We are witnessing unprecedented clashes and escalating political rhetoric between cash-starved state governments and their public service unions.
The conflict has yielded the worst notion yet among an array of increasingly painful potential solutions – declaring state bankruptcy, among other reasons, to escape the onerous bonds of contracts and accumulated promises made by multiple generations of politicians of both parties.
As a former Virginia governor, my advice is to consign that particular idea to the cutting room floor. In harsh reality, bankruptcy would likely cost taxpayers more over time than tax hikes or unaffordable public union contracts. And it would put the final financial decision-making in the hands of a federal judge whose persuasions and ultimate directives would be entirely unknown.
In the real world of government and finance, well-rated state and municipal bonds are a safe harbor for retirees, the elderly and small investors who are desperate today for as much certainty as they can find.
In 2010, investors seeking that certainty invested more that $84 billion in state and municipal bond mutual funds. The creation and development of mechanisms for states to go bankrupt, and ask a federal judge for permission to default, could prompt painful and costly credit rating downgrades that hurt all classes of investors, including working men and women holding 401 (k) plans that have already been beaten down.
By being trustworthy, creditworthy borrowers, responsible states and municipalities promote certainty for people who need it. They promote assurance for managers overseeing the nation’s retirement funds, pensions, mutual funds and money market funds on behalf of individuals.
The fact is it would cost any state an exorbitant amount of money in the long term to default on its investors through tactical bankruptcy engineered to escape union contracts or creditors. Even if anybody were willing to lend anything at all in the future, the required interest rates would be astronomical. Eventually, draconian spending cuts or dramatically higher taxes would likely be needed to pay that debt. Penalties on state governments fresh off a tactical bankruptcy and the citizens they serve would be severe.