Query to readers. Over at Slate Explainer, Christopher Beam explains that although municipalities and cities and such can go bankrupt under the Federal bankruptcy code, states are not included under Chapter 9. Right, got it. He then adds something I don’t doubt is true, but wonder if readers can point me to the relevant legal authority – the ability of the Federal government to take a state into “receivership” – something, he adds, that has never happened.
What is the legal authority for this process of Federal receivership of a state of the United States?:
Say the state can’t make its debt payments, and no one will lend it any more money. In that case, the federal government can step in and put the state into receivership. This would involve the assignment of an accountant to manage the state’s debt, overseen by a judge. It would be a lot like bankruptcy, except instead of following a structured set of steps—informing creditors, appointing creditors’ committees, a 120-day window to file a plan, etc.—a receiver has the authority to force creditors to renegotiate loans in a speedy fashion. However, the accountant in charge would not have the power to make decisions about the state’s budget, such as which programs needed to be cut and which taxes had to be raised. (No state has ever gone into receivership.)
AMcA says:
I’ll take a crack at this. I think the key question is whether the states are sovereign. And I believe that States are sovereign under the Constitution. They are not parts of a whole that the whole cedes to the control of others (as, for instance, a town is a part of the whole of the state). This is why we refer to states having “sovereign immunity” from certain kinds of liability imposed on others by the federal government.
The Bankruptcy Code does not mention bankrupting a state by design, I bet.
And I think a state could, probably, do as its sovereign little heart desires with regard to its debts. It could default on its own terms, I think.
There endeth tonight’s informed speculation.
March 9, 2010, 9:56 pmCalderon says:
I honestly have no idea, but Beam says that for the answer he relied on “Kenneth Klee of UCLA Law, Alexander Laughlin of Wiley Rein LLP, and John Pottow of the University of Michigan Law School.” One of those must have given him the receivership idea. If you really want to know, you could e-mail the three of them asking which one provided the information to Beam. Of course, if they all deny giving that info to Beam, then you can start an intertubes scandal for Slate!
March 9, 2010, 10:02 pmJ. Aldridge says:
I’m more concerned with the United States going into bankruptcy than a state.
March 9, 2010, 10:06 pmEvilDave says:
If they go into receivership can we bounce them back to territory status (ala Reconstruction)?
March 9, 2010, 10:13 pmAfter all, by definition, they are failed states.
Goobermunch says:
Nah, at that point, we can just go through their pockets looking for loose change.
–G
March 9, 2010, 10:20 pmCornellian says:
Neither your quote nor the article you link to provides any legal authority for the notion that the Federal government can simply step in an assign a receiver to take control of a state’s finances. It’s certainly questionable whether such a measure would even be constitutional and even if it were constitutional, the article doesn’t mention any federal statute purporting to authorize such a receivership.
March 9, 2010, 10:29 pmMark Field says:
If there isn’t such legal authority, there ought to be. It should include penalizing states in some way if they do go bankrupt (e.g., reversion to territorial status). If there are no such consequences, the rest of the nation bears the risk of stupidity in places like CA.
March 9, 2010, 10:44 pmBarbara Skolaut says:
Unless it’s California – then Bambi et al. will just give the unions there more of our money and tell them it’s not their fault – they’re “too
March 9, 2010, 11:05 pmin the tankbig to fail.” :-(DangerMouse says:
I think you’re right. States are sovereign and sovereign means sovereign. Nowhere does the Federal government have the power to take a state into “receivership.” If Congress tried to pass a law to do it, it probably would be unconstitutional. States can probably default on their own debt.
March 9, 2010, 11:12 pmLe Comte says:
The Pew Center on the States held a conference on 13 November 2009 in which Michael Genest, the Director of the California Department of Finance, said that he had been looking very hard at the legalities of California reverting to territorial status. The only purpose of such an act would be to avoid debt repayment, i.e. to default on the Commonwealth’s massive debt.
I’m not sure what he was thinking as California already has sovereign immunity. And I think it HIGHLY likely that California WILL default. The bond holders will have no recourse and will be vilified as greedy predatory lenders by the same lovely folks who incurred these debts on behalf of the citizens of the Commonwealth. The “evil” bondholders will meekly negotiate and will take a sizable haircut.
As for Illinois: rinse and repeat.
There’s an MP3 of the event somewhere on the site near here: http://www.pewcenteronthestates.org/events_detail.aspx?id=55948&nav=past
March 9, 2010, 11:24 pmSun Tzu's Nephew says:
Well, one state can, once….
March 9, 2010, 11:33 pmBlue says:
I don’t see that a state needs to go into formal bankruptcy at all. It would simply cease paying most debts incurred prior to some date and be forced to finance current operations through a combination of current revenues and forced script/short term loans to employees. (Some debt, backed by specific revenue streams, would probably still be current.) What that won’t do is get the state out of property claims held by pensioners and the like, of course.
March 9, 2010, 11:35 pmll says:
Would it also be unconstitutional for the federal government to bail out a sovereign state?
March 9, 2010, 11:45 pmmkellerm says:
States can and have defaulted; Pennsylvania, Maryland, Illinois, Indiana, Michigan, Louisiana, Mississippi, Arkansas, and the Territory of Florida all defaulted on or repudiated their debts in the early 1840s. Some eventually repaid, some restructured, some did nothing, but they all regained access to debt markets after a time. There is an academic literature on this; for example, see William B. English, Understanding the Costs of Sovereign Default: American State Debts in the 1840′s, The American Economic Review, Vol. 86, No. 1 (Mar., 1996), pp. 259-275.
March 9, 2010, 11:59 pmTravis Ormsby says:
Um, no. Didn’t we have a whole war about that? Plus there’s that pesky Article I, Section 10 thing.
I’ll agree that receivership seems kinda far fetched, but sovereign most definitely doesn’t mean sovereign as far as the states are concerned.
March 10, 2010, 12:18 amyankee says:
The federal government has the authority (and therefore presumably the power) to ensure that each state has a republican form of government. If Congress finds that a state has so badly mismanaged its finances that it no longer has a functional government, it can arguably step in to restore the state’s government to functionality. Under the political question doctrine Congress has the final word in interpreting the Guarantee clause, so its authority in this area is (arguably) quite broad.
March 10, 2010, 12:20 amPerseus says:
I agree with mkellerm. A earlier example is Hamilton’s famous plan for assuming state debts left over from the Revolutionary War. Without assumption, Hamilton argued, “the debts of a large majority of the States would have remained without adequate provision, and would have been in danger of being frittered away by means inconsistent with the spirit of public credit.” I.e., it appears that not even Hamilton contemplated such an assumption of power by the federal government over a state. So long as a state does not try to create its own currency or pass a law that actually impairs the obligation of contracts, the federal government seems to lack any authority to force a state into receivership (especially given the sovereignty of the states). Then again, the federal government can always threaten to withhold federal money to force a state to acquiesce.
March 10, 2010, 12:48 amShelbyC says:
Well, the 11th amendment keeps states out of federal court, but wouldn’t state judges have the power and the obligation to force states to pay? And the contracts clause prevents them from repudiating them, no?
March 10, 2010, 1:02 amcubanbob says:
AMcA says: You are correct. States are sovereign and can default on or repudiate its debts.
Congress has no authority on this matter over the states and under the current constitution it cannot. Indeed states can absorb the debts of all governments under its jurisdiction, forbid them to incur any future debt (for any defined period of time) and declare those debts as odious debts and repudiate them. And Congress can do the same for all federal obligations. That is the risk of lending to or entering in to a contract with a sovereign.
Yankee the the states predate the federal government, they created it they are not departments of or sub-divisions of the federal government. They are co-equall sovereigns who chose to limit their powers when they chose to create the constitution. As for new states and territories added after the adoption of the constitution the Northwest Ordinance requires that state and territories constitutions cannot be alien to the US constitution. Simply stated they can grant greater rights than the US constitution but not less.
ShelbyC again states like the federal government are sovereign and cannot be sued unless they allow themselves to be sued and only to the extend they allow themselves to be sued.
Can a state default ? Yes. Would it be wise? Absolutely not. As pointed by others, several states defaulted in the 1840′s. However they paid a ruinous price for decades when they could not sell bonds or when they were able to they had to pay much higher rates to induce lenders. Argentina not that long ago stiffed its creditors. They are not exactly doing too well in attracting new lenders or investors.
Perseus: interesting point, perhaps they can sweeten the pot by banning the deductibility of taxes paid to a state the defaults or repudiates its debts. It might encourage states to pay up. Or they may play a game of chicken with Congress by stating that all taxes paid by its state citizens must be to the state department of revenue for further credit to other governments. States like California for certainly have the technical means to do something along these lines. It’s not something that the feds or the states ever want to get into a contest over.
If this situation continues and worsens perhaps the only way out would be for a constitutional amendment that allows a state or state transfer it debts to the federal government and in return forbid that state and its sub-divisions from incurring any new debt for a defined period of time.
March 10, 2010, 1:55 amCornellian says:
Well, the 11th amendment keeps states out of federal court, but wouldn’t state judges have the power and the obligation to force states to pay?
Doubtful since the state likely hasn’t waived sovereign immunity in state court. Besides if a state really were worried about that scenario, they’d just retract their sovereign immunity waiver before defaulting.
And the contracts clause prevents them from repudiating them, no?
I doubt it. Even if the contracts clause prevented a state from passing a law nullifying its debt contracts, I don’t see why it would prevent a state from simply defaulting on those contracts and then relying on sovereign immunity as a defense to a breach of contract suit.
Governments pay their debts largely for political/economic rather than legal reasons. It’s hard to run any large operation without credit and institutions that default (including governments) have to spend a long time in the no-credit penalty box.
March 10, 2010, 1:56 amCornellian says:
If this situation continues and worsens perhaps the only way out would be for a constitutional amendment that allows a state or state transfer it debts to the federal government and in return forbid that state and its sub-divisions from incurring any new debt for a defined period of time.
California would be fine if it reduced spending to 1990 levels with an adjustment for inflation and the increase in population. The state wasn’t falling apart in 1990 so I don’t see why that amount of cutting represents some kind of doomsday scenario.
March 10, 2010, 2:00 amJ. Aldridge says:
You should read what both Republicans and Democrats said could not be done by the Federal Govt. to former rebel states after they had been restored.
March 10, 2010, 3:06 amNathanM says:
This is all true, and even if it wasn’t, the state could pass a law preventing enforcement proceedings so any judgment against the state enforced under state law would be meaningless.
March 10, 2010, 3:30 amPerseus says:
This article by California Assemblywoman Diane Harkey suggests how a state can be forced into federal receivership:
Obviously, the federal government can dictate the terms of a federal bailout. The accumulation of lawsuits would come about as a result of the state failing to meet federal standards and requirements. E.g., California prisons are already under federal receivership, and the proposed cuts to the parks budget could trigger a federal takeover of several of them as a result of the terms of their transfer to the state.
March 10, 2010, 5:55 amConnie says:
How can you find an impartial judge, whose pension is not going to be influenced by a decision? Every single state judge has an unresolvable conflict of interest.
March 10, 2010, 8:59 amBlue says:
The choice California may face is between the bad limitations imposed by the Federal government as a condition of receiving funds and the bad limitations imposed by the market due to a default. Any private lawsuits aren’t really an issue; they’ll simply linger since the judges cannot force the appropriation of funds. E.g., every session here in Texas people who have been horribly wronged by the State and have a judgment must try to find a member to sponsor a bill to pay them and get it through the Lege process. It’s totally dependent on how the members feel about whether it happens.
As Perseus points out, however, the Federal lawsuit question is more interesting. Since the vast majority of Federal control over states is related to restrictions in funding, what a default and corresponding reduction in expenditures would largely entail is a cut in Federal matching funds of various types.
As to what happens when the Feds tell a state that its has to spend money to correct, say, an equal protection fault through a lawsuit and the state tells the Feds to suck eggs…that’s a more interesting question to me. I guess at the end of the day the Federal government could send in the military to protect certain Constitutional rights (a la Little Rock).
March 10, 2010, 9:03 amShelbyC says:
Gotcha, I’d forgotten about that. Sounds like states don’t need bankruptcy, as many of the other folks have pointed out.
March 10, 2010, 9:26 amSun Tzu's Nephew says:
Article I Section 10:
No state shall enter into any treaty, alliance, or confederation; grant letters of marque and reprisal; coin money; emit bills of credit; make anything but gold and silver coin a tender in payment of debts; pass any bill of attainder, ex post facto law, or law impairing the obligation of contracts, or grant any title of nobility.
How’s that?
March 10, 2010, 9:39 amFormer Army MP says:
There is quite a bit of tribal based law on this. Many many tribes have just up and said “No thanks, we don’t want to perform on this contract” and “No thanks, we have decided not to pay you what we owe you.”
March 10, 2010, 9:41 amThe courts are clear, sovereign means sovereign. Never, ever, do a deal with a tribe unless you have outside security or an outside payment bond.
Matt says:
My goodness, how have could nobody thought of the interstate commerce clause?
California borders other states and some people cross those borders carrying things that are bought and/or sold. As a matter of regulating interstate trade the federal government must be able to regulate the the commerce in a state (ala Raisch) and because state debt eventually will have an effect on commerce (higher taxes, less state spending, etc, etc) the federal government must step in to take control of California.
The commerce clause, is there anything it can’t do?
March 10, 2010, 9:47 amDavid says:
I don’t know if it’s directly germane, since–unlike states–cities aren’t sovereign entities, but isn’t there some relevant precedent in the “Big Mac” (Municipal Assistance Corporation) arrangements that were made for New York City in the 1970s when they threatened to go bust (“Ford To City: Drop Dead”)?
March 10, 2010, 10:23 amwill47 says:
Sovereign immunity can be waived, of course, and it’s possible, but unlikely, that a state could have a blanket statutory waiver that would apply to state receivership statutes. What’s slightly more likely is that sovereign (and 11th Amendment) immunity has been waived, perhaps unwittingly, for a development corporation of the state; these entities are often exempted from general provisions of state law in manners that the legislatures creating such entities don’t really understand.
March 10, 2010, 10:33 amSmooth, like a Rhapsody says:
Per Kelo, the feds could/should declare the entire state of California a blighted area and sell it to someone who can run it efficiently.
March 10, 2010, 10:36 amStuart_the_Viking says:
Matt: Sadly no. There is (aparently) nothing that the interstate commerce clause can’t do. What a brilliant and sadistic idea. You win the internets for today.
s
March 10, 2010, 10:47 amAllan Walstad says:
If the state can’t borrow more money, its pols will be forced to set priorities on how to allocate the revenue streams they do have. That’s a good thing, and the sooner it happens the better. Unless of course the federal pols decide on a bailout and use it as a wedge for assuming even more unconstitutional powers. Then we’re moving a little faster down the road to insolvency on a national scale. Who’s gonna step in then? Nobody, let’s all hope.
March 10, 2010, 10:53 amElliot says:
If California defaults, who will be blamed and vilified as greedy? Who will be cast as victims. We shouldn’t have to wait to start the game.
March 10, 2010, 10:55 amgeokstr says:
Huh?
The only reason the Fed’l Govt isn’t in the same exact position as CA, only lots bigger and much worse, is because they can print money, and borrow from themselves via the Fed, the largest owner of our debt by far. They’re going to show the states how to do it right?
Please.
Fortunately, a model and precedent already exists on how to handle this. The US tells the CA bondholders to take a hike, gives the SEIU a 55% ownership stake in the state with no cuts in their own loot, and then tells private businesses in the state how much they can pay their executives.
That’ll fix it.
March 10, 2010, 11:12 amH Frisson says:
>>It should include penalizing states in some way if they do go bankrupt (e.g., reversion to territorial status).
What about those 13 states that were colonies and were never “territories”? Do they revert to the British crown? Kidding, of course, but this is a fine pickle to find ourselves in. ;-)
March 10, 2010, 11:23 amray_g says:
In the early 1980s in Washington State the Washington Public Power Supply System defaulted on their bonds. Did that have significant fallout (pun intended) for Washington State? Now, it wasn’t the whole state, but IIRC at the time it was the largest municipal bond default in U.S. history.
March 10, 2010, 1:01 pmMark Creatura says:
I read Beam’s article, and figured he was writing nonsense when he wrote about a federal ability to put a state into receivership. Then I saw his thanks to Ken Klee. Well Ken Klee on any given morning forgets more about restructuring and insolvency than I ever knew, so I have to take the idea seriously. No other reason, though, just reliance on that authority.
March 10, 2010, 1:22 pmcubanbob says:
Sun Tzu’s Nephew says:
cubanbob: AMcA says: You are correct. States are sovereign and can default on or repudiate its debts.
Article I Section 10:
No state shall enter into any treaty, alliance, or confederation; grant letters of marque and reprisal; coin money; emit bills of credit; make anything but gold and silver coin a tender in payment of debts; pass any bill of attainder, ex post facto law, or law impairing the obligation of contracts, or grant any title of nobility.
How’s that?
Impairing obligation of contracts is referring to States interfering with contracts between private parties. A state is still sovereign and the feds cannot compel it to pay its obligations. States like California, Illinois and New York are are hoping for an implicit federal bailout guarantee like that of Fanny Mae and Freddy Mac but politically that is an near impossibility.
March 10, 2010, 1:27 pmObserver says:
“Impairing obligation of contracts is referring to States interfering with contracts between private parties. ”
Wrong. United States Trust Co. v. New Jersey, 431 U.S. 1 (1977)
March 10, 2010, 5:14 pmagesilaus says:
Don’t the Federal Courts have authority over interstate debts? As in bond holders who live outside the affected state?
March 10, 2010, 5:49 pmpublic_defender says:
What’s the source of this “receivership” argument? A code section? Constitutional provision? Court decision?
I also don’t see how the sovereign immunity doctrine protects the states. The Fourteenth Amendment prohibits states from taking property without due process of law, and 42 USC 1983 provides a remedy in federal court against states. A contract with a state government creates a property interest that would seem to be enforceable through a 1983 action.
Of course, maybe the author is right. Maybe he means that Congress could pass a law that would modify section 1983 to create a receivership. If true, that means the pro-receiver side would have to muster a majority in the House, 51 or 60 votes in the Senate, and a non-veto from the president. Imagine the horse-trading that would lead up to that.
Of course, that’s just a guess. But the professor’s unsupported assertions could use some citations to authority. He needs to show his work.
March 10, 2010, 8:13 pmpublic_defender says:
My last post got muddled in my show-your-work points.
Maybe the professor was saying that Congress pass legislation that immunized a certain state from suits to enforce debts or other property interests unless the claimant’s agreed to some sort of arbitration as to the amount of debt. After all, the Fourteenth Amendment leaves it to Congress to pass enforcement legislation. What Congress giveth, Congress can taketh away.
That would also explain why the professor says the “receiver” could not touch budgetary questions.
I’m just speculating here. I’m waaaaay outside my area of knowledge. But at least I give a coherent theory that others can support or refute.
March 10, 2010, 9:22 pmPeter says:
Havent judges ordered states to spend more money on schools in urban areas, either because of education clauses in st constitutions or the fed eq prot clause?
I could envision a Dem judge in a Dem state, such calif or iL, ordering a st legislature to pay state employees before creditors or bondholders, and even one ordering a legislature to raise taxes to do it.
I think it has been pretty much established that the sup ct will not use the contract clause to force states to pay their debts.
i bet the situation ends up similar to that involving chrysler or ford–persons owning state bonds get screwed, the feds throw a pile of money at the st with the understanding the lion’s share of it will go to employees or retired employees.
the other wrench complicating this issue: several sts, including IL and NY, have clauses in their st consts prohibiting the st from lowering pension payments.
What I would like to know is: could Congress condition a fed grant so that a state accepting it had to agree to (a) amend its const to get rid of such a clause, (b) agreeing to cut pension payments regardless of the clause?
In other words, the grant itself would provide that such const clauses of sts accepting grants are null and void. Could Congress do that? could the sts? perhaps any legislature doing so would be violating its own st const.
March 10, 2010, 10:10 pmpublic_defender says:
I don’t think Congress could require a state to violate a Fourteenth Amendment property interest, which is what state pensioners have in the pensions they have earned. Congress might be able to immunize the state from federal lawsuits to enforce that right, but that’s it, at least as far as I see.
Part of the problem is that California is only insolvent because of the voluntary choices of its leaders and its people. It could tax more, cut spending, or sell off assets. But it refuses to take substantial steps on any of those fronts.
And that explains why a “receivership” would be ineffective as a matter of policy. It might (might!) give California a clean slate, but the structural governance problems would remain in place. The initiative and super-majority rules in California make it too easy to add spending, too hard to cut spending, and too hard to raise taxes to cover the spending problems.
March 11, 2010, 7:34 am