Bankrupt states — why not?

As it now stands, states have no legal way to declare bankruptcy. Municipalities and counties, however, may do so. New York City famously came close to bankruptcy in 1975.
Some conservatives, including former House Speaker Newt Gingrich, pictured below, believe it’s time to change this. Let states declare bankruptcy. It may be the only way for some of them to reorganize, get out from under harmful pension and union obligations, and set themselves back on the road to recovery.

It’s not going to happen. House Majority Leader Eric Cantor, R-Va., ruled that out this week, carrying the water for GOP leaders who obviously wanted to back away from the idea. That’s too bad.
The objections to such a move are twofold. The one most often stated is that even passing a state bankruptcy law would throw bond markets into a tizzy. (Read a stateline.org piece on it here.) State-issued general obligation bonds are considered safe investments precisely because state’s can’t declare bankruptcy. Throw the possibility of such a thing into the mix and interest rates would rise while investors get the jitters. Actually declare bankruptcy and all of a state’s creditors would suffer, which could devastate a local economy.
The second objection may be the most important. Unions do not like the thought that pension obligations and employee contracts could be scrapped in a reorganization.
But let’s look at this realistically. Some states are in a horrible mess. According to the Center on Budget and Policy Priorities, the combined projected deficits of 44 states and the District of Columbia is $125 billion for the next fiscal year. California’s bonds already carry high interest rates.
Why has the possibility of municipal bankruptcy not disrupted the bond market for cities and other local governments? The ones that manage the best carry debt that is considered a sound investment. But even those with worse credit ratings are considered safe.
Just because states might be allowed to file for bankruptcy doesn’t mean they must do so. In fact, states would have strong incentives to do all within their power to avoid such a thing, for obvious reasons. That would force fiscal prudence.
Frankly, despite all their claims to the contrary, I don’t see how some states are going to pull themselves out of their current mess without reorganizing. They have obligations that won’t go away, and they don’t have the money they need.