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States, Bankruptcy and The Pothole Theory

Posted By admin || 16-Feb-2011

A large pothole on a country road.

Despite the unlikelihood that states will be granted the right to file bankruptcy anytime soon, analysts are still debating the issue.The opponents of bankruptcy have come up with some very ridiculous theories about why bankruptcy would be "horrible" for states. One anti-bankruptcy theory is that if states are given the right to file bankruptcy then investors will demand more interest on their bonds and with more interest to pay, fewer potholes will be fixed.

"The higher the interest rate a state has to pay, the more potholes that can't be filled," says Marilyn Cohen of Envision Capital, a company that invests in bonds. "There's a whole chain reaction."

This is almost laughable.  Right now many states have much more than potholes to worry about.  States are already facing a real bankruptcy, just without the protections that municipalities get when they file bankruptcy. Bankruptcy in essence is insolvency and states such as California are already insolvent. Bankruptcy for them would probably enable them to fill the potholes in their state both figuratively and literally. Stopping them from cutting their debt through a formal bankruptcy won't make their troubles go away.  What is happening now is that states are cutting funding to essential services because they are required by law to balance their budget (with the exception of Vermont).

Other opponents to state bankruptcy are saying that if states are allowed to declare bankruptcy, then it will turn into a "free for all" where all 50 states will go bankrupt and discharge or reduce their debts.

Some also question whether allowing states to go bankrupt would be wise economic policy in the long run. When a company or family cuts its debt through bankruptcy, it risks encouraging others to do the same, notes Dean Maki, chief U.S. economist at Barclays Capital. With states, the danger is greater.

Another illogic theory-how can Mr. Maki say that because one person files bankruptcy that it encourages others?  This is not a situation where bankruptcy debtors are trying to "keep up with the Joneses."  Families are filing bankruptcy because they are in debt and need financial relief. And so is it with states. States are drowning in debt and quite logically are looking at all the options (and non-options) including changing the law so they can file bankruptcy.

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