Should States Be Allowed To Declare Bankruptcy?

By Christopher Maag

To most consumers, declaring bankruptcy is a scary prospect. Sure, you get out of paying your debts. But a bankruptcy stays on your credit report for seven years, which means good luck finding anyone but a payday lender to give you a loan. Many people would likely also feel a sense of guilt about failing to meet their financial responsibilities.

But imagine if your entire state declared bankruptcy. It boggles the mind. Thousands of local businesses that sell products and services to the government might never be paid. Suddenly the state would find it difficult or impossible to sell bonds – government’s version of taking out a loan. Big construction projects would be put on hold, others scrapped. Public schools and hospitals could close. Roads might crumble.

That, anyway, is the fear.

“Bankruptcy would make a state scramble,” says Marilyn Cohen, owner of Envision Capital, a California company that invests in government bonds. “It would be cataclysmic.”

[Resource: Bankruptcy Survival Guide]

A small but powerful cadre of top Republicans thinks that fear is overblown. With so many states facing record deficits, bankruptcy would give them an opportunity to dynamite their current budgets and start from scratch.

Perhaps most important to Republican leaders, bankruptcy would allow states to renegotiate pay and pension contracts with public employees’ unions, which they say have become too bloated.

On Jan. 21, former House Speaker Newt Gingrich told Reuters that a bill giving states the option to declare bankruptcy would be introduced in Congress within the month.

“I think it’s an important tool for states,” says Grover Norquist, an influential Republican strategist and leader of Americans for Tax Reform, a conservative lobbying group. “It would make it easier for states to reorganize themselves if they get into too much trouble.”

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