House Democrats, GOP both slam state bankruptcy proposal

Republicans and Democrats in the U.S. House criticized a proposal to allow states to file for bankruptcy to escape their debts, calling it an unnecessary intrusion into local affairs that could roil the bond market.

Rep. Lamar Smith, R-Texas, chairman of the House Judiciary Committee, said in Washington on Tuesday that allowing bankruptcy filings could encourage profligate borrowing and penalize even sound states with higher interest costs. Former House Speaker Newt Gingrich, a potential presidential candidate in 2012, has advanced the idea.

“States currently have ways to put their fiscal houses in order,” Mr. Smith said during a hearing of a subcommittee of the Judiciary Committee. “Congress should not hinder restructuring efforts at the state level by passing laws that make it more expensive for states to access capital in the bond market during a recession.”

Suggestions that states should be allowed to file for bankruptcy, as cities can, have drawn criticism from federal lawmakers in both parties, state officials and public employee unions, whose contracts might be jeopardized in a filing. Municipal bond analysts have also expressed concern that a change may rattle the $2.86 trillion debt market by casting doubt on the safety of the securities.

Rep. John Conyers Jr., D-Mich., said it is a “useless” idea. Rep. Hank Johnson, D-Ga., said, “State bankruptcy may be a solution in search of a problem.”

U.S. states are forecasting a collective $125 billion in budget deficits for the next fiscal year, according to a study by the Center on Budget and Policy Priorities. Investment losses suffered during the financial crisis left a more than $1 trillion hole in pension funds, according to the Pew Center on the States.

States were left out of a Depression-era law that lets municipalities reorganize their finances under Chapter 9 of the bankruptcy code.

The skepticism about allowing states to seek protection from creditors was echoed by experts invited to speak before the subcommittee.

“Legislating state bankruptcy would disrupt the current municipal bond market and undermine investor confidence,” Matt Fabian, a managing director of Municipal Market Advisors, said in remarks prepared for delivery.

The hearing was the second congressional forum in as many weeks at which experts advised representatives against letting states file for bankruptcy. At a separate House hearing on Feb. 9, analysts from the Manhattan Institute for Policy Research and the Center on Budget and Policy Priorities, groups with differing political viewpoints, said it would do more harm than good.

There are some signs that states are beginning to emerge from the worst effects of the recession. U.S. state tax collections headed for their biggest jump in more than four years during the last three months of 2010, the fourth-straight increase, according to a study this month from the Nelson A. Rockefeller Institute of Government.

James Spiotto, a bankruptcy attorney with Chapman and Cutler, told the subcommittee that any move to allow bankruptcy would be fraught with practical and legal challenges, including potential conflicts with the state's sovereignty.

“While the creation of a vehicle for state bankruptcy may initially appear as an attractive solution to a difficult problem, upon careful consideration, its problems outweigh its benefits,” Mr. Spiotto said in remarks prepared for delivery.