What if Your State Goes Bankrupt?


"To take away the earned benefits of people in their golden years would force some to depend on social programs, which could ultimately cost California even more money," he said. Politicians, he said, "need to look beyond easy scapegoats."

Pensioners, though, wouldn't be the only ones hit hard.

Holders of the state's bonds would suffer, too, since under bankruptcy they would be treated as unsecured creditors. If you were such a holder, said Dick O'Brien, an executive vice president with brokerage Folger Nolan Fleming Douglas, "You'd be screwed. The only question is: to what degree?"

In Vallejo's case, he said, bond holders stand to get somewhere between five to 20 cents on the dollar. The mere fact that people are even discussing letting states go bankrupt he sees as one reason for the outflow of some $30 billion from municipal bond funds in the past 10 weeks. (The entire market, for perspective, is valued at between $2.8 and $2.9 trillion.)

If you're thinking about buying municipal or state bonds, he said, there are several things you can do to reduce your risk: Visit the website of the Financial Industry Regulatory Authority, FINRA, which has checklist of questions you should ask your broker before buying any bond.

Go, too, to the website of the Municipal Securities Rulemaking Board, MSRB, where you can find the safety rating assigned a bond.

O'Brien said the chance of a state declaring bankruptcy is remote. California, he says, isn't Greece.

"If you compare debt to GDP, Greece is at 133 percent; the U.S. is at 88 percent; and California is at 5 percent," he said. "Now, you tell me: Who has the problem?"

Practical considerations, he said, militate against a state's choosing bankruptcy.

"If a state declares bankruptcy, what is their ability going to be in future to get financing?" O'Brien said. "At the very least they're going to pay more. At the worst, they're not going to be able to float any new debt. Who will build the schools? Who will build the roads? No governor wants his state to go bankrupt. No unions want it."

Who does? Bankruptcy lawyers, he thinks, for the fees involved.

What if there were a way for a state to enjoy some of the benefits of bankruptcy, without having to enter it?

James Spiotto, head of the bankruptcy practice at Chapman & Cutler in Chicago, said he thinks he's found one.

Spiotto proposes creation of a Public Pension Funding Authority, a quasi-judicial body that would have the power to compel states and their unions to settle pension disputes. The power it would have he likens to a court-appointed special master's power to resolve a thorny and complex litigation.

It would be, he said, "a forum for the two sides to work out their problems" and to pay the cost of resolution either through an increase in taxes, say, or an increase in worker contributions.

America, he says, in past times of crisis has appointed "blue ribbon" panels to help resolve them. So, too, could the pension problem now be solved, without states' having to have resort to the more extreme remedy of bankruptcy.

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