The federal government needs a ‘state fiscal task force’

Some analysts predict that if the federal government is faced with the choice of a bailout or a state failure, the bailout will win the day. This is understandable. A state failure would mean the shutdown of vital services and a default on municipal bond debt. Without question, this would lead to chaos in the streets and a massive disruption, if not shut down, of the capital markets. While a bailout may prevent this, it would have its own significant moral hazard risks.

First, states would avoid the hard choices necessary to fix their long-term, structural problems due to the implicit federal government guaranty of their obligations. Second, the implicit guaranty of the states’ obligations effectively would add the liabilities of the states to the federal government’s balance sheet. And, third, the public unions would have no incentive to negotiate reasonable, yet meaningful, modifications to their pension and healthcare entitlements, entitlements which must be addressed for states to achieve long-term fiscal health. 

Rather than taking a “wait and see” approach that could make a federal bailout likely if a state runs out of money, President Obama should be encouraged to form a federal bipartisan “State Fiscal Task Force” comprised of respected public union representatives, economists, restructuring advisors, business leaders and others to make recommendations on how to help a state on the precipice of failure. Specifically, the State Fiscal Task Force should take 90 days to complete a comprehensive analysis of the issues, weighing the costs and benefits of competing recommendations, the goal of which would be to develop a concrete policy to enable states to avoid both a default and a bailout.

A bankruptcy law for states should be on the table for debate. While recent proposals for such a law have been both politicized and criticized, bankruptcy works in the corporate and municipality settings and deserves consideration. Bankruptcy is misunderstood and attacks on bankruptcy as a process for alleviating fiscal problems are not new. When General Motors was teetering on the precipice of failure, many argued that a General Motors’ bankruptcy would lead to the end of the automotive industry in the United States and the loss of thousands of jobs. But, in the end, the General Motors bankruptcy was a success for General Motors, its employees and the automotive industry. 

This is because bankruptcy works, when it is planned out in advance, experts do their jobs well and an experienced judge presides over the process. Rather than Washington simply bailing out GM to help it avoid bankruptcy, the federal government provided the financial assistance needed to finance the company’s Chapter 11 case and that enable it to restructure successfully. 

And this may be the best argument for the creation of the State Fiscal Task Force. The auto task force created in response to the auto industry’s crisis enabled bankruptcy to work as part of the plan to revive GM and Chrysler.   Creating the “State Fiscal Task Force” would allow for debate, transparency and time to get prepared.

Over the last few years, we have learned as a nation that even the unthinkable can happen. We have also learned that being prepared for the worst case economic scenario is far superior to acting when fiscal disaster strikes and chaos begins. Consequently, the creation of a “State Fiscal Task Force” will allow us to be prepared. 

Worst case, we debate interesting issues that are theoretical and create a policy that never needs to be used. Best case, we are prepared when a state runs out of cash and comes to the federal government seeking a bailout. Without question, we need to be prepared.

Mr. Henes, a partner with Kirkland & Ellis LLP, is a restructuring attorney who represents large corporations in financial distress and distressed investors.