Should Cash-Strapped States Be Allowed to Declare Bankruptcy?
A disrupted muni market, also, seems negligible compared to the ramifications of the federal government getting in the foxhole with states. But, Simon continues, “As such, facing a massive and immediate liquidity crisis, they would be in more need of a federal bailout than before the bankruptcy legislation was seriously mooted.”
Mooted? Perhaps. Necessary to avoid more serious financial meltdown? Perhaps. Necessary to consider before firing up the printing press again? Absolutely.
“Given the general political consensus against future bailouts, maybe just maybe, this is something to think about. And better to do the thinking now, rather than when such a tool is actually needed, fast,” opined bankruptcy expert Stephen Lubben for Dealbook in The New York Times.
Fast is already here if you take into account what economist Nouriel Roubini recently told me. Dr. Doom already cast his spell on the states, telling me debt is up to 20 percent of state GDP and unfunded liabilities of state and local pension funds is another 20 percnet of GDP, or $3-5 trillion.
The argument that the states’ GDPs are huge relative to their debts is right, of course, until it's wrong. Panic is inevitable if a big state fails—you’d have a run on the bank, or should I say a run on the state.
As such, a panel including former White House officials Robert Rubin, Glenn Hubbard and Josh Bolton met in October to simulate what it would look like if a state went down. They set the scenario in 2013, when the fictional state of New Jefferson—said to be the third largest U.S. state—faces a $1.5 billion bond payment.
Its governor and legislators are gridlocked. The mock governor calls on the Fed for an emergency loan to avoid default and another sizeable loan to keep the state afloat. Then the chairman of the National Economic Council calls a meeting. This is where the simulation turned to real-time; the audience watched as the mock Treasury secretary, Fed chairman, chief of staff, chairman of the Council of Economic Advisers decided the fate of New Jefferson and analyzed the systemic risk.
It doesn’t need to be "Too Big to Fail" déjà vu just yet.
“There are ominous parallels between the states' predicament and the condition of the big banks in 2008 before they were bailed out. The one big difference is that, this time, we can see the problem before it blows up and we have a real opportunity to do something about it before it's too late,” says Skeel.
We know the lights are flickering in 48 of 50 statehouses right now. The question has become, do you light a candle or pray the water won’t shut off, too?