A Switch in State Bankruptcy Rules
24 Pages Posted: 6 Aug 2022 Last revised: 14 Feb 2023
Date Written: July 31, 2022
U.S. states are sovereign entities and can’t declare bankruptcy as cities and municipalities. This paper examines the impact of a switch in sovereign bankruptcy rules that allows declaring bankruptcy from an economics model perspective. Allowing bankruptcy increases ex-ante risks for the government to refuse repayment, but provides ex-post benefits of reducing default costs and saving federal bailouts. This paper provides a simple framework to analyze this tradeoff. Whether allowing for bankruptcy increases or decreases borrowing costs depends on the level of income and borrowing for the government.
Keywords: Sovereign bankruptcy, bankruptcy rules, bailouts, state government
JEL Classification: H74, F34, H81
Suggested Citation: Suggested Citation