By: Mark Glennon*
When the possibility of Congress authorizing bankruptcy for insolvent states was last discussed a couple years ago, most of Illinois’ media and political establishment either ignored or ridiculed it with words like “dangerous,” “silly,” and “unconstitutional.”
The discussion is returning and this time it will be informed and rational, if Friday’s New York Times article is an indication.
The spark for the new round of discussion is Puerto Rico’s full reorganization plan, recently proposed in its bankruptcy-like proceeding under a federal law called PROMESA, which Congress authorized in 2016.
“If the plan survives the challenges ahead, it could be a model for how struggling states deal with their financial problems in the future,” says the Times, referencing Illinois and New Jersey in particular.
Those in Illinois who scoff at talk of bankruptcy, particularly public pensioners, should read the Times piece with an open mind. They may find much to their liking, especially if they understand the chaotic alternative Illinois faces if it does not find another orderly way to address its rapidly deepening insolvency.
Yes, pensions would be cut under the Puerto Rico plan. As the Times reports, the new restructuring plan would reduce the island’s $54.5 billion pension obligation to $45 billion. However, cuts would be made on a sliding scale. The biggest pensions would be reduced by, at most, 8.5 percent, and the smallest pensions would not be cut at all.
Illinois, too, needs some kind of progressive or means-tested pension reform. Many pensions here are very excessive, but smaller ones need more protection. Federal legislation can permit or even mandate differential treatment.
But bondholders would bear a far bigger burden to give Puerto Rico a fresh start under the plan. It would trim the island’s bond obligations to $41 billion from $75 billion — a 45 percent reduction. That, too, is an average, with cuts to bonds ranging from 64 to 93 cents on the dollar. Others could risk getting nothing at all, according to the Times.
Puerto Rico retirees would also get legal assurances of future funding under the plan. “The result,” according to the Times, “is retirees get a better deal than almost any other creditor group: at least 91.5 cents on the dollar.” Most Illinois pensioner who truly knows our numbers would take that deal and run because, as things stand, one way or another, those with the larger pensions will be lucky to get 60 cents on the dollar in the long run.
In total, Puerto Rico’s plan would cut $129 billion in debts to about $86 billion — a reduction of 33 percent, NYT calculates.
How did they conclude that was the right amount? That is, how did they balance the need for debt reduction against the need to maintain competitive levels of taxation and services while still giving the island a fresh start?
On that, the federally-appointed oversight board, which proposed the plan, took a sensible approach. From the Times article:
First, the board looked at the debt burdens of America’s 10 most indebted states, calculated the average, and pared back Puerto Rico’s debt to an amount less than that. Then it began pushing for changes meant to make the government perform more efficiently, rebuild the public trust and encourage businesses to grow and hire.
Could Congress pass legislation for states comparable to PROMESA for Puerto Rico? There’s no constitutional obstacle, notwithstanding claims to the contrary by some opponents. “The constitutionality of bankruptcy-for-states is beyond serious dispute, according to David Skeel, a law professor at the University of Pennsylvania and member of Puerto Rico’s oversight board. The key is that bankruptcy would be entirely voluntary for any state, which eliminates any concerns about federal intrusion on state sovereignty.
Would Congress ever do so? In 2017, there was enough interest in Congress to prompt then-Governor Bruce Rauner to predict that such legislation would be passed that year. He obviously overestimated Congressional interest in the subject, and interest abated in 2018 when Democrats, who are more opposed to the idea, took control of the House.
However, action is probably just a matter of time. It would likely take a state controlled by Democrats telling Washington it needs bankruptcy-for-states. Illinois and New Jersey may be the worst off, but Connecticut, Massachusetts, California and Kentucky are not far behind.
The real fight would then about what form bankruptcy-for-states would take. It needn’t be identical to PROMESA nor similar to Chapter 9 of the federal Bankruptcy Code, which is for municipalities but not states. Issues about priorities among bondholders, pensioners and other creditors, as well as many other matters, could be addressed by Congress in its legislation.
If you still think the concept of bankruptcy-for-states is far-fetched, be aware that those with the most financial expertise and skin in the game think otherwise. That’s the municipal bond industry. They saw the risk to their wallets back in 2016. Knowing that PROMESA could set a precedent that would jeopardize outstanding bonds, they fought hard to defeat it in Congress and ran a national ad campaign in opposition.
The author of the New York Times piece, interestingly, is Mary Williams Walsh, who has long been following state financial and pension issues in Illinois and elsewhere. You may recall her 2015 article, “Bad Math and a Coming Public Pension Crisis,” about the efforts of Jim Palermo and others here in Illinois to expose the work of an actuary for many Illinois pensions, Timothy W. Sharpe. That work, and probably her article, resulted in Sharpe’s suspension by the American Academy of Actuaries from membership for two years.
When we wrote about bankruptcy-for-states in 2017 we quoted Arthur Schopenhauer: “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”
Hopefully, we’ve now at least passed through that first stage.
That’s not to say we endorse bankruptcy for Illinois or any other state. We do think, however, the topic warrants consideration. It would depend on the specifics and the details of the legislation. It would also depend on whether Illinois pursues the drastic reforms it needs in some other manner. However, the only alternative that would allow for real pension reform in Illinois is an amendment to our constitutional pension protection clause, which our political establishment has ruled out. And if equity requires sacrifices from other creditors, only bankruptcy can do it.
*Mark Glennon is founder of Wirepoints.