector compensation.

Tough Loive

You seem to misunderstand. Hard-Freezing ALL DB Plans and replacing them with SS and a 401KPlan (with a %-of-pay”Match” comparable to the 3% typically received by Private Sector workers) gets RID of virtually ALL of those issue………… because nothing is “deferred”, and Elected Officials can only grant what they can afford to pay for IN THE YEAR EARNED.

Rick
With 401k the employer alone determines the matching contribution and has wide freedom to match heavily or not at all, or even overmatch legally if they want to. Vesting typically is 20% a year. And the most common match formula is 50% of the first 6% of contribution. With folks like Madigan being “the employer” I have high confidence in their ability to scam a liberal 401k law that basically lets an employer match however they want. This is fine if you are a private sector employer that has to make a profit, that’s a natural throttle on matching for the stockholders (taxpayers). or if you are… Read more »
Tough Loive

It’s simple. The law itself can specify an X% match that can’t be changed absent a new law.

erik

Bankruptcy is assured given our unserviceable debt. Illinois will be the first state to walk down that path. My greatest fear is the protracted litigation that will inevitably accompany the nation’s first state bankruptcy. If it delays the process less than a year, we’ll survive it. If it delays the process more than five years there will be very few businesses left to start anew.

Doug

So first Congress would have to agree on a bk process. Illinois would have to agree, but who? The governor, Illinois legistlature? This process will not be smooth, if I had to guess.

The alternative to bk process would be millions of different lawsuits against Illinois and some of its munis. People would stop service and goods to Illinois because most will not be getting paid. It could be that fear of complete shutdown could allow for a quick process but we are talking about Illinois here.

Crabcakes

would seem to get to the “accepted as being self-evident” stage for the feds & states to change bankruptcy laws would first have to agree to some accounting standard to measure debit levels? here in Illinois, even applying GASB standards to pension actuarial reports is largely thwarted and ignored, including in the press. Is the pension debit $130 billion or 3 times that-who knows, deception is the name of the game if your a club member? what standards did PROMSA use to assess Puerto Rico debit?

Tough Loive

It’s not that difficult to make a SOLID estimate of the pension debt.

S&P, Moody’s, and Fitch have all chucked the ridiculous (iu.e. FAR too liberal) methodology used by Gov’t entities in valuing pension Plan liabilities. While each of their methods are somewhat different, they ALL produce FAR greater liabilities then the Gov’t-approved methodology (even AFTER the GASB changes).

I agree that allowing federal bankruptcy is not a bailout.

I disagree that Congress will make this happen. Or that the Supreme Court would let them, even if they did manage to pass something.

Tough Loive

Public Sector workers, knowing they can move away from a sinking State and take their pension with them, care about NOTHING but getting everything they were “promised”, no matter how excessive, unfair to the State’s taxpayers, or clearly unaffordable.

For every $100 in concessions (i.e. reductions in pensions/benefits) undeniably needed for the workers/retirees, they will RARELY offer even $5.

Clearly such reductions must be forced upon them, and if it takes a Bankruptcy proceeding to do so, so be it ….. and the sooner the better.

BillD
Bankruptcy is like chemotherapy, it’s (hopefully) better than the alternative. It’s nothing to look forward to, but it is cathartic. People in IL should look at the experience of United Airlines. Poor management and poor union leadership led to its bankruptcy. Everyone other than lawyers, bankers, and consultants got screwed. BUT the company got to keep going. The place got more efficient. After going through the stages of grief even many union employees acknowledged the necessity and value of the process. The immediate impact on customers was minimal – the planes kept on flying. In the longer run United (and others) implemented changes that many customers would… Read more »
For Illinois or another state to formally go bankrupt, the United States Congress would have to pass legislation…Would they? I think so. In fact, bipartisan support is reasonably foreseeable and, ultimately, that legislation is unavoidable, which will trump any debate… A bankrupt government can opt to keep or renegotiate whatever labor contracts it has….This isn’t about whether bankruptcy is a good option. It’s about whether it’s the only option. Only option? States have their OWN POWER, as sovereign entities, to repudiate any debt with impunity under the 11th Amendment. Why ask the Congress for power they already have? What cannot be paid, such as grossly excessive salaries… Read more »
Doug

The sooner the better! The corrupt democrats = death spiral.

John Doe

S&P claimed that Illinois is actually $250 billion behind on their pension payment, Not the 130 previously thought. Property taxes are skyrocketing and Democrats want to raise income taxes by 5 billion with no changes to Illinois government. No amout of tax increase is going to fix a $250 billion hole. If the legislture doesnt start making some unpopular cuts, bankruptcy is the only option. I am union member and embarrassed of what special interests have done to this state at the coat of all taxpayers.

Mark

Let Illinois sink. The brain-dead voters keep reelecting them and therefore deserve to lose…..at NOT at other’s expense.

Fred

Could the federal government authorize a mediator to handle the mess in Illinois ? If by law the budget is to be balanced every year then what is the penalty for not doing so. NONE as far as I know. No one will go to prison or get a fine. In Alabama they do. The taxpayer needs to UNIONIZE!!!!

j.a. herzrent

in Detroit, the Bankruptcy Judge appointed another federal judge as a mediator and, through negotiations, the mediator was able to engineer a settlement that included reduction of pensions and health care.

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