Public debt as a percent of GDP, as listed on ...

The argument for and against a bankruptcy process for this country’s states is looming large in the headlines. But for the most part many of those who are arguing against a bankruptcy chapter that allows states to restructure their debts are missing the point. Two of the biggest flaws in the arguments against a bankruptcy chapter that allows state debt restructuring is that bankruptcy will make it impossible to raise cash and that bankruptcy will leave many ordinary citizens penniless.

Let’s take a look at some of the problems with those two arguments against state bankruptcy:

  1. The argument against bankruptcy because it will leave the states with no capital to fund projects is flawed because it’s simply not true. As with corporate bankruptcy, states who would file bankruptcy (if possible under future legislation) would be able to find “debtor-in-possession” financing that could help them fund their operations. With their other debts restructured and manageable, many investors might feel more confident in lending money to a state going through the bankruptcy process.
  2. The argument against bankruptcy because it will leave ordinary citizens penniless is flawed because it is based on the assumption that states will be completely relieved of their obligation to repay creditors. Under a state bankruptcy, much like a corporate bankruptcy, state government would be able to settle outstanding debt with creditors such as retired state works, health care beneficiaries and current state workers. Through negotiations within bankruptcy, the state and their creditors would presumably be able to come to some type of agreement.

Pointing out the flaws in these anti-bankruptcy arguments doesn’t mean that we’re saying states should or shouldn’t be able to file bankruptcy. What we are saying is that the idea should not be completely removed from discussion or dismissed as outrageous.