Don't say no to bankruptcy option

JAN. 31, 2011

Congressional Republicans “should be ashamed of themselves for even suggesting” bankruptcy as an option for California and other debt-plagued states, according to Sacramento Bee Capitol columnist Dan Walters. Unlike municipalities, states aren’t allowed to go bankrupt, but some conservatives have talked openly about changing the law. Walters, reflecting conventional inside-Sacramento wisdom, is aghast at the thought.

Walters quotes state Treasurer Bill Lockyer, who argues that “No state needs to declare bankruptcy. The states have sovereign taxing authority.” Lockyer, who has recently argued that the state merely suffers from a bad national economy and who downplays California’s half-trillion-dollar pension debt, promotes one handy solution to everything: higher taxes. His point is that the state is not really insolvent because it can keep increasing the tax burden on its residents.

How soon would it be after a dramatic tax increase before the state faces the same problems it faces now, given that the state government is not willing to reform itself? What are the chances the public will approve new taxes or that the Legislature can get the necessary two-thirds vote to do so? Even if the state’s leaders could raise taxes at will, how long would it be before businesses and taxpaying residents make a beeline for Arizona or Texas, thus depressing revenue?

Walters ought to be ashamed of himself for parroting this viewpoint, and Lockyer, for a change, ought to think like a treasurer rather than a Democratic partisan.

Allowing states to declare bankruptcy would not be a panacea. The city of Vallejo, for instance, is now emerging from bankruptcy and chose mainly to cut public services rather than rework the pension obligations and salary levels that put the city in its bind. But this state and a handful of others are fundamentally bankrupt. They spend far more than they take in, year after year.

Lockyer and other bankruptcy opponents argue that states face political problems and aren’t bankrupt in a technical sense, but legal rulings and political limits are genuine obstacles to financial health. We can’t magically erase those obstacles – except through Bankruptcy Court.

For instance, California has been promising unsustainably generous benefit packages to its employees, but the courts have ruled that once those benefits are granted they are a binding contract. There’s no legal way out. Some hopeful legal arguments have been raised that suggest there might be some wiggle room – but those are just theories, and the courts have shown no signs of relenting.

Wednesday, a state appeals court ruled against Orange County in its potentially precedent-setting challenge of a retroactive pension increase granted to the sheriff deputies union in 2001. The county challenged the granting of retroactive pension benefits – by an earlier collection of supervisors – as an unconstitutional gift of public funds. Although another appeals court rejected retroactivity in a separate case, the setback affirms how difficult it is in the current legal climate to do much of anything to rein in existing pension costs.

And the state faces a political climate that simply won’t allow for the serious reforms needed to avoid insolvency or to fix long-term debt problems. Democrats control the Legislature, and they are controlled by union interests. I’ve watched at the Capitol as they quash efforts to slice costs, privatize services or even create a new slightly lower pension benefit for new hires. These solutions are nonstarters in Sacramento. Just as tax increases are nonstarters (thankfully) with Republicans and, usually, with voters.

We’re at an impasse and declaring that the state has taxing authority is about as useful as noting that it has great weather and beautiful beaches. True enough, but California is still in de facto bankruptcy.

On Jan. 24, the state Supreme Court ruled against Richmond’s firefighter union, which challenged that financially strapped East Bay city’s decision to lay off 18 firefighters during a 2003 financial crisis. The firefighters claimed that layoffs must be subject to collective bargaining. The court slapped down that idea, ruling that city management can, indeed, fire public employees to deal with a financial problem.

If agencies had to negotiate with the union before laying off employees, then there would be little they could do cut costs. According to the ruling, however, the agencies must negotiate with the union over the nature and timing of the layoffs. And the case made it clear that decisions such as contracting out or hiring nonunion workers are, indeed, subject to approval by the union. This gives you an idea of how likely it is that cities – or, for the purpose of this article, state governments – can implement the kind of cost-saving reforms that are needed to stave off insolvency.

The rules are rigged in favor of unions at every level. Thanks to redistricting and union expenditures, the political rules are largely set in stone as well. We’re at the point that any reform that can pass won’t do anything that fixes things, while anything that would actually fix things can’t possibly pass.

No wonder the idea of state bankruptcy is a refreshing one. The judge could potentially throw out many of these rules and cast aside the union contracts that are turning California into Greece. Even some conservatives are blasting the bankruptcy option. Scholars at the Manhattan Institute argue that bankruptcy would spook the bond markets and that the state already has needed powers to reform the system now. The state has those powers but it can’t use them for the reasons detailed above. If California went bankrupt, by contrast, Gov. Jerry Brown could say, “I hate to make these cuts, but the judge made me do it.”

Congressional Republicans already are backing away from the bankruptcy idea, which should warn us that the new GOP will be just as squishy as the old one. Still, the bankruptcy option for states needs to be widely debated rather than shut down by advocates for the status quo.

–Steven Greenhut