Carla Fiorina made a very understandable gaffe the other day when she suggested that California may have to consider filing bankruptcy to extricate itself from its financial mess. Under the Federal Bankruptcy Code, states may not file for bankruptcy.
Fiorina may have been mixed up because of all of the attention that Vallejo is receiving for its bankruptcy filing. Because of the state's massive deficit, legislators in Sacramento have massively cut the aid California provides to cities. In turn, many cities have had to publicly consider bankruptcy as a way out of their own financial messes. In other words, cities have openly hinted about defaulting on bonds and labor contracts, two issues that California is struggling with as well.
Chapter 9 bankruptcy is a separate chapter of the Bankruptcy Code exclusively available to municipalities. The most famous example of a Chapter 9 bankruptcy was Orange County in 1994. Before bankruptcy protection was extended to cities, the last resort for creditors of distressed cities was to acquire a court order for the cities to raise taxes. In Chapter 9, municipalities can restructure their debt, including pensions, labor contracts, and outstanding bonds.
Because Fiorina's slip-up occurred in the heat of her campaign in the Republican primary for Barbara Boxer's senate seat, her opponents did not waste an opportunity to pounce. Still, the real shame is not that Fiorina did not know the Bankruptcy Code, it was that a serious politician considers California's financial situation possibly impossible to fix through traditional means.
