State Bankruptcy: A viable option or not?
State Bankruptcy would there be a benefit?
The topic of the potential for a state bankruptcy capability rose to the top of news releases from statements made by Senator Mitch McConnell yesterday. It has been some time since I have given this topic serious deliberation, but it does surface periodically. The pandemic is driving financial stress in all states but has been much more harmful to a select group of states. The spreading of the virus has been agnostic in terms of all affiliations or labels. Had the awareness of the severity of the virus been raised earlier, we may have taken some of the risk away. Densely populated locales have been more affected than others. Physical proximity has been a real factor as we have learned by taking preventative measures over the last several weeks. Due to the decline in all activities, cash flow for the states is being impaired. We are not certain of the timeline for the pandemic despite an array of opinions out there whether medical or otherwise. The negative financial implications will persist for a time.
The federal financial support that has been targeted to states and large localities and the aid directed to the healthcare sector is valued and is considered very necessary in this environment. There was disappointment that more aid was not included in the recent bill. The push is on for more direct aid for states and localities in Phase 5.
Which brings us to the bankruptcy consideration for states. If financial deterioration deepens to such a point that extraordinary measures need to be taken, should state bankruptcy be an option?
Bankruptcy filing for states is not a feature of present law. The last time that the municipal bankruptcy code was updated in 1988, there were no provisions for such a filing.
The consideration of a state bankruptcy goes to the heart of our system of government. The United States was founded by an affiliation of independent states. Although our federal government has strengthened in its powers in many respects over the years, there is still the concept of states rights. The states have retained sovereign powers that are not granted to the federal level. Our system of federalism over the years has clouded some of the clarity because of the financial interdependence of the different levels of government.
Many of my industry colleagues in the legal community have argued that a state bankruptcy capability may be theoretically possible. There are considerations with the Constitution and the Commerce Clause before this may even be contemplated. I do not believe that granting the right to a state to file for bankruptcy is just a statutory matter that would require an Act by Congress. There may be a need for a Constitutional amendment of some kind, but this consideration is in the realm of the constitutional legal community.
I have worked in the past with states that were under extreme financial duress. One of the examples was Louisiana in the mid-1980’s. Louisiana was and still is an energy and chemical industry dependent state to a degree. At the time, oil declined to $10 per barrel from a much higher level. In addition, the so-called First Use Tax on oil was declared unconstitutional. At the time, the state’s rating was lowered to Baa/BBB category. Cash flow was becoming critical and there was a need for some time to find a way to replace lost revenue from the loss of the First Use Tax. The Louisiana Recovery District bonds were floated to provide the necessary time. A portion of the sales tax was pledged to the repayment of the bonds. There was some conviction that there would be an effort to redeem the bonds as quickly as possible. Looking back, the financing prevented Armageddon. In a relatively short amount of time, the state developed a set of financial practices and principles that set it on a positive course and the state’s rating was raised once again.
California had various imbalances over the years that required a financing solution. At one point, the imbalance was approximately $23 billion. A consortium of banks backstopped a note issuance that provided the solution. Also, recovery bonds were sold that were backed by sales tax. The state found ways to balance its budget by tax increases and spending adjustments and bond ratings ascended in response.
My point with these two examples is that states are resourceful and innovative when they need to be. This time is different due to the exogenous nature of the virus. It would appear only fair that federal aid would prevent the creation of even more dire and systemic financial and economic problems.
Many states have pension challenges. Present market conditions especially equities will be contributing to even more potential underfunding. Even the best asset managers are being tested in the current climate. Most states have pursued pension reforms over the years. In some cases, the courts have not allowed the sought-after changes that would have helped to address the funding shortfall.
There should be some fine distinctions made between the definition of bail out and federal support. We are in an unprecedented predicament in modern times for which there are no easy solutions. We are also talking about support in the near term versus a capacity to pay in the long run. “Ford to City: Drop Dead” that resulted in federal financial support for the City in the end worked out well. New York City repaid the federal government loan ahead of schedule and with interest. It could work out well again.
If there is a conviction that any federal support offered should not be devoted to pensions, then there should be a form of a negotiated stipulation. This condition would be an improvement over the possibility of a state bankruptcy filing.
Bankruptcy creates a raft of its own problems and unintended consequences. Providing for a state bankruptcy capability would change the fundamental risk parameters of the municipal market. This $3.7 Trillion market serves the spectrum of issuers both large and small across the land. Other nations have admiration for our municipal market. We need to think beyond an expedient solution that would bring its own specific set of challenges.
John Hallacy
John Hallacy LLC
04/23/20
President at John Hallacy Consulting LLC
4 年Thank You. Orange was a real test.
Attorney | Investment Banker | Published Author | Entrepreneur | Chairman, BOD cybersecurity firm | Member of Board of Directors, A.G. Edwards & Sons | Federal/State Reg. Compliance | English-Spanish Native Fluency
4 年I was involved in the work that pulled Orange County CA out of bankruptcy (at the time I worked at AG Edwards & Sons, Inc.). Chapter 9 municipal bankruptcy is made most difficult by the outdated language and concepts that remain from Chapter 9’s initial creation in 1934 (declared unconstitutional), then 1937 (as Chapter X), 1976 and 1988. Our Orange County team of bankers and lawyers tried to get attention from Congress to further modernize Chapter 9 in 1996, but got nowhere. I provide this history to support the concept of allowing States to pursue a more streamlined reorganization of debt and “other obligations” only somewhat similar to a Chapter 11 reorganization. A State bankruptcy should be looked on as very very very unusual, and a State’s ability to pursue any “bankruptcy” or other type of “reorganization” merits modern and streamlined powers separate and apart from the current Bankruptcy Code Chapter 9 of the Bankruptcy
Author of Shades of Public Finance at Shades of Public Finance
4 年Dale was great banker for MAC but went over to the dark side in Orange County and mistakenly allowed bankruptcy over restructuring and selling a secure portfolio maturing when needed for pension payments ( tho temporarily below value on Markto market analysis .) Another veteran of MAC also has apparently forgotten the teaching of Governor Carey and lessons learned about Federal relief and has gone over the dark side is Dick Ravitch who advised in both Detroit and Puerto Rico without insisting on any ?restructuring effort and once again according to the recent Bond Buyer ?article is making it seem that The City needs massive amount of federal largesse or else. ?Or else what ?like Detroit or Puerto Rico is the necessary inference. As a veteran of MAC I just know a cooperative effort by bankers, unions and Governor Cuomo New York City and State can restructure and bond out the structural deficit(gap) over the next three years ?. If Pelosi and Schumer can achieve some federal help fine but to count on that source covering the most of loss of revenues and increased costs of the Pandemic with this Senate and administration is fantasy . We need a plan A restructuring plan and I for one believe this the one natural emergency for which scoop and toss refunding is acceptable public policy as it was in 2975
Author of Shades of Public Finance at Shades of Public Finance
4 年John : my book in two volumes includes several chapters analyzing actual bankruptcies in Orange County , Detroit and Promesa in Puerto Rico and threats of bankruptcy in Bridgeport, New York City and Yonkers each of which fiscal crisis I had had a key legal role . My chapters clearly show that in Orange County the investments were solid and mark to market analysis was a mistake, in Detroit the grand bargain was in fact a grand theft of the multi billion dollar art collection easily securitized to the benefit of Detroit taxpayers and in Puerto Rico an easily imposed island wide real and personal property tax is still an alternative restructuring option but for the embedded Rosello political power. Restructuring and Securitization of revenues by MAC and its progenies at state (Dorms) and city (Transitional Finance Authority , New York City Water Authority are financing options now established and marketable where there is weakness in the general obligation credit.? but to the point there is never a need for a state bankruptcy . Why this pandemic is a natural emergency comparable in depth and scope to the depression and every state and major city can access cash to cover the cost of increased expenses and lost revenues by “scoop and toss” taxempt current and taxable advance refundings of debt service and pension funds . There is no public policy justification ?to cover that structural deficit gap fund gap by shocking the next three budget cycles trying to balance the general fund budget . The cost of recovery from this disaster should amortized over thirty years especially as the rates taxable or tax exempt are stable and very low ?. The federal reserve short term window is nice if the long term take out is a planned scoop and toss refundings : otherwise it is just inducing a working capital deficit financing based on fictional economic recovery in the short term. Finally it is clear the Trump like Ford is not looking to bail out budgets so the Federal resources for anything close to covering the structural gaps of all state and local budgets is whimsical and any “deal” will undoubtedly include loss of state sovereignty over its service to its constituents . Better we model a major infrastructure nationwide program like the interstate highway federal / state partnership to provide employment and economic recover ? Richard Land Sigal May 2 2020
Municipal Trader
4 年I don’t think McConnell was actually offering bankruptcy as a real solution. I think he was saying we are not giving you Federal taxpayer dollars to fund your legacy pension deficits. Nearly impossible to track where the money goes once inside each state’s bureaucratic operating funds. How about opening a window for states to use taxable bonds for deficit financing using a limited Federal backstop similar to the famous Muncipal Assistance Corp? Specific revenue source not a unlimited guarantee.