It’s a bankrupt idea

Former House Speaker Newt Gingrich is apparently trying to burnish his credentials in the race for the GOP presidential nomination by encouraging states to default on their debts. Gingrich is the leading cheerleader for the idea of letting states declare bankruptcy to evade problems with unfunded public employee pensions and other benefits for future retirees. Those problems are real, but letting judges pick winners and losers among a state’s creditors wouldn’t solve them.

The housing market meltdown left many states, and particularly the populous ones, with plunging revenue. State and local governments have reduced the size of their bureaucracies, the cost of their safety nets and their spending on education, yet they continue to face daunting budget gaps.

Retiree pension and health benefits are a longer-term issue. Although a handful of local governments are sinking under the weight of their payments to current retirees, for most states and municipalities the issue is how they will pay the benefits promised to retirees in the future. Pension benefits alone are underfunded by an estimated $700 billion to $3 trillion, depending on how large a return one assumes government pension funds will make on their investments.

Federal law lets local governments declare bankruptcy, but not states. Gingrich and his allies in Congress want to change the law for two reasons: to allow states to abrogate contracts with public employee unions, and to provide an alternative to a federal bailout. Letting a state file for bankruptcy protection, however, wouldn’t relieve it of its obligation to pay retiree benefits. It would simply put state workers in line with other creditors for reimbursement — near the head of the line, actually, in states such as California that give priority to pension obligations in their laws or constitutions.

The losers in any state bankruptcy filing would be the investors who’d bought supposedly safe state bonds. Merely creating the possibility of a bankruptcy filing would make it harder for states to sell bonds, raising the interest costs they would have to pay and intensifying their financial troubles. Also harmed would be the many private contractors who did work for the state.

States already have all the tools they need to pull themselves out of the short-term problems caused by the recession and the longer-term threats posed by unfunded pension and healthcare liabilities. State officials are addressing the former through painful spending cuts and unwelcome tax increases. And they’re starting to tackle the latter with contracts that give new hires less generous retirement benefits and require current employees to pay more into their pension funds. That’s the difficult but right course. Lawmakers need more political will to get through these difficult budget times, not the easy out of default.