State officials on Friday angrily denounced reports that senators may be quietly developing a proposal to allow states facing fiscal crises to seek protection in federal bankruptcy court so that a judge could alter their obligations, including outstanding debt levels.
The officials warned that giving credibility to the idea of state bankruptcy will harm the municipal market, particularly in the current environment of alarmist headlines about munis.
Passage of such a law, even if it authorized a restructuring less extreme than bankruptcy, would trigger fears of a pending wave of filings and lead to higher yields, many issuer and market participants said.
“To the folks in Congress cooking this baloney: Don’t bother,” California Treasurer Bill Lockyer said in a release. “States didn’t ask for it. We don’t want it. We don’t need it.”
The outlines of a specific plan have yet to surface, but the idea became a political football during a Senate Budget Committee hearing earlier this month. At the hearing, Sen. John Cornyn, R-Tex., pressed Federal Reserve Board chairman Ben Bernanke whether states should be permitted to file for bankruptcy.
Though Bernanke punted and said it is up to Congress to determine whether such legislation would be a good idea, he stressed that states have adequate tools and means to meet their existing obligations.
The issue surfaced again on Friday in a front-page story on the subject in the New York Times, prompting the round of denunciations from state officials.
Many issuers argued that the concept of a bankruptcy plan is driven by Republican interest in crippling public-sector unions — some of the biggest and most effective organizers for Democrats — and also reflects confusion between states’ near-term budget deficits and long-term funding obligations such as unfunded pension liabilities.
Said Lockyer: “Advocates of this preposterous idea want one thing above all: to see government go up in flames and, with it, the lives of a certain class of working people they don’t like.”
Cornyn’s representatives could not be reached for comment.
Ben Watkins, director of Florida’s Division of Bond Finance, said reports of a bankruptcy proposal, coupled with dire headlines about the fiscal health of states and localities, are “a lot of noise” that is “having an adverse impact on the market” and “scaring people unnecessarily about the safety and security of municipal bonds.”
“Anything that would adversely affect the security of our bonds is bad,” Watkins said, who stressed that muni issuers are not looking for a way to stop paying their debts.
Though insolvent municipalities are currently able to file for federal bankruptcy protection in some states, the proceedings do not often result in a quick turnaround. For instance, Vallejo, Calif., has been in bankruptcy proceedings since May 2008.
In addition, general obligation bondholders become unsecured creditors in bankruptcy proceedings, which means that they are not guaranteed that they will be paid in full and may only get a fraction of what is owed them. For instance, Vallejo filed a plan to exit from bankruptcy last week that proposed paying unsecured creditors 5 to 20 cents on the dollar.
And although many state constitutions currently mandate that bondholders are among the first to be repaid with state revenue, federal bankruptcy legislation would override those laws because of the supremacy clause in the U.S. Constitution that essentially elevates federal law above state law, attorneys noted last week.
Frank Hoadley, capital finance director of Wisconsin, suggested that the idea of state bankruptcy, along with alarmist news headlines, are part of a larger plot to raise yields in the market to benefit hedge funds, which make money from negative market news.
“It looks uncomfortably like there are people out there that are deliberately trying to move the market,” he said.
The issue was a hot topic at the Government Finance Officers Associations’ winter meeting here Friday. Members of the GFOA debt committee, who were unanimously opposed to the state bankruptcy idea, noted that the idea had played a noticeable role in raising interest rates.
“There’s fundamentally no difference between October and today’s market, yet rates are up 100 basis points because people have been making irresponsible statements without proof or support” about the muni market, said one committee member who did not want to be identified.
Another committee member, arguing that the perceived need for state bankruptcies is overblown, noted that while corporations can “go under in two days,” municipalities do not cease to exist overnight.
The debt committee agreed to cultivate a set of talking points for the issuer group’s executive board that could lead to a formal position against such legislation.
