State Debt

I recently read a post by Yuval Levin about the dilemma that's about to face Congress on what to do about our bankrupt state governments. As a federalist, pretty much nothing is more offensive to me than forcing the taxpayers of Georgia or Alaska to fund the bad spending decisions of California and Massachusetts or the bad investment decisions of those who funded their bankruptcy. Yuval is correct that it would be extremely costly not to bail states out, but from my perspective it's even more costly to bail them out. The most recent "stimulus" contained billions in funding to perpetuate the failed policies of bankrupt states and prevent them from having to make the difficult decisions about which of their unaffordable services to cancel. What this means is that if California decides that everybody needs a car and starts handing them out with welfare then when they don't have the money to pay back bondholders who financed their boneheaded moves the citizens of Ohio (who don't have a free car) can pay the loans. Worse, there currently isn't any reason to believe the fed will force California to stop handing out cars. And if Greece is any model for how a US state might behave, telling California we'll bail them out only if they stop handing out cars won't work out either.

So this raises the question, if (as I argue) it's completely unfair and unsustainable to bail states out and (as Yuval argues, and I agree) it's going to destroy the bond market to not bail states out, what do you do? I don't know, but it's a discussion we better start having soon.