In his illuminating and timely Liberty Forum essay on the constitutional impediments to a state-level bankruptcy procedure, Michael McConnell emphasizes the importance of the sovereignty of the states in the framework of American federalism. Unlike Detroit and San Bernardino, and perhaps unlike Puerto Rico, the states are considered fully sovereign with respect to taxation, expenditures, and borrowing in the Supreme Court’s understanding of the U.S. Constitution. As Professor McConnell points out, some of the key features of bankruptcy are hard to square with this understanding of the states’ sovereignty.
Indeed, it is difficult to envision an effective bankruptcy process that does not involve a temporary and voluntary reduction in state sovereignty. However, this response posits that one of the most important arguments in favor of an ex ante process to structure orderly defaults is that it would be a way of guarding against bailouts, which pose a far greater and more permanent threat to the sovereignty of the states than the temporary involvement of control boards or courts. Rather than representing a threat to state sovereignty, bankruptcy could be a way of preserving it.
First, I make a distinction between what it means to be sovereign in terms of taxing and spending, and what it means to be a sovereign borrower.
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