Washington policymakers are seeking to make it easier for states to declare bankruptcy and escape the burdensome debt that they labor under, often exacerbated by generous pensions paid out to retired public employees.

According to a report in the New York Times, any measures to allow states to file for bankruptcy would have to clear “high constitutional hurdles because the states are considered sovereign.”
Unlike cities, states are prohibited from bankruptcy protection.

Supporters of the move point out that some states are facing such monumental debt – including populous California, Illinois, Texas and New York – that the luxury of bankruptcy might be their only way out of their problems.

The Times report noted that some bankruptcy lawyers who have been consulted by Congress revealed that some officials in Washington think it is only a matter of time until cash-strapped stated seek a bailout.

Aside from short-term budget shortfalls, the report noted that some states “have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care.”

Bankruptcy would allow states to change their contractual promises to retired workers and could provide alternatives to a bailout. Of course, passage of such a move would hurt not only the retirees themselves but also state bond investors.

Consequently, fears of disturbing the municipal bond market has led officials who work quietly behind the scenes.

“They are readying a massive assault on us,” Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees, told the Times. “We’re taking this very seriously.”

Meredith Whitney has already warned that up to 100 U.S. municipalities could default this year. Jamie Dimon, the head of JP Morgan has sounded similar alarms.

For the moment, it would appear that even presenting a draft of a bill allowing states to go bankrupt would face many hurdles.

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