<p>Lergnom:</p>
<p>There has actually been a piece of legislation in Sacramento that would PROHIBIT cities from filing bankruptcy without the state’s permission! Thankfully, it hasn’t passed yet and hopefully if it did, the Guv’s veto pen would come right out. To think that some overseers at the state level would do right in decision making on any one city’s bankruptcy is lunacy.</p>
<p>A state is not allowed to use bankruptcy court, which is federal, to restructure is debts. It simply would not be recognized by the court. Entities (corporations/individuals/municipalities) use bankruptcy court to protect their assets from being legally seized by creditors while the debts are being renegotiated.</p>
<p>A state can default, simply say “we’re not going to pay”. The IOU episode in California was getting kind of close to this. It’s just that the conversation on resolving the conflict cannot take place in federal bankruptcy court. For a state to try this, as it is more realistic than theoretical, would be chaotic, and creditors, without the protection of due process granted them in bankruptcy court, would flee like you would not believe, at least short-term. You need creditors to provide interim financing, and those creditors need someone to have their back, like a court.</p>
<p>This potential is what keeps states from defaulting- their inability to borrow in the future - not to mention their ability to raise taxes at will.</p>
<p>It can happen that there is a non-court bankruptcy - look at Argentina in 2001 and Ecuador last year. There is no legal and accepted entity to enforce property rights and due process of repayment so everyone is left to figure it out ad hoc, and Argentina was able to borrow again a lot quicker than expected. It was a credit bubble, but they could do it.</p>