On state bankruptcy and bond traders

Implicit in the question of whether states should be allowed to file bankruptcy is, what happens to the bondholders? Do they get paid in full or take a haircut? In fact, this is probably a core issue.

Bond holders say that defaults or haircuts will have unseemly effects. They weep crocodile tears that default will only hurt those who default, because bonds will then be harder to get and cost more. (Gosh, that sounds like a threat, doesn’t it?) But Iceland recently called their bluff, defaulted on all bond payments, and is now recovering. Their world didn’t end.

We will probably see the functional equivalent of state bankruptcy soon. Too many states have obligations they can’t possibly meet and the federal government is in no position to bail them out. One version of this may come if and when states default on bond payments. That’s when the real fireworks will begin.


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