State Bankruptcy and Government Default

I’ve never been a fan of California.  Any state that can house Lindsay Lohan and the Kardashians within 30 miles of each other must have something horribly wrong with it.  Aside from Hollyweird, though, it doesn’t seem like there is much of anything doing, business-wise, in Cali.  California isn’t the only state that’s in an increasingly hopeless financial situation.

I’m thinking of my home state, Illinois: Land of Lincoln, where Chicago thinks that it’s the real capitol.  Seriously though, Illinois has been in a terrible financial situation for a lot of years.  Our politicians aren’t exactly known for being honest – the last two, Governors Ryan and Blagojevich, have wound up in the pokey for being so corrupt that even the Chicago machine couldn’t hide it.  I suppose it’s not exactly surprising the Illinois is going down by the head.  Unfortunately, these two sad sack states are also joined in the financial nether regions by New York and Michigan.  Together, these four states comprise about 25% of the US GDP and are home to about 25% of the population.  Not exactly encouraging news.

A month or so back, everyone was wringing their hands and sweating about the possibility of the federal government defaulting on its obligations.  To my way of thinking, that was hardly the massive crisis which the media made it out to be.  For one thing, it wouldn’t be the end of the world if the government were forced to cut back and make choices about which bills to pay.  The fact is that we can’t afford the world police state, corporate welfare, and welfare for the citizens.  It’s not possible.  Besides that, America has defaulted before, whether or not the media makes that known.  In 1933, we defaulted when President Roosevelt devalued gold (back then, our currency was very definitely tied to gold) from a little over $20 an ounce to $35 an ounce.  WWI bonds issued during the Wilson administration, which were redeemable in gold coin, were not honored by the Roosevelt administration.  Congress passed the resolution, and it was upheld by the Supreme Court.  The bonds were only redeemable in paper currency.

What’s my point here?  Well, part of  my point is that is not unheard of or impossible for a government to default.  The Illinois state government has been in what I would consider a state of default for quite some time.  Businesses have gone bust in Illinois due to lack of repayment by the government.  According to the comptroller’s office last year, Illinois was about $5bn dollars in the red.  Who wasn’t being paid?  The state university, schools, child care and rehab centers… The list is extensive and getting longer all the time.  The problem gets worse when you figure in the fact that the state is borrowing to pay on the debt that it already has.

So what happens if the states – any of them – start going bankrupt?  What happens if nobody will loan them the money to eke out another week of meeting payroll?  Well, more than likely they’ll be put into receivership with an accountant overseeing budget cuts and tax hikes.  The accountant will be overseen by a judge.  It would not be entirely dissimilar to what happens when a corporation goes into bankruptcy.  In an attempt to stave off insolvency for another few months, Illinois decided to raise the income tax rate by 66% and the corporate tax rate by 45%.  That’s about an $800 per year increase for someone on a $40K salary.

The inconvenient truth of the matter is that it is possible for states and federal governments to go bankrupt.  Printing money will not solve the problem but rather serve to make the end all that much more painful.  Honestly, I think there is a quite a strong possibility that, rather than the federal government going bankrupt overnight, which is what the media and the yay-hoos in Washington were threatening, the states will slowly start to go bankrupt one-by-one.  Assets, such as roads and bridges, would be sold off or privatized.  Pensions will not be paid out.  The state employee unions will howl, but if there’s no one to pay the bills, well…

Although I am not certain that this is the way that things will go, I certainly think that it’s possible that the defaulting of America will come from the state level rather than the federal level.  It would be somewhat similar to what the EU is experiencing now, I’d expect.  It will be impossible to float the entire economy if state after state is falling into the net.  And that is when things could get really ugly.

Here are two articles that cover the subject of the states’ bankruptcy in greater detail: Four Bankrupt States and Illinois Bankrupt.  If you Google it, you will come up with plenty of information concerning the topic.