Will Alaska become the next Detroit?

As the price of oil continues to plummet, the ripple effect — on jobs, energy companies, the stock market — is painfully felt. The impact has even reached America's "Last Frontier."

Earlier this month, Standard & Poor's downgraded Alaska's AAA general obligation bond rating, officially making the state the most recent victim of the oil decline.

This is a state that in 2014 was able to pay for 90 percent of its operations with oil and gas revenue and had not had a personal income tax for 35 years. Now with a budget shortfall of more than $5.2 billion, state lawmakers are scrambling. But Alaska's leaders need to be careful that they do not fall into the same trap other governments have by opting for quick fixes at the expense of long-term economic health.

Cook Inlet stretches 180 miles (290 km) from the Gulf of Alaska to Anchorage in south-central Alaska. The Cook Inlet basin contains large oil and gas deposits including several offshore fields.
Danita Delimont | Getty Images
Cook Inlet stretches 180 miles (290 km) from the Gulf of Alaska to Anchorage in south-central Alaska. The Cook Inlet basin contains large oil and gas deposits including several offshore fields.

Governor Bill Walker has proposed a sweeping fiscal plan that has received praise from economists in the state. However, it's worth noting that the plan includes the issuance of $2.5 billion in pension obligation bonds, also known as POBs. POBs are a debt instrument that essentially let local governments pay unfunded pension liabilities by betting that the investment will earn a higher return than the interest costs of the state's pensions.

If this feels slightly familiar, it might be because Detroit did its own $1.4 billion pension bond deal in 2005. Ultimately, the bet was a disaster. Not only was the move labeled by the Detroit Free Press as "the last straw" that led to Detroit filing for Chapter 9 bankruptcy, the deal became a controversial focal point of the city's 2014 bankruptcy trial and was held up as epitomizing the reckless risk taking municipalities should avoid. Now, with $65 billion in savings, Alaska is no Detroit—but this type of move is never taken lightly.

In Detroit, Puerto Rico, and now Alaska, a disturbing trend among cash strapped municipalities is emerging. It seems that when things get tough, the first preference is to walk away from contracts under the cover of creative lawyering and revisionist history calling into question the deals themselves. This is the epitome of short-term thinking.

Interestingly, the political fight that has currently drawn the spotlight in Alaska is not over the wisdom of legislators passing the bond deal, or even any other major element of the Governor's plan, it's over the building where the lawmakers themselves work.

The Legislative Information Offices (LIO) building in Anchorage has become the center of the debate. Now that macro circumstances have changed, the legislators want to get out of paying the agreed upon annual rent of more than $3 million. Two years ago, when they signed the LIO lease, the legislators unanimously approved the deal that increased rent from $682,000 after substantial renovations. It is also worth noting that, according to local news reports, the developer has offered to sell the building direct to the state at roughly $10 million less than its current asking price. Now, some Alaskan politicians argue that the state should stop paying the rent.

While the LIO building deal on its own may be small, it represents a slippery slope.

Members of the financial community have been clear that breaking the contract instead of negotiating a compromise could have negative consequences. Back in April, the Alaska Banking Association explicitly warned in a letter that this course would "likely impact the State's credit worthiness and the cost of borrowing in the future." And that's to say nothing of the reputational hit Alaska would take or the trust lost with Alaskan businesses within the state.

Who in the municipal markets is going to want to enter into contracts to help finance a state whose word is evidently less than guaranteed? Whether it is bond agreements or contracts, this trend of reneging on commitments by governments can lead nowhere but downhill.

States or Commonwealths that follow this course are essentially writing their own economic epitaph.

No one is going to step up to help them fund the operation of their government or the building of their infrastructure if the risk is that they will abandon their commitments in the name of political expediency. Governing in difficult times, whether self-inflicted like Puerto Rico's or driven by market changes like Alaska's, requires those who govern to look beyond the political answers and think about the future of their residents and their communities. This requires that they act responsibly, not arbitrarily.

The Alaskan legislature is expected to make a decision by early next month on the LIO lease. No one can blame the state for failing to foresee the price of oil falling to historic lows. That being said, what Alaska and its lawmakers should be held accountable for are the decisions they make now—and the consequences of those decisions for the state's future.

Commentary by Judd Gregg, a former governor and three-term senator from New Hampshire who served as chairman and ranking member of the Senate Budget Committee, and as ranking member of the Senate Appropriations Foreign Operations subcommittee.

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