Is Bankruptcy For Illinois The Answer?

Tyler Durden's picture

Authored by Mark Glennon via WirePoints.com,

Could a formal bankruptcy proceeding for the State of Illinois be the answer to it’s fiscal crisis? If you think that’s out of the question, as many do, you’re wrong. On the contrary, though Congress isn’t working on it now, the option is quite viable, though subject to obstacles and open issues. The question is certain to gain growing national attention as a number of states sink further into insolvency, so it’s time to get up to speed. I have yet to see a single Illinois politician or reporter raise the question, but plenty of others outside the state are talking about it for Illinois. More on that later.

This article summarizes the basic issues.

First, why? Why would Illinois or any other state consider bankruptcy? Just as for insolvent corporations and municipalities that reorganize, a successful state bankruptcy would provide a fresh start by putting a state on a sustainable path that frees up funding for needed services — funding that’s getting crowded out by legacy debts. It would do that in three primary ways:

  • Debt that cannot be repaid gets cancelled. In the case of governments, that includes unfunded pension liabilities insofar as there’s no realistic hope of paying them. For Illinois, that means part of its $130 billion pension debt could be erased notwithstanding the state constitutional pension protection clause. Unsecured bonds and other debts could also be cut. Illinois will never have a truly balanced budget or be restored to competitiveness unless those cuts are made, as we’ve written so often before.
  • Unfavorable contracts and leases can be cancelled in bankruptcy, which include employment contracts and collective bargaining agreements.
  • Bankruptcy provides an orderly, rational process to sort out who gets what. Without it, a free-for-all eventually sets in for any entity that can’t meet its obligations. Creditors start suing and racing to courts to get the first judgement liens. Bankruptcy halts that tsunami of litigation and foreclosures.

There are constitutional objections to expanding bankruptcy to states. Bankruptcy for governments is a matter of Federal legislation — Chapter 9 the United States Bankruptcy Code. Today, it covers only cities, towns and other municipalities, but not states.

Expert legal opinions differ on whether Chapter 9 could simply be expanded by Congress to states, but my sense is that the weight of opinion is that Congress could, and eventually will, do so.

Congress unquestionably has the power to make bankruptcy laws — it’s expressly granted in the Constitution. Further, its power to apply bankruptcy to municipalities was upheld by courts over seventy years ago. Skeptics think putting state finances under control of a Federal bankruptcy court would upset the notion that states, unlike municipalities, are “sovereigns.”  They cite the 10th Amendment, which reserves to states powers not granted to the Federal government, and the 11th Amendment, which prohibits lawsuits in Federal courts against a state by citizens of another state. For those interested in the details, see the article linked here by Michael McConnell, a Stanford Law School professor.

A leading expert on the other side is David Skeel, a law professor at the University of Pennsylvania. He wrote outright that, “The constitutionality of bankruptcy-for-states is beyond serious dispute.” The key, as he sees it, is that bankruptcy would be entirely voluntary, which should eliminate any concerns about Federal intrusion on state sovereignty.

A professorial legal analysis, however, probably wouldn’t matter in the end. Courts often bend the rules or make new ones when major emergencies or humanitarian issues arise. Even Professor McConnell, who doesn’t like the idea of state bankruptcy, agrees with that:

If we were facing a genuine fiscal meltdown, which could be solved only through bankruptcy or some equivalent process, and if the use of that process enjoyed the support of Congress, the President, and the affected states, it is not hard to imagine the Court swallowing its theoretical objections.

Beyond the legal issues, some fear that merely authorizing the option of bankruptcy would drive up state borrowing cost because potential bond buyers would face the added risk of having debt cancelled. That’s probably true for states in or near insolvency, but wouldn’t it also instill the needed borrowing discipline never to get to that point?  Bankruptcy would only be available upon insolvency — that’s already required under the Code — which means inability to pay what’s owed. If you can’t pay you won’t pay, bankruptcy or no bankruptcy, so it might not make a difference in the long run. In any event, higher borrowing costs would only result during the period from when it was authorized to when a state filed.

Remember that most objections to bankruptcy come from the municipal bond industry, so take them with a huge grain of salt. That industry primarily just wants to protect against losses on bonds already issued. The state shouldn’t be concerned about those; only future borrowing costs should matter. Future borrowing costs are lowered, not raised, if a successful bankruptcy reduces legacy debt.

And remember that the muni bond industry is already well aware that Congress could extend bankruptcy to the states. Rest assured they know all that’s being written here, and much more. They are way ahead of the curve. To some extent, they’ve already built bankruptcy risk into what they will pay for state bonds. And their efforts to shore up their position to assure they come ahead of taxpayers and other creditor are underway, discussed in our earlier article.

Public employee unions and their supporters also don’t like bankruptcy because of the threat it poses to pension obligations. That’s perhaps rational, if you assume states will in fact eventually find some way to pay scheduled obligations. Not Illinois, in my opinion. All sides need to get on the same page about the plain math. And a bankruptcy court should not be expected to cut pensions if it’s indeed feasible to pay them in full. Unions would be wise to recognize that bankruptcy courts so far have typically favored public pensioners over unsecured bondholders. However, time is not on the pensioners’ side: The muni bond industry is hard at work doing all it can to get first liens and other mechanisms to attain priority over pensions.

Unions also worry that collective bargaining agreements could be cancelled. Well, maybe. This highlights the most important general question about how state bankruptcy would work. And the issue applies to municipal bankruptcies as well: Who controls the bankruptcy proceeding?

The key here is that, on the face of Chapter 9, the bankrupt government — basically, the incumbent politicians — have exclusive power to submit the plan of reorganization. But it’s essential, if a bankruptcy is to be successful, that the same politicians and special interests responsible for bankrupting a government not control the bankruptcy, too. Otherwise, that government is doomed forever and a day.

That problem can be overcome in a number of ways that could be written spacifically into legislation expanding Chapter 9 to states. That is, Chapter 9 would not be extended ‘as is’ to states; appropriate changes for states certainly would be made.

Puerto Rico offers a particularly interesting way to address the problem. For Puerto Rico, Congress last year passed legislation similar to bankruptcy, known as PROMESA, that included appointment of a qualified ,seven-member oversight board. That board effectively has control over most major financial issues and will have to sign off on any reorganization plan that cuts debts. Opponents of bankruptcy for states are terrified that PROMESA may have set some sort of precedent. A national television ad campaign opposed PROMESA while Congress was considering it for just that reason. We’ll be writing separately about PROMESA and whether parts of it could work for Illinois.

The problem of who controls the bankruptcy can also be overcome at the state level. Detroit handled the problem in its bankruptcy by having the state appoint an emergency manager empowered to negotiate its reorganization plan. The same concept could work for appointment of a financially competent control board similar to New York City’s during its crisis in the 1970s.

Various “bankruptcy-light” proposals have also been floated. They would have Congress use its bankruptcy power to allow states cut pension debt through a proceeding short of a full bankruptcy. One, proposed by the Manhattan Institute, was the subject of a Chicago Tribune guest article last year.

But that’s about all you’ll find from the Illinois press about bankruptcy for states. Outside, however, the discussion has proceeded for some time. In 2011 the New York Times reported that policymakers were working behind the scenes to come up with a way to let states declare bankruptcy. They did their work “on tiptoe,” according to the Times, to avoid alarming the municipal bond community. Supporters included Jeb Bush and Newt Gingrich.

Legislation never materialized but the discussion continues. Bloomberg-Business Week wrote last year under the headline, “The Case for Allowing U.S. States to Declare Bankruptcy.” Significantly, William Isaac also wrote last year that both Illinois and Chicago should already be in bankruptcy. He’s the former Chairman of the FDIC and a nationally recognized insolvency expert.

I’m not quite to the point of saying bankruptcy for Illinois is unavoidable, but it’s getting mighty close.

*  *  *

For those who dismiss the possible need for bankruptcy, I’ll let two points suffice here:

  • The only legal ways to cut the state’s $130 billion unfunded pension debt, thanks to the Illinois Supreme Court’s interpretation of the Illinois Constitution, are 1) amendment of the state’s constitution, or 2) bankruptcy. However, the constitutional amendment might not work because serious objections would remain under the United States Constitution. Further, amending the state constitution then cutting pensions would would raise the question, “Why only pensions?” Shouldn’t other debts, especially unsecured bonds, be cut equally?  That would be an entirely fair objection, and the only way to fairly cut those other debts along with pensions is bankruptcy. Nobody has ever proposed a solution for Illinois that truly balances the budget and pays its debt. Pensions already consume about 25% of the state’s budget even though they remain badly underfunded, which keeps the pension debt growing rapidly.
  • The reason why Illinois can’t get a budget solution in place is there’s not any real one to be had. The true budget deficit is two to three times the official one that lawmakers can’t balance. See the numbers linked here. Spending has already been slashed, and tax increases attempting to stabilize the state would be suicide — they would backfire by accelerating the flight of our tax base, ultimately lowering revenue. Illinois will continue to sink rapidly into further debt unless existing obligations, especially pension debt, get cut.

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38BWD22's picture

 

 

In the last thread (China), I suggested diversity!

But, maybe not into State of Illinois paper...

 

xythras's picture
xythras (not verified) 38BWD22 Mar 26, 2017 7:37 PM

Here's some bankrupt people.

 Just morally for now, but let's wish them to become trully bankrupt

Huma Abedin Takes Weiner Back

http://dailywesterner.com/news/2017-03-26/huma-abedin-takes-weiner-back/


 


jcaz's picture

"But.... But.... But...  My Teachers' Union rep told me I was ok!!!!!!"

BUWHAHAAHAHAHAHAAAAHAHAHAH!!!!!!!!!!!!!!!

Poof!!!!   And it's gone.

earleflorida's picture

look at the defined pension plans the education administration have given themselves with the public work bureaucrats not far behind--- $150k -$500k

And,...

that's not a typo
jcaz's picture

..Add a zero to your numbers for Chicago educators-  the numbers are public info.  There are superintendents in Chicago with $25M+ defined packages....

Or so they thought.

Chris Dakota's picture
Chris Dakota (not verified) jcaz Mar 26, 2017 9:08 PM

States can't declare bankruptcy, only municipalities.

 

Mano-A-Mano's picture
Mano-A-Mano (not verified) Chris Dakota Mar 26, 2017 9:22 PM

Still, we can send BILLION$ every year to IsraHell, but we can't help the states?

https://biblicisminstitute.wordpress.com/views-of-news/#armingapartheid

kavlar's picture
kavlar (not verified) Mano-A-Mano Mar 26, 2017 9:42 PM

Don't you know the Jews got Congress by the balls?

francis_the_wonder_hamster's picture

Are you implyiing we SHOULD help the states?

WestVillageIdiot's picture

I do have some advice for everybody.  Even though we all know this makes sense don't try to discuss this with any of the apparatchiks that are in line for these ridiculous pensions.  They will go to their most illogical place, and call you names, most certainly.  These pensions were granted from God himself.  Just ask these "public servants".  Your life will be much easier.

philipat's picture

So, having screwed the people/taxpayers by allowing underfunded pension schemes and by making unrealistic pension promises to Government and Unionized workers, Government will now screw the people again by declaring bankruptcy. More financial engineering on top of the financial engineering that created the problems in the first place. Here's another idea: make the people respondible for the underfunding (Corporations, Unions, State and Local Government size reductions etc) not the taxpayer meet their obligations in full before other measures are discussed.

red1chief's picture

I live in Illinois, and the promises to the average workers are not that great. There are two main problems:

1. Corruption. "Pay to play" schemes have led to "alternative investments"by the pension funds, in which the money is basically stolen by investing in insider stuff.

2. Higher-level goverment workers are given gigantic raises on the day before they retire, and their pensions are set based on their pay when they leave. Then these amounts are plastered on the front pages and the public is led to believe that the promises made to all workers were too great. 

silvercity's picture

I live in Ill. also. This author seems to think that the people who run and rob Illinois will voluntarally give up power when there is still billions to be stolen before the end. Good luck with that.

38BWD22's picture

 

 

Civics was not Bearing Dude's strong point when getting educated, maybe one of you all can fill me in here:

HAVE any states ever gone bankrupt and defaulted?

That alone would suggest an investment NOT worth making.

 

red1chief's picture

Somthing's still up with your space key. Is this a problem you can't fix? 

earleflorida's picture

municiple bonds-- away

bust`in-a-boom

bob_bichen's picture
bob_bichen (not verified) xythras Mar 27, 2017 3:59 PM

You have NO IDEA how troubled this individual, Xythras, is.  He has trolled and spammed his website crap on here forever, always with the same M.O. of "upvotes" from a long series of "imaginary playmates." It really is quite perverse and whoever "he" is, he seems to really get his rocks off fondling himself and giving himself green arrows; he appears to have no life beyond making off-topic comments with his link to the SPAM-, TROJAN-, VIRUS-INFESTED  "dailywesterner,com"

Other ZHers  may wish to take one minute to send an email to abuse@zerohedge.com requesting that all of the "imaginary friends"  as well as XYTHRAS  be permanently banned for spamming.

As you do that, use your imagination to try to conceive of what type of whackadoo would spend their life in pajamas, eating stale chips and drinking cheap soda from the dollar store, popping zits, watching Road Runner cartoons and spamming zerohedge.

johngaltfla's picture

Dude is on crack. Does anyone with half a brain actually think a Republican led House and Senate would actually help Obama's home state out? No just no but HELL NO.

Let them eat debt.

They spent it, they can bail themselves out.

GUS100CORRINA's picture

My vote:

LET THEM CRASH AND BURN beginning with Cook County.

Yog Soggoth's picture

No. The answer was already written on the wall a long time ago. Chicago needs to secede or be attacked by Illinois. Two choices. Either way, Illinois wins. We sack Chicago and the debt is paid off with surplus. They secede and Wisconsin attacks.

earleflorida's picture

funny, the bushes take residence in five states

WestVillageIdiot's picture

I've seen bush in more states than that. 

Mazzy's picture

Split off the Chicago metro counties into a 51st state.

There's nothing saying that we need to have a nice easily rounded number.  We could have 73 states and that would probably be pretty reasonable too.

Give the Chicago metro area all the state's debt (they racked it up anyway), and obviously all of Chicago's metropolitan debt. Fence it off and see what happens.

Now just call the newly formed southern portion West Indiana, or East Iowa and watch it become a fiscally sound powerhouse.

johngaltfla's picture

Fuck Chicago. If it's so great let Joe Maddon fix it. The Dimocrats have fucked that city up so bad why should any other city, state, or taxpayer that doesn't reside there pay to fix their corrupt shithole?

Screw them all.

Let them eat Cubcakes.

red1chief's picture

It's not just the Dimocrats. The right-wing governor is a turd, and a personal friend of Chicago turd mayor Clinton chief of staff. 

red1chief's picture

No, the rest of the state is bad also. Chicago is a drag, but most of the suburbs are healthy. Indiana is held up by Indianapolis.

Lanka's picture

We used to have 57 states.

red1chief's picture

You are having trouble with your space key. It is being hit too much.

xythras's picture
xythras (not verified) Mar 26, 2017 7:38 PM

After it will fail completely we can give it to the canucks.

CHoward's picture

As corrupt and inefficient as the State of Illinois is - they'd be back in Bankruptcy Court in a few years again...and again....and again.  When would it stop?

techpriest's picture

When people wise up and stop giving them money.

drdolittle's picture

I hope not. My dad's 60k from paying his farm off (divorce after 24 years means he paid it off 1.5 times) and relies on his Illinois pension. I'll pay it off for him, it's worth too much for a bankster to get on the cheap. 

Yog Soggoth's picture

Then you need to get into a local militia and plan the attack!

Nobodys Home's picture

I knew militias were lead by Cthulu! Yog Sog Go Goth..Sir!

Lost in translation's picture

Come ooon CaliPornia, blow UP already!

Nobodys Home's picture

Who says immigration doesn't pay.

Along with tacos, silicone tits valley, drugs, tourism, hollyweird and shipping ports.

SantaClaws's picture

Lots of floodgates around the U.S. waiting to be opened.

WestVillageIdiot's picture

Can New Jersey really be far behind in this race?

OCnStiggs's picture

Liberals can NEVER live within their means. This is why the Obama administration never operated under a budget.

Once formally in bankruptcy, perhaps with no one buying their debt, the loons will have to live within their means.

The pension disaster will crater a generation or two who bought the lies sold to them by greedy unions and politicians. The math NEVER worked.

If a few people hung from lamp posts, this kinda thing might be an aberration. Unless people get hammered, it will happen again and again.

Part of the "no consequences, no blame" world brought to us by the Progressive mindset.

WestVillageIdiot's picture

I love your profile picture. 

silvercity's picture

Governments can never live within their means no matter who runs them. The evidence is every government that has ever existed on earth since the beginning of time.

Stan522's picture

It's a race between kalifornia and Illinois on which terrible leadership of Democrats will drive their states into bankruptcy first....

WestVillageIdiot's picture

Ahem!  Please do not count out New Jersey, or even New York, for that matter.

Wage Slave 927's picture

"There are constitutional objections to expanding bankruptcy to states."

 

Yeah, like I don't want to pay the bills for those effin' crooks.

Bay Area Guy's picture

The problem is that the powers that be are so beholden to unions in Illinois that they would never modify pension obligations, nor would they cancel unfavorable employment contracts.  They would cancel every single debt other than those (thereby making it virtually impossible to ever borrow money at less than usury rates ever again), then they would use their newly fond "wealth" to double down on the crappy union deals they made in the past.

Never underestimate the unions' hold on politicians in predominantly (or completely) blue states.

chubbar's picture

Which is why BK is being seriously considered. Unless someone comes in and abrogates these ridiculous union contracts and pensions, the state will never be solvent again. Something that should (and probably was) evident when these contracts were signed. We are rapidly approaching that moment in the future where someone is going to be holding the dynamite when it goes off. All debt is going to be written down, which is someone elses "asset", which means large losses to someone or group. It'll be interesting to see who (besides pensioners) takes the hit on the muni bonds and other debts. I see many BK's coming out of this if the state declares BK.

silvercity's picture

You have the cart in front of the horse. The public sector unions are dependent on the politicians for their income and wealth. The stupid party, Republicans, could win elections if they ever gave the taxpayers a reason to vote for them. Republicans like to spend just as much as Democrats so why vote R. Republicans have almost never reduced spending even locally. Where they have, they win.