Can California declare bankruptcy? What about Greece?

Answers to your questions about the news.
March 8 2010 5:01 PM

Can California Declare Bankruptcy?

What about Greece?

Arnold Schwarzenegger. Click image to expand.
Gov. Arnold Schwarzenegger

California passed a gas tax last week to help make up for its nearly $20 billion budget gap, the latest in a series of measures to right the state's teetering economy. The country of Greece is in even worse shape, with accumulated debt higher than 110 percent of GDP, set to reach 125 percent this year. Can a state declare bankruptcy? Can a country?

No and no. Chapter 9 of the U.S. bankruptcy code allows individuals and municipalities (cities, towns, villages, etc.) to declare bankruptcy. But that doesn't include states. (The statute defines "municipality" as a "political subdivision or public agency or instrumentality of a State"—that is, not a state itself.) For one thing, states are said to have sovereign immunity, as protected by the 11th Amendment, which means they can't be sued. In other words, they don't need any protection from angry creditors who would take them to court for failing to pay their debts. As a result, states can simply borrow money ad infinitum.

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Say the state can't make its debt payments, and no one will lend it any more money. In that case, the federal government can step in and put the state into receivership. This would involve the assignment of an accountant to manage the state's debt, overseen by a judge. It would be a lot like bankruptcy, except instead of following a structured set of steps—informing creditors, appointing creditors' committees, a 120-day window to file a plan, etc.—a receiver has the authority to force creditors to renegotiate loans in a speedy fashion. However, the accountant in charge would not have the power to make decisions about the state's budget, such as which programs needed to be cut and which taxes had to be raised. (No state has ever gone into receivership.)

Greece is in a slightly different situation. There's no international bankruptcy court for countries that can't pay their debts. Instead, other EU countries that depend on Greece's solvency, such as Germany or France, would have to agree to bail it out. (When the economy of one member of the Eurozone sinks, it drags the euro down across the continent.) In return for loans, Greece would agree to implement austerity measures, such as hiking the price of gas, freezing government salaries, and raising the retirement age, to steer the country toward solvency. Whichever countries bail out Greece may not get their money back. But at the very least, Greece wouldn't pull the European economy down with it. Another option would be a bailout funded by the International Monetary Fund or the World Bank, which have stepped in when the economies of Ecuador, Russia, and numerous African countries have tanked. But their leaders seem reluctant. Worst-case scenario, the EU could expel Greece—Greece's deficit is already four times higher than what the EU allows. But that could hurt the euro as well by signaling to investors that the EU is unstable and thus a risky bet.

Got a question about today's news? Ask the Explainer.

Explainer thanks Kenneth Klee of UCLA Law, Alexander Laughlin of Wiley Rein LLP, and John Pottow of the University of Michigan Law School.

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