A Third Option Beyond State Bailouts and Bankruptcy

John Baker and Robert Miller identify an alternative

|The Volokh Conspiracy |

Some states experiencing enlarged deficits due to Covid-19 are hoping for a bailout from Congress. Senate Majority Leader Mitch McConnell briefly suggests that state consider filling for bankruptcy as an alternative. Neither seems like a particularly attractive option, for a variety of reasons. But is there any alternative?

Professors John S. Baker Jr. and Robert T. Miller recently suggested a third option in the Wall Street Journal, and it's not default. Perhaps counter-intuitively, they suggest the best approach for many states may be "more borrowing"–albeit with contractual provisions that will make investors more willing to lend. They write:

States can put investors at ease by waiving their claim to sovereign immunity in the contract under which the bonds are issued. States routinely give such waivers, and courts enforce them.

States can do more. They can agree that the contract under which the bonds are issued will be subject to the law of another jurisdiction and that they themselves may be sued in courts of that jurisdiction. This helps attract investors, because just as creditors generally don't trust a court in a country with poor credit to enforce the terms of a bond contract against that country, many wouldn't expect, say, a California court to enforce a California bond contract. . . .

States could reduce the interest rates they would otherwise pay by providing bondholders with credit enhancements. The simplest one would involve offering some state property as collateral, which would require an additional waiver of sovereign immunity. Another would be to set up a "sinking fund," which would require the state to deposit a certain percentage of its tax revenue into a trust located in another jurisdiction for the benefit of bondholders.

Borrowing in the capital markets allows states to solve their own problems. It preserves states' sovereignty and avoids a federal bailout, which would perversely reward spendthrift states. Suddenly, states would have large real obligations enforceable against them, which would teach financial discipline.


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  1. Bailing out states is a bad idea.

    But bailing out airlines, who afterwards form plans to engage in mass layoffs, is an excellent idea?

    1. Both are bad ideas.

    2. Why bail out states? Federal taxpayers are also state taxpayers. The money comes from the same place.

      1. Because the federal government can recklessly borrow more openly, while the states have to pretend their bookkeeping is honest.

        1. The Federal government can “print” money. The state governments cannot.

          (Print in this case is shorthand for a number of fiscal moves in combination with the federal reserve that increase the money supply is such a way that the federal government gains a benefit)

        2. Because the federal government can recklessly borrow more openly

          It isn’t “reckless” to borrow money to deal with the temporary economic catastrophe that is this virus, than it was “reckless” to sell war bonds to finance WW2 (all of which we paid back when the economy was back at full peacetime operation).

          1. You think the money will be paid back? Seriously?

            1. It always has been.

              Which is to say the debt has been successfully rolled over. Given the level of interest rates on Treasuries it doesn’t seem debt-holders are panicking.

              1. Yep, in 2014 Britain paid off it’s last debts from WWI. If only our time on this earth was as long as a government’s time horizon.

                1. You mean the UK was debt-free in 2014?

                  I don’t think so.

                  What they paid off was some perpetual bonds issued a century or more ago. Notice that, since these were perpetual bonds, they were never in default, and the holders were happy to continue drawing interest.

                  When the government rolls over debt, which it does all the time, it is paying off the old debts with new borrowing. There is nothing inherently dishonest or shifty about this. If you start approaching a dangerous level of debt you will find interest rates rising on the new borrowing.

                  1. *sigh* don’t take a joke so literally. The point is, that our government’s debt is so high, that it is impossible to even pretend we can pay it off, and the bond market won’t let you do it forever.

                    1. Don’t pull Trump and claim something silly you said was a “joke.”

                      Nobody claims we will ever actually reduce the debt to zero, or that we are likely to reduce it much in nominal terms.

                      Hopefully, when the economy gets going we can bring it down somewhat as a percentage of GDP, which is what matters. That is, if we can steer clear of frenzied tax-cutting by Republicans.

              2. ehh…

                Rolling over debt isn’t exactly the same as paying off debt, any more than rolling over credit card debt to a new credit card is paying off the credit card debt.

                The debt is still on the books, it just has a new name on it.

                1. It’s not reducing debt in nominal terms, but it does show that the market is willing to lend to you. The market seems happy to lend to the Treasury, at absurdly low rates.

                  If the return, in terms of GDP, on the borrowing is positive then it makes sense to borrow.

          2. Not exactly the same. War bonds are typically sold as patriotic gimmicks, so you can get people to buy below the price of an actual bond or debt market. They’re typically sold to citizens of the country raising the money, so it’s basically just borrowing from the very people you’re going to tax to pay it back.

          3. But it’s reckless to borrow to bail states out of their pension obligations, which they are currently trying to fold into the bailout. Actual Covid-19 related expenses? Yeah, sure, borrow for those, and it would be a hell of a lot easier to borrow for those if we hadn’t already been routinely borrowing for day to day expenses.

            But bail the states out of debts they had prior to this? Screw that. They’ll just cheer and then incur more.

      2. I will consider answering you question when you answer mine.

        Why bailout airlines, but not states?

        1. Because the airlines didn’t create this mess by deliberately crashing the economy.

          1. Either did the states.

          2. Come on, Matthew.

            The sates didn’t “deliberately crash the economy.” The assumption you are making is that all would have been just fine – the virus wouldn’t have affected things at all – without the various lockdowns, etc.

            1. Actually, my assumption is that the pandemic would have some effect in the absence of lockdowns, but it wouldn’t be even half as severe as what the lockdowns actually did to the economy.

  2. A truly interesting idea — except that these states feel entitled to a Federal bailout and hence aren’t going to agree to this.

    And the larger question is what would happen were the states to borrow via this means, and then declare bankruptcy? There is the precedent of how secured creditors were treated in the GM bankruptcy and investors have to be thinking of that possibility.

    1. Yes, the problem with reassuring potential creditors, is that the federal government has already demonstrated that it’s willing to screw over creditors despite their being legally entitled to the money.

      How about a 4th alternative: Sell off assets.

      1. Reining in spendthrift ways comes to mind as well.

        1. States need to spend more money, not less, because of this.

          You don’t get all your anti-government policy preferences enacted just because there is a pandemic.

          1. If you look at the history of legislation, right or wrong, the big stuff ALWAYS get passed after a crisis.

            Airline crash -> safety regulations
            financial crash -> bank regulation
            terror attack -> gov’t spying expanded
            mass shooting -> gun control/gun rights laws (depending on state)


            A crisis lets you do things you wouldn’t be able to do otherwise. I’m not saying using the pandemic to do XYZ is good thing, but it’s pretty much inevitable.

          2. Forgive my snarky reply down below about the Green New Deal. To be more productive, I’ll respond on this topic here.

            The reason that big laws usually come out of a crisis, is exactly *because* of democratic preferences. Most people don’t pay much attention to politics, let along specific issues, until they get galvanized about it. When this happens, like a surfer catching a wave, a savvy politician pulls out a pre-existing solution (because you don’t have time to debate and compromise to come up with something else) and they try to ride that wave of public interest to get that bill into law.

            1. God I hate ‘big laws’. They almost never work out well. Better to be incremental about things.

          3. Such as giving illegal immigrants the same sort of bailouts given citizens by the federal government. The governors of both CA (of course) and WA have proposed that, along with demanding a federal bailout. They ignore, of course, that government money is highly fungible.

          4. States can’t spend money that doesn’t exist.

            Necessary does not necessarily mean possible.

      2. How about a 4th alternative: Sell off assets.

        That’s idiotic and is just your ideology talking.

        There’s no permanent crisis here. The state will need its assets when we come out of this. So it’s obvious you want to borrow.

        1. Really? Chicago privatized the Skyway Bridge, part of the interstate highway system. Worked out fantastically for them and everyone who drives across it because now it’s well managed.

          States could privatize some public universities, maybe, but that that’s just spitballing.

          Anyway, its the pensions that are the problem. This whole thing debate is meaningless unless we talk about public employee pension obligations. That’s why states like IL are broke.

      3. the federal government has already demonstrated that it’s willing to screw over creditors

        Well, the Republican debt ceiling shenanigans may have suggested that, but do you mind telling us the last time the Treasury actually defaulted on a debt obligation?

        1. In the GM bailout, the federal government screwed over GM’s creditors, forcing them to take a back seat to unsecured debtors. Were you unaware of this bit of history?

          1. We’re talking about government borrowing, Brett.

            When did the government “screw over” its creditors?

            1. I didn’t say it screwed over “its” creditors, though, did I? I don’t see where I’m obligated to defend something I didn’t say.

              If it’s the states’ creditors, and the federal government does the screwing over, it’s perfectly analogous to what happened in the GM bailout, because the federal government won’t be screwing over “its” creditors, but instead somebody else’s, yet again.

      4. Selling off assets is often not much different than borrowing.

        Say the state owns an office building. It sells it and collects a wad of cash, but now has to pay rent on the space. Looks a lot like a loan.

        1. Depends on the asset you’re selling, obviously. States have a lot of assets they’re not using, or compelled to use. State lands, for example.

          But I’ll grant you that some of the states have gotten so far into debt by taking on crazy pension obligations, that they’re probably just underwater in terms of debt/assets.

          I see no (good) reason to bail out debts incurred prior to the pandemic. Those pension debts were incurred deliberately, and not as a result of some natural disaster.

    2. I’ll go further — it’s being openly suggested that certain Governors are intentionally exacerbating these deficits so as to be able to have an all-inclusive bailout and that the real goal is to bail out the underfunded state pension plans.

      1. Nice passive voice.

        1. IL Governor JB Pritzker said he wants “unencumbered” dollars to bail out the state’s broke pension system. While I don’t know if he is delaying the opening up of the state’s economy only to try to get the feds to perpetuate the grift AND to save lives, but well, why let a crisis go to waste? You can do both.

          1. “While I don’t know..”

            It would be irresponsible not to speculate. Is that your point?

            1. I would say Ed and I are appropriately cynical, as everyone should be, about politicians. I thought such a thing that Ed felt unencumbered enough to express.

              Let me give you a comparison, Trump is using the pandemic to turn the nation against China and advance his economic nationalism. If he goes about punishing China (you pick the way) he might think would be worth a slower economic recovery in order to advance that agenda. Same kinda thing.

              1. Well, except that using the pandemic to turn the nation against China is sort of like using Pearl Harbor to turn the nation against Japan. The facts of the matter are such that the nation SHOULD turn against China.

                And China’s own economic threats of late are reason enough to disentangle our economy from a strategic enemy.

        2. The owner of the Sunday River Brewpub, who reopened in defiance of Maine Governor Janet Mills’ fiat, claimed (in an interview) that the Mills Admin had openly admitted this to him.

          1. Seems legit.

    3. And the larger question is what would happen were the states to borrow via this means, and then declare bankruptcy?

      Nothing, because there is no provision of law allowing states to declare bankruptcy.

      1. Didn’t Puerto Rico do it?

        1. 1. No.

          2. Puerto Rico is not a state.

          1. Are you sure? My hairdresser 40 years ago told me that she ran into a Puerto Rican woman who said it was a state and had declared bankruptcy. I remember it vividly.

      2. Nothing, because there is no provision of law allowing states to declare bankruptcy.

        This x 1000

      3. Wasn’t Cali a decade or so ago looking to back into territory status to reneg on its obligations? That failed, and under the Terminator and Moonbeam, they got their books into the black financially (until 2020).

        1. Into the black by government accounting practices, which can result in doing hard time if you’re in the private sector.

  3. It doesn’t take a Biblical quality prophet to see where this one ends up.

    Five years hence, any state which starts down this path will be unable to pay the interest. Now the hypothetical of having the states pledged assets be foreclosed will be very real. NOW those waivers get really tested, and may well be found wanting, it’s uncharted territory.

    Not a pretty picture.

    1. Five years from now, several states won’t be able to pay their pensions…

  4. Professor Adler, I don’t want to say this is naive thinking….but.

    States can (and have) abrogated contracts, and contract terms they find objectionable or problematic. Happens more than you would think. Heck, here in the People’s Republic of NJ, we have raised this ‘change it after the fact’ to an art form. Only IL does it more corruptly, and that is saying a lot.

    No Professor, if a state wants to borrow more from the capital markets, they’ll have to raise interest rates and guarantee the bond payments by backing them with asset sales/revenue.

    Unless and until that happens, there will be no blue state ‘bailout’.

    1. They can. The argument is, if its in another jurisdiction, they can’t just abrograte the contract.

      1. Well….A state could choose to default on their debt obligations. That has happened before. The capital markets tend to brutally punish deadbeats defaulters, which is maybe something that should happen here. Fiscal irresponsibility put these states where they are now.

  5. “which would require the state to deposit a certain percentage of its tax revenue into a trust located in another jurisdiction for the benefit of bondholders.”

    I have trouble seeing this as a realistic option for a state that already can’t make ends meet on it’s existing tax revenue. Especially not when their revenue drops drastically because they deliberately tanked their economy.

  6. How about reducing non-essential services and reducing the workforce?

    1. See above. A pandemic isn’t your opportunity to override democratic preferences and get policy preferences the rest of the public thinks are stupid enacted.

      1. That’s right. A pandemic is instead time for a massive Green New Deal, an opportunity to override democratic preferences and get policy preferences the rest of the public thinks are stupid enacted.

        How about cutting nonessential services but spending more on pandemic response items? Or is that crazy-town?

      2. Then the democratic preference in these states should be to raise taxes to meet the need, not run to Uncle Sugar.

        1. How do they raise taxes when after they deliberately crashed their economy? They are in a bind because their tax base has been shrunk drastically as a direct consequence not to the pandemic, but to their response to the pandemic.

      3. “A pandemic isn’t your opportunity to override democratic preferences and get policy preferences the rest of the public thinks are stupid enacted.”

        I agree. The residents of a state should be able to vote for any level of state spending and taxation they desire. What they should not be able to do is expect to levy the citizens of other states for the difference if they vote for more spending than their taxation will support.

        And for some of these states, their financial problems long predate this epidemic.

        I should add that fiscal responsibility applies to the federal government as well. I strongly support some of the recent pandemic related spending, e.g. various extensions to unemployment. But the spending bills should have also included a tax surcharge or some other way to fund the spending.

    2. I don’t think laying off a lot of people in the midst of a recession is sound policy, to put it mildly.

      You’ll really see your state economy crater.

      1. “You’ll really see your state economy crater.”

        The “stay at home” order already did that.

      2. No, we should keep a lot of people on the payroll doing unproductive things, at the expense of the people actually keeping the economy going. Right? Wouldn’t want that money being diverted to the productive economy.

        Look, government is parasitic on the productive economy, at best it’s necessary overhead.

        1. Ah. Unproductive. Again, your ideology is talking.

          government is parasitic on the productive economy,

          Oh stop sounding like a teenager who just read Atlas Shrugged and was converted to the faith.

          It’s a bad look for a grown man.

          1. Well, then you stop sounding like a teenager who read it and idolized Wesley Mouch.

            It’s an even worse look.

  7. “offering some state property as collateral”

    Welcome to the Port of San Francisco, a subsidiary of Uncle Bob’s EZ Credit Lending Corp.

  8. Just wondering if we’ll have this same conversation after hurricane, tornado, and drought seasons? Just kidding. I know we won’t. The same jokers who become so fiscally prudent when the northeast or some other “Blue” area needs aid are always quick with their hands out, extra pockets sewn into their suits, and their Hypocrisy Blasters set to “kill“ when their states need help.

    1. Right, no aid to the the northeast after 9/11 or Hurricane Sandy.

      Nope, its just yoekels that suffer natural disasters.

      NYC seeded half the country with the virus. Maybe they should aid the rest of the country this time.

    2. We should. States shouldn’t be looking for aid after events that common. If something happens as often as once every 10 years, it’s rainy day fund material.

  9. For any sort of collateral of sinking fund to provide any sort of real assurance to lenders, it would probably have to be built into the state constitution. Too many of the state deficit are there today because of provisions in the state constitutions which guarantee the retirees their full pensions, and so cannot be abrogated by mere state law.
    States which are fiscally sound today are sound in large part because they have strong constitutional provisions, and officials responsibility for enforcing those provisions. The accountability has to start somewhere, and become a part of a culture of governmental accountability.

  10. One possible, albeit small, contribution to the problem might be to issue small denomination Covid Bonds, by analogy to War Bonds. Take advantage of the we’re-all-in-this-together-fight-against-Covid patriotism by letting ordinary folks contribute by buying long-term savings bonds at, say, half the rate the market would demand (putting the appeal to patriotism aside). A lot of people might see this as a way to chip in toward doing their part.

    1. I think the case for War Bonds is obvious and have been making it for a month.

      Jeff Bezos is about to go over a trillion dollars in net worth. There’s tons of patriotic billionaires out there who would surely buy some bonds if it was made into an issue of patriotism as it was during WW2. The entertainment industry would happily promote them too.

      1. “Jeff Bezos is about to go over a trillion dollars in net worth.”

        He is about 850 billion short so “about” is doing a lot of heavy lifting.

  11. How about blue states stop paying cops and teachers $200k a year with pensions at age 45?

    1. But COVID-19!!!

  12. “Suddenly, states would have large real obligations enforceable against them, which would teach financial discipline.”

    So they don’t have any idea how state public finance works.

  13. The problem with state budgets in many places is unfunded pension liabilities. The promises made were never realistic. The groups that benefit from the public pensions are largely supporters of the Democratic Party. There is no end of alternative solutions… however they all require political will, which is lacking in the first place.

    I do not see Republicans in Congress essentially helping public employee unions.

    1. Make no mistake about it though, the SS and Medicare bubble is just as bad.

      1. It is, but the Federal Govt can print money. Back in the late 1700s different states actually had different inflation rates due to budgetary mismanagement. Some states had bank notes that was virtually worthless – a little known or perhaps forgotten fact. Inflation is a more subtle form of default or depreciation, or as Benjamin Franklin observed, a different kind of tax. If states were allowed to circulate their own banknotes, how fast would NJ or IL banknotes depreciate?

      2. Sure, with the difference that members of both parties go on SS and Medicare, while the public employee unions are almost uniformly of one party.

        1. Yes, this is true. It’s also why I don’t like one legislature binding legislatures in the future with promises.

  14. It still does not make sense to me. Even if a state waivers sovereign immunity in a contract under the laws of another state and if the courts in that other state rule in favor of the bond holders, what will force the borrowing state to pay? The offending state merely says ” I won’t pay and you can’t make me.” It seems to me the lenders lose again.

  15. One issue unmentioned here is state constitutional restrictions on borrowing.

    Many states, as I understand it, are only allowed to borrow for infrastructure projects. (States who allow this, by the way, don’t really balance their budgets in the way that some want the federal government to do.) How will they get around that?

  16. It’s very easy to make borrowing easier when don’t have to worry about paying back.

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