Senate leaders eye option of state bankruptcy

WASHINGTON (Reuters) - Senate Republican leaders said on Tuesday they were considering introducing legislation to allow financially stressed U.S. states to declare bankruptcy, even though the No. 2 Republican in the House of Representatives has rebuffed the idea.

U.S. Senate Republican leader Mitch McConnell (R-KY) speaks at a news conference following the Senate Republican Annual Issues Meeting on Capitol Hill in Washington, January 6, 2011. REUTERS/Jim Young

“We’re exploring that as a responsible option,” Senator John Cornyn, who sits on both the Budget and Finance committees, told reporters.

Some Republicans have embraced the bankruptcy option, which would allow states to sort out finances and renegotiate contracts with public employee unions, as an alternative to sending in federal aid.

Pension obligations to state workers including teachers and law enforcement personnel pose a major burden on many states.

But analysts -- and states themselves -- are concerned that opening up a bankruptcy option would spook the buyers of state debt, driving up interest rates and making borrowing more expensive.

Washington Governor Chris Gregoire and Nebraska Governor Dave Heineman said in a joint statement on Tuesday that states would not use bankruptcy as a budget solution.

“The mere existence of a law allowing states to declare bankruptcy only serves to increase interest rates, raise the costs of state government and create more volatility in financial markets,” they said.

Senate Republican leader Mitch McConnell said no decision had been reached on whether to introduce legislation that would open bankruptcy courts to states beset by financial troubles from the 2007-2009 recession.

But he closed off the option of Congress sending states large sums of money, as it did in 2009 as part of the $814 billion stimulus plan championed by President Barack Obama.

Republicans rode a wave of public discontent over bailouts and burgeoning federal debt in November elections that handed them control of the House and more seats in the Senate.

“There will be no bailouts, I can tell you that. No bailouts,” McConnell said.

The bankruptcy option was dismissed by House Republican Majority Leader Eric Cantor, on Monday, meaning any bill will face an uphill battle in that chamber.


States are already projecting collective budget gaps that exceed $100 billion for the fiscal year that starts in July for most states.

Because Federal Reserve Chairman Ben Bernanke has also balked at suggestions that the central bank could provide assistance, bankruptcy may be the only option for beleaguered states, Cornyn said.

“The question is what do states that are under water -- particularly with regard to their pension obligations and other debt -- do?” he said. “And what’s the impact of their default on the overall U.S. economy?”

Under the U.S. Constitution, states cannot declare bankruptcy as cities and counties can.

Top Republicans have voiced apprehension about states’ shaky financial condition since the November elections, even as they appear divided on how best to proceed.

Last week, former House Speaker Newt Gingrich, who remains a powerful figure in the Republican Party, told Reuters that legislation opening up a bankruptcy option would likely be introduced within a month.

However, Cantor said on Monday that states already have “the requisite tools to address their fiscal ills.”

Gingrich has been discussing the bankruptcy idea for months, drawing a flood of criticism from states, economists and investors in the $2.8 trillion municipal debt market.

“Bankruptcy does not necessarily provide a new tool for the states,” Anthony Valeri, investment strategist for Fixed Income at LPL Financial, said in a note on Tuesday.

“Debtors and creditors still have to negotiate more economical solutions. The taint and legal costs associated with bankruptcy lessen the appeal of such a last resort measure.”

Additional reporting by Lisa Lambert; Editing by John O’Callaghan and Todd Eastham