State Bankruptcies Could Alter Pension Promises

January 21, 2011 ( - Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts including their pension obligations, the New York Times is reporting.

Unlike cities, states are barred from seeking protection in federal bankruptcy court, but proponents of the effort say some states are so burdened that the only feasible way out may be bankruptcy. Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides, according to the Times.  

The news report notes that bankruptcy could permit a state to alter its contractual promises to retirees, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.   

In addition, discussions about something as far-reaching as bankruptcy could give governors and others more leverage in bargaining with unionized public workers.   

“They are readying a massive assault on us,” Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees, told the Times. “We’re taking this very seriously.”   

Loveless said he is meeting with potential allies on Capitol Hill, making the point that certain states might indeed have financial problems, but public employees and their benefits were not the cause. According to the Times, the Center on Budget and Policy Priorities released a report on Thursday warning against a tendency to confuse the states’ immediate budget gaps with their long-term structural deficits. “States have adequate tools and means to meet their obligations,” the report stated.   

It would be difficult to get a bill through Congress, not only because of the constitutional questions and the complexities of bankruptcy law, but also because of fears that even talk of such a law could make the states’ problems worse. The Times speculates that lawmakers might decide to stop short of a full-blown bankruptcy proposal and establish instead some sort of oversight panel for distressed states, akin to the Municipal Assistance Corporation, which helped New York City during its fiscal crisis of 1975.   

David A. Skeel, a law professor at the University of Pennsylvania, who published an article, “Give States a Way to Go Bankrupt,” in The Weekly Standard, explained in the news report it is possible to envision how bankruptcy for states might work by looking at the existing law for local governments. Called Chapter 9, it gives distressed municipalities a period of debt-collection relief, which they can use to restructure their obligations with the help of a bankruptcy judge. Unfunded pensions become unsecured debts in municipal bankruptcy and may be reduced.