Monday, January 24, 2011

Upside Down

Bankruptcy is generally a messy affair. Whether the assets are minimal or massive, the dissolution of a household or a company, the disbursement of the assets, and the intrusive nature of the process take an emotional toll on the principals involved. Creditors, secured and unsecured, often must swallow losses and lose business or income. In other words, a bankruptcy of any size is no walk in the park.
The issue of insolvency becomes more complicated when one considers that local governments and some states are faced with the reality that their obligations are much larger than are their incomes. Under our federal system the states are sovereign although the limits and definition of their preeminence have been blurring for the past century. Increasingly, states have acted as if they were compliant extensions of the national monolith rather than independent entities that created and control the federal government. As a result of the States’ willing complicity in the geometric growth of the federal government, they, too, have found themselves in dire fiscal straits as federal mandates placed huge burdens on state budgets. A sad irony is that as the federal spending has increased to unsustainable levels, states’ shares of the mandated services have increased also, thus placing all strata of government in “upside down” positions. Broke, more broke and most broke…..busted.
At first blush, bankruptcy for those states who are unable to meet current obligations and whose future underfunded contractual requirements cannot be fulfilled, seems to be a viable remedy. Clean, clear and final. Old debt and future contracts would be vaporized and allow the state to begin anew. Perhaps. Using Ohio as an example (because I live here), the U.S. Bankruptcy Courts are organized to coincide with U.S. District Courts which means that there are two in Ohio. The Northern jurisdiction and the Southern one could both be involved in a state bankruptcy proceeding although the state capitol, Columbus, is in the Southern District. The primary constitutional issue is should a sovereign state willingly submit to the authority of a federal judicial panel that represents a portion of the state? Maybe, a special court could be convened that would merge the two districts within Ohio, but that would require special legislative treatment.
There are additional roadblocks and speed bumps associated with potential bankruptcy for a state of the federal union. The three most common forms of bankruptcy, Chapters 7, 11 and 13, have glaring weaknesses for the administration of a sovereign state’s insolvency.  It seems reasonable that a new chapter designed specifically for sovereign states would be necessary in order to preserve the political and sovereign integrity of the state after the proceeding had been finalized. Using our Ohio example if the current laws were extended to the states, then it’s quite possible for the assets of the state to be sold to satisfy the un-or underfunded liabilities. Horror of horrors! Can you imagine that the state of Michigan would have the highest bid for The Ohio State University? Clearly this hypothesis is ludicrous …on several levels. Michigan has no money, and it’s impossible to imagine a state having a dissolution auction, but certainly there are some assets that a state or a trustee may sell to protect the contract principals, the bond holders and the unpaid vendors. As a sovereign state, who decides which assets can or must be sold? The court or the Legislature, or, of course, another freaking Blue Ribbon Commission made up of former politicians and CEO’s. The conundrum continually grows in complexity.
Today we have briefly examined the jurisdictional issues, but the pitfalls go beyond the separation of powers and the 9th and 10th Amendments. Sadly, there is more to come, but if the assets of Ohio go on the auction block, I want the Capitol and the Ohio Department of Agriculture Complex in Reynoldsburg.


  1. My concern is that the feds will solve this problem by allowing the state to declare bankruptcy in return for a federal receivership, which would be, in fact, a voluntary surrender of that state's sovereignty.

    Such a move would greatly erode my confidence in the rule of law to resolve the issues before us.

  2. Thank you for taking the time to dig into the hypothetical mechanics of processing a state's bankruptcy. You're right to bring out the legal aspects.

    Thinking about who the highest bidder in an auction for the state's assets is interesting. Do our State Constitution and borders stay in place? It certainly would be messy but bankruptcy might offer a fast way of shrinking Leviathan.

  3. Scares me to death for the reasons Harold states. There is no good outcome. Under the best of circumstances, we've still set one hell of a precedent.