NOT GOOD FOR TOURISM – AT 8:52 A.M. ET:  We reported yesterday how a delegation of mayors visited Washington, hat in hand, asking for financial help.  Now we find that the states, possibly even more desperate, are considering a drastic step to remove all the red ink from their ledgers.  From The New York Times:

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.

Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.

COMMENT:  This is going to be messy, and the mess will be concentrated in the largest liberal states, like California, New York, and Illinois.  We may well see powerful unions up against each other, and ugly racial and ethnic conflicts.  Everyone will be fighting over the same pie.

Here in New York, the prospect of defaults on pension payments exists in sharp contrast to huge payouts on Wall Street, something that will not encourage support for the free enterprise system. 

Illinois has just decided to raise taxes dramatically.  Surrounding states are now moving in to lure Illinois companies.  The potential for state financial crises to lead to shifts in population is very real. 

So is the potential for real social disruption.  A good chunk of California's deficit is caused by payments to those here illegally.  If California raises taxes, how long will it take for the immigration issue to bubble to the surface?

January 21, 2011