FEDERALISM, THE CONTRACTS CLAUSE, AND CALIFORNIA

A number of states are seriously under water financially (led by California, Illinois, Michigan, New York, Massachusetts---the usual suspects), and there has been speculation that Congress will add a provision to the Bankruptcy Code to allow states to go bankrupt. Currently, there is no such procedure, so if a state defaults on its obligations, it will remain liable for those debts into perpetuity. The magic of bankruptcy is that, by operation of law, it permits the debtor to discharge prior obligations and obtain a "fresh start."

The reason there has never been a provision for states in the Bankruptcy Code is that states retain many aspects of sovereignty under the federal system, and one traditional aspect of sovereignty is that THE SOVEREIGN CANNOT DISCHARGE ITS DEBTS except by paying them. Default is the end of the line, and the end of the sovereign. This has been the case, basically, forever. When the sovereign is truly broke, there's a revolution, or the country is taken over by another country, or Marie Antoinette gets beheaded, or the Weimar Republic disappears. Unlike the most destitute schnook in Manayunk, the sovereign can never say, "Sorry, guys, but I'm not going to pay." Other sovereigns have to give you a loan, or "restructure your liabilities" or agree to something similar, or you're dead.

But the campaign to provide states with a route to bankruptcy and discharge of their debts creates a Constitutional issue. (This is one of the amazing and beautiful things about our Constitution---that it pops up when you least expect it and makes you think about what you are doing.) The Contracts Clause, in Article I, Section 10, provides: "No State shall...pass any Bill...or Law impairing the Obligation of Contracts...." It is curious that the Contracts Clause applies only to states, but the explanation is fairly straightforward. There was no reason to place limits upon the federal government because the power to alter contracts is not among those enumerated in the Constitution. In other words, since the feds have no basis upon which to exercise such a power, there was no reason to explicitly bar them from doing so. (In addition, it would not have occurred to anyone in the 18th Century that a sovereign nation could default on its debts and continue to exist, so the power of the United States to renounce its debt was not an issue of any practical import.)

The powers of the states, however, were a different matter. Were they to be sovereign entities or not? This is the argument between the Federalists and the Anti-Federalists that is no more settled today than it was in 1887. The Contracts Clause embodies the Founders' resolution of the issue ---the states, just like the new federal government, were to be sovereign in at least this limited sense. The states, just like the feds, had to pay their bills.

So what will happen when California (for example) defaults? There are several possibilities.

First, the federal government might decide to bail them out. This would be a complete victory for the Federalists who, today, are called left-wing Democrats or Progressives. They HATE "state's rights," and this would be the end of them, at least where California is concerned. If the federal government were to keep California afloat, it would do so only on condition that the state consent to federal supervision of basically every state function. The sovereign (or quasi-sovereign) entity that is California would remain a "state" in name only. As other states fell under the weight of their debt, state sovereignty would begin to seem like a quaint and antiquated notion until finally it disappeared altogether.

Another possibility is amending the Bankruptcy Code to allow states a discharge of their debts. The thorny Constitutional issue is whether such a thing is permitted under Art. 1, Sect. 10. It is true that this would be a federal law and that the Contracts Clause, by its terms, applies only to state action. However, in order for California to take advantage of such a provision in the Bankruptcy Code, it would have to choose to do so, and that choice would be the equivalent of a "Bill...or Law impairing the Obligation of Contracts." That, in any event, would be the argument. If anyone tells you he knows how the Supreme Court would decide this question, he's lying.

If a state bankruptcy is permitted, the Federalists win again. Though a legal discharge of debt would not instantly make California a ward of the federal government (as would a bail-out), it would fatally undermine any claim California might make that it remains an independent entity. Again, sovereign states just don't do that sort of thing, and the only reason it could do so in this case is because it was permitted to by the REAL sovereign, the United States of America. At that point, it becomes hard to come up with a theory of government that would justify California in running its own police force or passing its own laws. Logically, final authority would reside in Washington D.C.

The other possibility is for states to do nothing, and simply default. This is what happened following the Panic of 1839 when 10 US states (out of 29) defaulted on loans from British and Dutch banks. Almost all of the debt was ultimately repaid, but the citizens of the defaulting states rejected all proposals for the federal government to assume their states' debts. Even though this meant their states would be cut off from the world's credit markets, the attitude of the citizenry appeared to be that a long period of downsized government and severe austerity measures was only proper punishment for sovereigns that run amok.

It is unlikely that the citizens of California in 2011 would take this attitude. With millions enrolled in entitlement programs and tens of thousands receiving $100,000-plus annual pensions from the state, there will be no stomach for cutbacks. Nevertheless, it is probably the most sensible solution to the problem, just as it was in 1847. Neither the bailout nor the bankruptcy would be pain-free for California, and will probably only delay slightly the day of reckoning. A little harsh medicine now might be the best prescription, but...well, that's the rub, isn't it? Nobody wants the harsh medicine right now.

And now, at last, I will get to the point. As one of the last remaining Anti-Federalists in America, I view federal bailouts or state bankruptcy proceedings with alarm. The growth of the federal government, with its ever-increasing power over our lives, our livelihoods and our freedom, is the primary cause for most of the problems the American people now face. We are ruled by an elite political class of smartest-guys-in-the-room who all went to Harvard or Yale, rather than a government of and by the people. Supporting them is a corrupt, politically-connected group of economically-powerful forces (Goldman-Sachs, Fannie and Freddie, Google, the SEIU, the NEA) who are never subjected to our laws no matter what they do. At the federal level, government is purely an insider's game, and look at the results. Over the last fifty years, America has lost wars for the first time in its history, the black family has been destroyed (and many white ones) by a government-created culture of dependency and victimhood, our currency has been debased and we now find ourselves on the brink of insolvency. And then, of course, there's "Jersey Shore."

State governments may be the only means we have left to push back against the embedded corruption, profligacy, and authoritarianism of the feds. Granted, they're not doing a great job of it now, but that doesn't mean they can't. In the past, states have been a powerful check on Washington, often just by standing together and saying, "NO!" State sovereignty remains a vehicle by which free Americans can assert themselves.

And that's why the prospect of federal bailouts or a new provision in the Bankruptcy Code is so dangerous, because either one would render the states powerless against the federal government. If these things happen, they happen, and it looks like one or the other are going to, but I would like to see real consequences for accepting a bailout or using the Bankruptcy Code. Any state that does so should be stripped of its statehood and revert to Territory status, like Guam or Puerto Rico, or Alaska in 1959.

A reclassification to Territory status would merely reflect the new reality since by taking a bailout or a bankruptcy discharge,a state would have given up any legitimate claim to sovereignty. Not only would this discourage a state from taking the easy road to solvency, it would separate the fake states from the real ones, and the real ones could still assert their powers of sovereignty to resist the takeover of America by the modern Federalists. The Territory of California, well, that would be one thing, but the State of Texas would be something entirely different. And it should be.


Copyright2011Michael Kubacki