Will GM’s Politicized Bankruptcy Become a Model for States?

man in barrelThe New York Times reported last week that policy makers are working behind the scenes on ways to allow states to declare bankruptcy. States are currently banned from seeking protection in federal bankruptcy court.

One has to wonder if General Motors’ bankruptcy outcome will embolden lawmakers to pursue a similar course for states that are overburdened with pension obligations and municipal bond debt. In the case of the GM outcome, union pension obligations were given precedence over creditor claims. The precedents set by the Obama Administration’s manipulation of GM’s bankruptcy will continue to have far-reaching, negative implications.

During the General Motors’ bankruptcy process, the politically favored UAW benefited at the expense of GM bondholders. Regarding the possibility that this precedent can be repeated in a state bankruptcy, a Wall Street Journal opinion piece warns that “It’s more likely that a state like California would pursue bankruptcy if powerful unions and other budget-dependent interest groups saw this as a way to deflect some of the pain to bondholders. California is one of the states that constitutionally guarantees its general obligation debt, and whose bondholders are now seemingly untouchable. That could change with a bankruptcy option.” It is generally assumed that any such action would disrupt bond markets and raise the cost of borrowing for all states.

It seems that a safer approach to state liability reduction would more closely resemble NJ Governor Chris Christie’s attempts at reducing pension obligations at the state level. The WSJ piece points to the possibility of New Jersey’s unions seeking a federal bailout if bankruptcy were an option. As in the GM process, union members would benefit at the expense of creditors and taxpayers.

California Treasurer Bill Lockyer claims that any state bankruptcy would be dangerous and could ultimately end up being devastating. Lockyer says that states did not ask for Congress to work on a plan to allow for bankruptcies. He goes on to say that states have the tools to fix budget shortfalls and that a state bankruptcy plan would be like taking a “wrecking ball” to state economies and taxpayers.

With huge corporate bankruptcies being viewed as “successes” and individuals defaulting on mortgages at a record pace, it might be prudent to reevaluate our country’s trend of becoming a nation of renegers. The General Motors’ bankruptcy process was an example of cronyism and political payback with egregious contract law abuse. Let’s not repeat the process at a state level.

Mark Modica is an NLPC Associate Fellow.