Governors Oppose State Bankruptcy Protection

Even discussing the issue will make borrowing more expensive, governors and legislators tell Congress.
by | February 4, 2011

State leaders are urging Congress not to move forward with proposals that would create a way for states to file for bankruptcy protection, despite the budgetary struggles they continue to face.

Even the suggestion that bankruptcy could help states restore fiscal stability "serve(s) only to threaten the fabric of state and local finance," they wrote in a letter to Republican and Democratic leaders in the House and Senate Friday.

Thirty-five states and Puerto Rico are projecting budget gaps for FY 2012 that total $83.2 billion, according to a National Conference of State Legislatures report released in November. The situation may worsen as growing obligations to state worker pension plans and expanding Medicaid rolls put financial pressure on states.

States -- unlike cities -- are barred from seeking bankruptcy protection in federal court. But some federal legislators have reportedly been quietly working on a workaround. If a state declared bankruptcy, it would theoretically be able to restructure its obligations to retired workers and bondholders.

But states fear that even the mere discussion of creating a bankruptcy option will made investors more skittish about putting money into state-backed bonds -- traditionally considered a safe investment -- thus raising their cost of borrowing and exacerbating the very financial problems states are struggling to overcome.

Bankruptcy protection is not something states have sought or would likely use, leaders of the National Conference of State Legislatures and the National Governors Association say in their letter. They write:

For the last three years, states have faced growing budget deficits and in each of those years, we have closed those deficits by spending cuts and when necessary increasing taxes.  Governors and legislators have had to make tough and politically unfavorable decisions to be fiscally responsible and balance our budgets.

Throughout this process, our colleagues never contemplated walking away from our obligations to our constituents or to the bond markets by requesting that the federal government allow states to receive bankruptcy protection. While a number of states continue to face budget deficits over the next few years, we will continue to use our sovereign authority to balance our budgets and meet our obligations.

If the federal government wants to help states, it should eliminate unfunded mandates and provide states with more flexible federal funds, state leaders wrote, reiterating traditional talking points.

They also called on Congress to remove a restriction that prevents them from tightening eligibility requirements for Medicaid in order to reduce the number of patients in the program. Medicaid is poised to become states' greatest expense, and state leaders have argued a key way to crub its costs is by restricting eligibility.

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