By James Spiotto
Myth: States need the ability to go bankrupt and have no standing debt resolution mechanisms.
Reality: Since the late 1800’s, no state has defaulted on its general obligation bonds with the exception of Arkansas in 1933 which was refinanced. State should not use and do not need a bankruptcy alternative especially because it would raise constitutional issues of the power of the federal court and a stigma on the states ability to borrow. There are a number of sovereign debt resolution mechanisms that can be used in addition to balancing the budget, cutting expenses and raising taxes. Bankruptcy affects all creditors of a state even those that are on good standing and desired to continue as is. Bankruptcy does not provide any additional sources of revenue while clouding the ability to borrow.
What About Sovereign Debt Resolution Mechanism for the States?
- Other Sovereign Debt Restructuring Mechanism (“SDRM”).
- Composition of Creditors (Provide a Forum for Creditors to meet to reach consensus as to what can be paid and what should be forgiven).
- Use of Contractual Restructuring Approval – The use of Collective Action Clauses where by a Majority or Super Majority of Creditors to that contract have the power to bind all holders to a debt restructuring and forgiveness. (Not a capital market acceptable provision) – Question of International enforceability.
- Arbitration Clauses – Again arbitration does not have the transparency and creditor participation that Sophisticated institution may require. (Many questions, including who can pull the trigger – in voluntary arbitration and what law will govern.)
- “Club” Approval – London Club or Paris Club but there is a question of whether it involves (and binds) all of the relevant parties especially in a more diverse world.
- Bankruptcy Court for Sovereigns.
- Use – International Monetary Fund – Sovereign Debt Restructuring Mechanisms – “Dispute Resolution Forum” – to verify and reconcile claims and possibly continue with Sovereign Debt Restructuring Court as a Sovereign Debt Tribunal with:
- Independence.
- Expertise.
- Neutrality.
- Certainty/Predictability.
- Attempt to reach volition of parties.
- Restructuring Plan must have vote of majority of creditors.
- The ultimate hammer of a Sovereign Debt Tribunal deciding what the payout will be if Restructuring Plan cannot be approved.
- Treaty among Sovereigns recognizing and authorizing Sovereign Debt Tribunal and enforcing results and decisions.
Should States Be Authorized to File for Bankruptcy as a Sovereign Debt Resolution Mechanism
The simple answer is NO!
Why?
- States have not asked for it or perceived they need it.
- No State has defaulted in payment of its obligations including G.O. Bonds, since its late 1800’s and repudiation of Debt incurred after the Civil War (except Arkansas in 1933 which default on G.O. Bonds).
- States have weathered the financial storms since then including the Great Depression.
- Bankruptcy for States raises constitutional and practical problems.
- Each State is a Sovereign and as such is not subject to the jurisdiction of another Sovereign such as the federal government.
- It is not only a Tenth Amendment issue but also the nature of Sovereign.
- Each State is a Sovereign and as such is not subject to the jurisdiction of another Sovereign such as the federal government.
Bankruptcy like Chapter 9 affects all creditor relationships – those that work and are desired to continue and those that are a problem.
- Why tip over good working relationship.
- Further Federal Bankruptcy Court cannot interfere with the revenues government and affairs of another Sovereign – § 904 of Chapter 9 – U.S. Supreme Court Decisions and Tenth Amendment.
- State Bankruptcy cannot provide interim financing or new revenues, new tax sources or an expeditious resolution of the major problem affecting the State.
- A State Bankruptcy will be an expensive and time consuming experience, expensive, intrusive into certain creditor relationships that should not be disturbed.
The discussion or existence of State Bankruptcy can cause concern or panic in the capital markets given the unprecedented threat of a State not honoring in full its obligations.
- The existence of a State Bankruptcy Option will cause a cloud or stigma on State access to the financial markets and increase borrowing costs.
- Compare 10-year U.S. Treasury Notes to Greek 10-year notes and the increased borrowing cost of almost 10% additional costs a year or the equivalent of almost pay twice the principal amount over 10 years.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved (2015).