The Volokh Conspiracy

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A Third Option Beyond State Bailouts and Bankruptcy

John Baker and Robert Miller identify an alternative


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.