California’s Nuclear Option

“President Obama, can you print up a few billion for my state?”

California, in the (appropriate) person of Governor Schwarzenegger, has gone crawling to Washington to beg for handouts.  This is a bad idea because it is no long-term solution and federal money comes with strings attached.  Washington, like Mr. Potter, the avaricious banker in Frank Capra’s It’s a Wonderful Life, cares only for its ambition to own and control everything and everyone.  There is another solution – debt  restructuring (“bankruptcy”).

Bankruptcy is a court-supervised procedure for settling debts owed by a debtor in financial distress.  Under Chapter 11 (oversimplified), bankruptcy commences with filing of the bankruptcy petition.  The debtor acts as a trustee overseeing the “bankruptcy estate“.  The court groups creditors into committees according to payment priorities (e.g., secured creditors, non-secured creditors, etc.).  The debtor works with creditors and the court to restructure debts under a repayment plan.  The court has the power to affirm or avoid executory (ongoing) contracts, and to recover some payments paid creditors before filing bankruptcy.

Federal bankruptcy law doesn’t provide for state bankruptcies.  The Constitution vests Congress with the power to create “uniform Laws on the subject of Bankruptcy throughout the United States”.  The federal bankruptcy code includes provisions for individuals, businesses, municipalities, farmers, and fisherman – but not states.  However, the 10th Amendment may limit Congress’ power to enact a state bankruptcy law.  And the Constitution may be no bar to a state debt restructuring law (like bankruptcy).  California seems the perfect test case for such a law.

Municipalities can file for bankruptcy under Chapter 9 of the bankruptcy code (subject to 10th Amendment limitations).  While similar to Chapter 11, Chapter 9 gives municipalities greater power to rewrite collective bargaining agreements and renegotiate unsustainable pension and benefit obligations. Chapter 9 provides a model and starting point for state debt restructuring.

Taxpayer groups might draft a California Debt Restructuring Act (CDRA) and submit it to the voters as a ballot initiative.  CDRA would vest judicial supervision in the California Supreme Court.  It would function essentially similar to Chapter 9 – preserving state executive, legislative, and judicial powers; authorizing creditor’s committee(s); permit avoidance of burdensome contracts and rejection of collective bargaining and pension agreements; include appropriate treatment of bondholders, adjustment of debts, and court confirmation of the restructuring plan.

CDRA would be problematic and would not cure California’s governance problems.  It’s problems would include due process – the “right to be heard“.  Chapter 9 provides for a right to be heard by “parties in interest” (including residents, property owners, and taxpayers).   CDRA might provide for this by including these groups in committees (e.g., “property owners committee”, “taxpayers committee”, etc.)  In any case, the CDRA process would be time-consuming and expensive.

But does California have any other choice?  CDRA may be the only way forward, so long as Sacramento remains captive to the special interests (especially public employee unions) whose endless appetite for spending can only be satisfied by robbing the citizenry of their savings and the economy of needed investment.


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