Republicans Propose Allowing States to File Bankruptcy

On behalf of Macdonald Fernandez LLP on Tuesday, January 25, 2011.

Newt Gingrich and Texas Senator John Cornyn are advocating allowing states, such as California and New York, to file bankruptcy. At present, only cities and other municipal entities can file bankruptcy under chapter 9 of the Bankruptcy Code. Allowing a state to utilize some form of bankruptcy protection would likely shift losses from taxpayers to public sector union employees and pension plans. In fact, Newt Gingrich's proposal would prohibit any tax increases as part of a reorganization. In addition to public employees, bondholders are likely to take a loss in a state bankruptcy, and adding a chapter of the Bankruptcy Code for states will certainly upset the government bond market. Nevertheless, University of Pennsylvanie law professor David. A. Skeel argues that state bankruptcy will make it easier for states to negotiate with unions and that the alternative of a federal bailout is unattractive. Skeel also notes that, although the bond market will be unhappy, California bondholders are already accounting for a potential default. - Reno Fernandez