The Crisis of State Bankruptcy

With Central Falls, Rhode Island, filing for bankruptcy, who in their right mind would invest in its municipal bonds? Luckily for current bondholders, Rhode Island passed a law in July that puts them ahead of other creditors, such as recipients of pension payments. But even with this law in place, who in their right mind would buy a Central Falls bond with a Moody’s rating of Caa1—“C” standing for “crap”?

“We didn’t want bondholders to think this state was not a good place to put their money,” says Rosemary Booth Gallogly, Rhode Island’s director of revenue, in speaking about the law. That’s not how markets work, Ms. Gallogly. That’s not going to cut it. The patient is still on life support. It’s like signing Rhode Island up for one of those debt consolidation programs that consolidate all your credit cards into one “easy” payment. It does nothing to pay down the debt the state is drowning in. It’s looking for approval to take on more debt. Give me a break.

What will happen when a state, not just a city, declares bankruptcy? Will President Obama and his team of bankruptcy specialists bail it out as they did GM and Chrysler? You can be sure that saving the union heads and their cushy salaries will be right up near the top of the work-out plan. So much for Gallogly’s law protecting bondholders. Washington prefers to cram losses down their throats.

There is a way for President Obama to sidestep the state mess heading his way, and that’s to allow states to file for Chapter 9 bankruptcy. David Skeel, law professor at the University of Pennsylvania, feels it’s the best option for avoiding a massive federal bailout. Right now, there are fewer than a handful of municipal bankruptcies. But what happens when more take place in states like California, Illinois, or New Jersey?

According to testimony in a 1934 congressional hearing, 2,019 cities and other governmental entities defaulted on their debt during the Great Depression. State bankruptcy is the only way to reorganize and get out from underneath this debt from pensions and create real reform by forcing union leadership’s hand. The last thing our campaigning President Obama wants to do is get embroiled in a nasty state bailout heading into 2012, especially in a non-battleground state.

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E.J. Smith - Your Survival Guy

Preparing your investments and family for when disaster strikes.

E.J. Smith is the Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH, where he completed course-work in Practical and Defensive Handgun, Conceal Carry Pistol, Shotguns, Precision Scope Rifle and Kidnapping Prevention. E.J. plays a Yamaha Recording Custom drum set with Zilldjian cymbals. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com. Sign up here to receive all the best content from Richardcyoung.com each week.