ByÂ MARY WILLIAMS WALSH, The New York Times
Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.
Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.
But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do whatÂ General Motors did with the federal governmentâ€™s aid.
Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.
Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a stateâ€™s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.
â€œAll of a sudden, thereâ€™s a whole new risk factor,â€ said Paul S. Maco, a partner at the firm Vinson & Elkins who was head of theÂ Securities and Exchange Commissionâ€™s Office of Municipal Securities during the Clinton administration.
For now, the fear of destabilizing theÂ municipal bond market with the words â€œstate bankruptcyâ€ has proponents in Congress going about their work on tiptoe. No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor, although SenatorÂ John Cornyn, a Texas Republican, asked theÂ Federal Reserve chairman,Â Ben S. Bernanke, about the possiblity in a hearing this month.
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