https://www.nationalreview.com/corner/what-happens-when-state-goes-bankrupt-richard-epstein/
https://www.forbes.com/sites/johnmauldin/2016/07/28/dont-be-so-sure-that-states-cant-go-bankrupt/
Excerpt:
Current law doesn’t let states go bankrupt… yet
If the law should change and a state actually tried to file for bankruptcy, creditors would immediately file constitutional objections under the contracts clause and the 10th Amendment.
Some legal scholars think those barriers can be overcome. The argument would go to the Supreme Court and probably take years to be resolved.
Passing such a controversial law for Congress could be quite difficult. There are good reasons to prevent state bankruptcies. The fact that they aren’t eligible for bankruptcy allows states to borrow money at lower interest rates.
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Arkansas: a precedent for state default
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In 1933, debt-plagued Arkansas unilaterally restructured and extended maturities on a series of highway and other bonds. Nowadays, we call that a default.
Bondholders sued, of course. The next year the state and its creditors reached a compromise refunding. Creditors exchanged their old bonds for new ones funded by a 6.5 cent per gallon gasoline tax.
In today’s dollars that would be about $1.16 per gallon, so this was a hefty tax on Arkansas drivers. I’m sure they complained. That deal fell apart, and after more twists and turns, the federal Reconstruction Finance Corporation (predecessor to the FDIC) bought the new bonds.
Back to the present
An April 2016 Moody's report sees almost zero chance that the federal government will bail out an indebted state government. I agree; the other state delegations in Congress would quash any such idea. You can debate whether the Arkansas episode was a “bailout” or just a refinancing, but it is one of the few precedents we have for a state default.
That leaves us in a very murky situation with regard to state and local pensions. We know many will have a hard time meeting their obligations.
Those at the state level can’t go bankrupt, nor can they expect federal help. Something will have to give in those states. Whatever the outcome is, it won’t be pretty.
And not every government below the state level can declare bankruptcy to discharge its pension obligations. Illinois and other states, including my own state of Texas, have passed laws that require cities to honor their commitments. They can change pension agreements going forward, but they are legally required to honor past agreements.