Katrina below links to a Sarah Palin Facebook post against bailing out the states, which is worth reading. Palin is in a decent position to make this argument, since Alaska is one of only two states (Michigan is the other) that do not have a defined-benefit pension system, and Palin took some smart steps as governor to shore up the state’s finances against a crunch.
The case against bailouts for the states that are in the most trouble (California, New Jersey, Connecticut, and Illinois generally top the list) is very strong, of course, and Republicans in Washington seem almost to yearn for the chance to say no to requests for such bailouts. But they should prepare themselves for the context in which such requests would come. They would not come in the course of a leisurely meeting in the Speaker’s office in which Jerry Brown would put out his tin cup and John Boehner would slap the cup away and lecture Brown on responsibility. They would more likely come in the course of a massive bond-market crisis, in which the value of all state and municipal bonds (and therefore the investments and retirement savings of a huge number of Americans) would teeter on the edge of disaster, and the pressure on Washington to act would be immense.
State bonds—including those of the states confronting the very worst fiscal crises—are remarkably strong today because the market implicitly assumes that states will not default on them because Washington would step in if a default were near. Maybe that assumption is unreasonable, but it is certainly widespread. If a state in fact neared or reached default and Washington declined to help, the value not only of that state’s bonds but of all state bonds (and with them a lot of municipal bonds and probably the bond market more generally) would likely plummet, and the consequences would be grave. Such a crisis could feel a bit like late 2008, when serious people of all political stripes were telling members of Congress that the sky could well fall if they did not act, and many conservatives as well as liberals felt they had no choice but to abide drastic measures.
It seems to me that Republicans in Washington are not prepared for this scenario. If they want to make the case in the midst of such a panic that a bailout would be worse than a bond-market crisis, they need at least to be thinking through those arguments now, and getting ready for the intense pressure they will face if the worst does happen. More importantly, they should be looking for ways to avert that difficult choice by making sure that default and bailout are not the only two options available to the states. I think providing the states with the option of bankruptcy—along the lines that David Skeel proposed a few weeks ago—would be one very good step to take while there is still time. There are no doubt some others too. The next Congress should put this on its agenda, because one way or another it is likely to have to confront the crisis of the states.