GOP Kills Bonds Program: Secret Plan to Bankrupt States, Bust Public Employee Unions?

The severity of the threat was underscored by the centrist business columnist for Reuters, James Pethokukis, who wrote a blistering piece last week headlined: ​“Secret GOP plan: Push states to declare bankruptcy and smash unions.” No, that wasn’t a headline from The Militant or a blogger at Democratic Underground, but from a sober-minded news organization.

As Pethokoukis explained (hat tip to Naked Capitalism):

Congressional Republicans appear to be quietly but methodically executing a plan that would a) avoid a federal bailout of spendthrift states and b) cripple public employee unions by pushing cash-strapped states such as California and Illinois to declare bankruptcy. This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011.

That’s why the most intriguing aspect of President Barack Obama’s tax deal with Republicans is what the compromise fails to include — a provision to continue the Build America Bonds program. BABs now account for more than 20 percent of new debt sold by states and local governments thanks to a federal rebate equal to 35 percent of interest costs on the bonds. The subsidy program ends on Dec. 31. And my Reuters colleagues report that a GOP congressional aide said Republicans ​“have a very firm line on BABS — we are not going to allow them to be included.”

In short, the lack of a BAB program would make it harder for states to borrow to cover a $140 billion budgetary shortfall next year, as estimated by the Center for Budget and Policy Priorities. The long-term numbers are even scarier. Estimates of states’ unfunded liabilities to pay for retiree benefits range from $750 billion to more than $3 trillion.

The program, which expires December 31, has subsidized both investors and the states, allowing the governments to offer competitive lower rates – and, as part of the original stimulus program, enabled state and localities to finance bridges, roads and other public works, as Bloomberg noted.

To some Republicans, forcing the states to stay within their statutory requirements to keep a balanced budget, even if it means leading some to default on loans, will have valuable side effects – even if it risks plunging some states into bankruptcy. To Republicans, the bonds subsidy program was just another part of what they see as the wasteful and useless original stimulus package, despite the nearly three million jobs saved or created by that broader Recovery Act.

Case in point: one GOP Congressional aide told In These Times, ​“We face enormous challenges, and the federal government will have to tighten its belt just like families and businesses have. The fact that you’re asking about additional money proves that the stimulus bill didn’t work. And extending stimulus spending that was originally billed as ​‘temporary’ (as well as ​‘timely and targeted’) will amount to throwing good money after bad.”

Underlying this view is a philosophy that sees state bankruptcy as positively virtuous. Reuters pointed to commentary in the influential The Weekly Standard and, for Republicans, the broader political benefits of bankrupting states with a few upsides: busting unions and avoiding a federal bailout. Of course, Republican-led states could also be hurt – but that’s just collateral damage in the partisan budget wars. As Pethokoukis observes:

Some Republicans hope the shock of the newly revealed debt totals will grease the way towards explicitly permitting states to declare bankruptcy. Indeed, legislation amending federal bankruptcy law is currently being prepared by congressional Republicans. Local municipalities do declare bankruptcy from time to time, most famously California’s Orange County in 1994. But states can’t. Allowing them the same ability to renegotiate obligations could enable them to slash public employees’ lavish benefits, a big factor in their financial woes. In a recent issue of the The Weekly Standard, bankruptcy expert David Skeel of the University of Pennsylvania walks through the implications:

“With liquidation off the table, the effectiveness of state bankruptcy would depend a great deal on the state’s willingness to play hardball with its creditors. The principal candidates for restructuring in states like California or Illinois are the state’s bonds and its contracts with public employees. Ideally, bondholders would vote to approve a restructuring…

“The bankruptcy law should give debtor states even more power to rewrite union contracts, if the court approves. Interestingly, it is easier to renegotiate a burdensome union contract in municipal bankruptcy than in a corporate bankruptcy… It is possible that a state could even renegotiate existing pension benefits in bankruptcy, although this is much less clear and less likely than the power to renegotiate an ongoing contract.”

It wouldn’t be easy to change the law. Public employee unions have traditionally carried great influence with Democrats, even if President Barack Obama’s willingness to freeze their pay on the federal level suggests their clout may be waning. From the Republican perspective, the fiscal crisis on the state level provides a golden opportunity to defund a key Democratic interest group. For the GOP, it’s an economic and political win.

Yet given the current political weakness of unions and the latest willingness of the Obama and Democrats to sacrifice government revenues and programs on the altar of tax cuts, no austerity measure is off the table in the new GOP-driven Washington. As the Atlantic Online business writer Daniel Indiviglio points out:

How would public employee unions be affected? Providing states the ability to declare bankruptcy would allow them to renegotiate state employee salaries and benefits. Of course, the renegotiation would more likely take the form of slashing, as some of lavish compensation packages are part of the reason why these states are in such a mess.

Yet could Republicans really make this happen? It’s extremely hard to believe that Democrats would allow it. As we saw with the automaker bailouts, they have a very strong allegiance to the unions. It’s difficult to imagine President Obama signing a bill that would result in a bloodbath for public employee unions. But then, until recently, it was also pretty hard to imagine him going along with tax cuts for the rich. So if compromise really is his new game, nothing is impossible.

Inaction could be enough for Republicans to accomplish their goal, however. Even without the ability to declare bankruptcy, if they are unable to issue enough debt to cover their costs, then they’ll have to slash costs somehow. Democrats and the President will then be left with the choice of higher unemployment if contracts can’t be renegotiated or lower wages and fewer benefits for state workers if they can. 

As Indiviglio explains their importance:

Build America Bonds are essentially a special type of municipal bond issued by state or local government entities. There are actually two kinds of these bonds. One sort provides bondholders a tax credit from the federal government for 35% of the interest. The other sort provides bond issuers (a troubled state, for example) a subsidy that allows them to issue bonds at a lower interest rate, competitive with high-grade corporate debt.

The latter form has proven to be more popular. In short, it provides state and local governments the ability to fund their deficits more cheaply, thanks to a handout from the federal government…

In measured tones, he and other critics underscore how significant the failure to extend the subsidy could be to states already reeling from deficits so severe some are dropping Medicaid programs and services altogether:

The fate of the states and municipalities that relied on these bonds for funding, however, is even more serious. The tax receipts that these governments rely on have shrunk since the recession began. Without the ability to issue cheap debt, they will have to cut programs, initiatives, and probably jobs. That is, if they can avoid bankruptcy…

As the well-informed Naked Capitalism economics blog says:

It isn’t hard to recognize this move as part of an effort to push America further into banana republic land, with a small and wealthy elite controlling the government and a greatly disproportionate share of the wealth. As we’ve indicated, those sorts of societies are unhealthy, even for those at the very top, but that does not seem to deter anyone behind this campaign. Notice that the objective here is not to do the responsible thing, which is to figure out the fairest and least destructive way out of the states’ budget woes; it’s instead to push this festering problem to a crisis to achieve another goal, namely, break unions, with the objective of transferring even more to the rentier class.

UPDATE: A new political magazine, Remapping Debate, highlights the ways this new tax deal represents an end on a few key fronts to additional new assistance to the states:

The package appears to mark a definitive end to an important element of stimulus policy: relief to strapped state governments. While states are expected to continue shedding workers and cutting services for the next several years even as the economy recovers, a continuation of spending assistance to states was apparently not considered during the negotiations that led to a tentative agreement between Obama and the GOP.

The fate of a much smaller measure [the Build America Bonds program ] designed to lower state borrowing costs, meanwhile, hangs on further talks. And, in its emphasis on tax cuts over other forms of stimulus, the package may in some cases worsen the state fiscal crisis, according to an analysis by leading state budget observers.