Conservatives could learn something from Detroit union’s argument about how municipal bankruptcy violates states’ rights

AFSCMETo most, the idea that Detroit would be considered ineligible for bankruptcy seems ridiculous, but more than 140 creditors have formally objected to the city’s Ch. 9 petition. Some of the objections are junk. Others must be taken seriously by both the city and the court, even if they are likely to fail.

Most of the arguments have focused on the constitutionality-of-pension-cuts issue and whether Detroit negotiated in good faith.

Detroit’s largest union, AFSCME, has taken matters a step further, and contested the very constitutionality of municipal bankruptcy itself:

Chapter 9 of the Bankruptcy Code is an unconstitutional violation of federalism because chapter 9 allows Congress to set rules controlling State fiscal self-management – an area of exclusive state sovereignty – as part of an unholy alliance in which the State receives in exchange powers in excess of those it would otherwise possess under the law.

Members of the public finance community  have laughed this off, pointing out that Ch. 9′s constitutionality was upheld by the Supreme Court back in the 1930s.

AFSCME knows that. When read through, AFSCME’s objection, though sophistical and (it goes without saying) grossly opportunistic, is not a hack job. The union makes a couple usefully critical points about municipal bankruptcy which conservatives in particular would do well to heed.

Conservatives have loudly denounced any suggestion of a federal bailout for Detroit, but have voiced no objection to the bankruptcy itself, which will entail a substantial intervention, on the part of an unelected federal judge, into a city’s affairs. There may be a contradiction there.

Are there any true federalists around? Detroit city government is a political subdivision of the state of Michigan. Why should a federal court get involved at all? Dealing with municipal distress is primarily a responsibility of state government. Why should it not be exclusively a state responsibility?

That’s what AFSCME says. AFSCME believes that Ch. 9 amounts to buck-passing on the part of state governments. Instead of setting themselves down to the tough work of dealing with fiscal emergencies on their own, states “outsourc[e]” the task to the federal judiciary in bankruptcy.

This not how federalism is supposed to work, says AFSCME. Federalism is supposed to protect individual liberties and enhance accountability, not enable evasiveness by craven politicians. Ch. 9 casts a “veil of accountability” (who will really be responsible for Detroit’s debt reorganization plan?) over local fiscal affairs, and in a way that clearly can threaten individual liberties. The liberties in question are, of course, those of retirees who will see cuts to their pension and healthcare benefits.

Ultimately, the allocation of state resources as between competing creditors of the City should be determined “by the political process established by the citizens of the State, not by judicial decree mandated by the Federal Government.”

Defenders of the constitutionality of Ch. 9 would say that any objection over fiscal distress’ being a non-federal issue is easily neutralized by the fact that Ch. 9 is voluntary: states must explicitly authorize cities to file for bankruptcy, and, indeed, some states even prohibit it.

AFSCME thought of that. It claims that some powers cannot, or should not be, delegated away, and the powers wielded by a bankruptcy court fall into this category. With Ch. 9, “municipalities’…essential role in the federal system of government has been unconstitutionally diminished by an Act of Congress.”

As AFSCME sees it, municipal bankruptcy was passed and upheld during the Great Depression, a time in which the nation, under the pressure of fiscal emergency, forgot itself and weakened federalism. Courts have since come to their senses, and produced “a robust vision of federalism” which invalidates Ch. 9′s justification.

AFSCME argues that, in addition to being unconstitutional, Ch. 9 is “unnecessary” because states can adjust debts themselves. Although this would seem to run afoul of the Constitution’s Contract Clause, it should be noted that the law professors Michael McConnell and Randal Picker, in their 1992 article, which is probably the most-highly regarded work ever written on Ch. 9, lend support to AFSCME’s view that “states can pass legislation to adjust municipal debts in a financial emergency.” If there can be such a thing as state bankruptcy law, this would be all the better for the principled federalist view that cities’ fiscal struggles should be the exclusive responsibility of state governments.

The second argument is worth exploring further, but as for AFSCME’s federalism argument, it has two important weaknesses. First, it relies on a concept of federalism that is a pure abstraction, which has nothing to do with how the system actually works. Federalism’s strong suit will never be accountability. It’s messy. The messiness and ambiguity over where states’ responsibilities end and the federal government’s begin actually protects individual liberties by preventing the federal government from assuming too much power. That’s the main reason for federalism.

Second, AFSCME never makes clear why it defines “individual liberties” as those of retirees. Don’t Detroit’s citizens have rights to basic services, rights that are now being infringed upon by the city’s massive retirement obligations? Bankruptcy may necessary, in extreme cases, to ensure those services are being delivered. That’s certainly Detroit’s argument.

We sometimes forget how much our views of the theory of Ch. 9 are shaped by the rarity of its application. Were it applied more often (as both conservatives and liberals have advocated), then we would have to face more squarely the unattractiveness of unelected federal judges directing municipal affairs, and in a much more thorough manner than even during the forced busing era.

And so credit to AFSCME for promoting a salutary wariness towards relying on federal judges to deal with cities’ problems. None of us, especially not conservatives who fancy themselves federalists, should welcome municipal bankruptcy. The best way to respond to pervasive fiscal distress among cities is for state governments to develop improved oversight and takeover mechanisms.

Comments (12) Add yours ↓
  1. Tough Love

    Quoting AFSCME’s argument … “Chapter 9 of the Bankruptcy Code is an unconstitutional violation of federalism because chapter 9 allows Congress to set rules controlling State fiscal self-management – an area of exclusive state sovereignty – as part of an unholy alliance in which the State receives in exchange powers in excess of those it would otherwise possess under the law.”

    Did you notice the words “unholy alliance”. Quite an interesting choice of words when one considers the “unholy alliance” between the Public Sector Unions and the elected officials they have bought-off with campaign contributions and election support.

    I guess it only “unholy” when it’s not working in your favor.

    Public Sector Unions area CANCER on Society.

    August 22, 2013 Reply
  2. Tough Love

    If not in the FEDERAL Bankruptcy Court, where can situations like those of Detroit effectively be resolved ?

    The Public Sector Unions OWN (yes OWN) the politicians, and the elected officials, including the State Judges (who also get these grossly excessive pensions and benefits). None will fix this in any material way.

    August 22, 2013 Reply
  3. John D.

    ASCME bitterly fought the Michigan Emergency Manager laws, leading a ballot initiative drive which erased one version from the law books. The Michigan Emergency manager law was essentially a state bankruptcy law for local governments. The latest version of the Michigan Emergency Financial Manager law explicitly allows any emergency financial manager to file a local unit of government under Chapter 9. The AFSCME argument is legally invalid and a breathtaking excercise in chutzpah.

    August 22, 2013 Reply
  4. AttyFAM

    The framers of the Constitution gave exclusive jurisdiction over bankruptcy to the federal government. There should not be 50 competing forms of bankruptcy.

    As to “unelected” judges, first, an unelected judge does not have to worry about satisfying a majority of voters; the judge can make a proper ruling without fear, and a bad ruling will be reversed on appeal. Second, unelected judges hear all sorts of cases across the nation, without any complaints. An unelected judge took the New Haven Railroad through a 19 year bankruptcy. Who else has the time? Bankruptcy judges have herded LTV, Eastern Airlines, American Airlines, Federated Department Stores, Greyhound, Pan Am and many other mighty businesses, through the trauma of reorganization or liquidation. Why should a city be beyond them?

    August 22, 2013 Reply
  5. marcus1124

    I love it when people who don’t understand federalism try to shroud themselves in it opportunistically. Federalist believe in a segregation of duties between the federal and state/local governments, and that this division is pretty clearly articulated in the enumerated powers (read as they were originally understood).

    That brings us to Article 1, Section 8:
    “The Congress shall have Power To…establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States”

    This power is all encompassing of all forms of Bankruptcy, it is not limited to individual, it includes municipal and state bankruptcies.


    August 22, 2013 Reply
  6. JeffT

    Article I section 8 clause D gives Congress the power to enact Bankruptcy laws. End of story.

    August 22, 2013 Reply
  7. Harry Lewis

    As a bankruptcy lawyer, my reaction is that Chapter 9 bankruptcy was tested twice before the U.S. Supreme Court. The first time, it was struck down. The second time, as amended, it was upheld by the Court. The article notes this, but does not make the counter-argument.

    Briefly, the U.S. Constitution confers the bankruptcy power upon Congress. The bankruptcy power is the power to impair contracts. By contrast, the Constitution expressly denies the power to impair contracts to the states.

    Chapter 9, in turn permits only municipal bankruptcy with express consent of the state legislature. It does not permit Chapter 9 for state governments themselves. Municipalities are creatures of the state, and may be created or dissolved by action of the state legislature. The federalism argument in favor of Chapter 9 is that the state has expressly consented to federal intervention. As the article notes, some states have failed to authorize bankruptcy filings by their municipalities.

    My conclusion: Chapter 9 bankruptcy is a last resort to force a reorganization of municipal debt when the political leadership has failed in its efforts to negotiate an out-of-court readjustment of debts. A federal bankruptcy judge oversees the process, in which all creditors are subject to the jurisdiction of the court, and a plan for reorganizing and rescheduling debts is negotiated among the creditors. Essential municipal assets necessary for delivering services cannot be sold off.

    In short, the Chapter 9 municipal bankruptcy process is a specialized way of addressing excessive municipal debt. The federal bankruptcy power permits reducing or discharging municipal debts under some circumstances. Municipal pensions also may be at risk in the process. That will be for a court, applying well-settled principles of debtor-creditor law, to decide.

    August 22, 2013 Reply
  8. john anderton

    I’m as big a fan of federalism and state’s rights as the next guy, but bankruptcy is one of the few powers actually given to the federal government by the constitution:

    Article 1, section 8, clause 4.

    And, from a policy perspective, a uniform rule of bankruptcy seems pretty needed to prevent fraud.

    Otherwise, all sorts of legal and financial trickery WOULD be used to screw creditors (and maybe debtors). Hell, it already is even with uniform rules. Consider unlimited homestead exemptions, for example.

    August 22, 2013 Reply
  9. eatingdogfood

    Yeah; My Union Boss down at the Town Hall emailed me yesterday and Told me that this article was hitting the Papers today, and He told Me to make it Look like I was Working till this Blows Over in a week. I know the routine !!! In a week, I’ll be back to my usual activity of Collecting A Paycheck for Doing Nothing !!! Hey, Private Sector Workers; You really gotta Pony Up more Taxes !!! I need at least a 10 % raise !!! My Cabin Cruiser at the Dock behind my Vacation House in Florida needs a New Engine. My wife has been after me for a new car. She wants a BMW X6 G-Power Typhoon S !!! I told her I can’t afford that car. So then she says she will accept a Mercedes-Benz CL-Class and Nothing else !!! I also got Private School Tuition of $ 40,000.00 due in September. I got Credit Card Expenses coming out my AXX !!! That new 3000 sq ft extension on my house raised my property taxes $ 15,000. The maid and the housekeeper want raises. The gardener also wants a raise. You see Bunky; It ain’t easy in the Public Sector !!! So come on Private Sector Worker; Pony Up and Pay More Taxes so I can afford to live here !!! You See; Life Is Not Fair, and the DemoRats will take care of Everything !!! HAPPY DAYS ARE HERE AGAIN !!!

    August 23, 2013 Reply
  10. Steve Eide

    Steve Eide

    Dear all,

    Thanks for the comments. Three points in response.

    First, AFSCME believes that SCOTUS’ understanding of federalism has changed since the 1930s. The case they lean particularly heavily on is New York v. United States, (1992).

    Second, even if there can’t be a state-level bankruptcy law, the truly federalist position here still seems to me to be to insist that state governments do much more in the way of oversight and intervention to avoid the need for a federal intervention. If a city gets in trouble, its state government must be, at some level, responsible, because cities have no powers that states did not grant them. There should more policy debate about the legacy of Home Rule and how to restructure the relationship between state and local governments. Municipal bankruptcy will never work like corporate bankruptcy.

    Three, McConnell and Picker base their reasoning about a more robust authority for state governments over debt and contracts on a 1942 case called “Faitoute Iron & Steel Co. v Asbury Park.” which AFSCME cites. Here are the key passages (from M&P):

    “The constitutional law of municipal default was further transformed in 1942, in Faitoute Iron & Steel Co. v Asbury Park. Prior to Faitoute, it was assumed that states were incompetent to provide relief for municipal debtors because any plan of involuntary composition of the debts would impair the obligation of the creditor’s contract, in violation of the Contracts Clause. Indeed, in upholding the 1937 Act, the Court had noted that a federal statute was necessary precisely because the Contracts Clause precluded states from passing laws for the composition of municipal debts. In Faitoute, however, the Court upheld a 1933 New Jersey law that permitted a plan of adjustment of municipal debt over the objection of minority creditors, if the city and eighty-five percent of the creditors agreed. The Court reasoned that such plans, viewed realistically, do not impair the obligation of contract but rather are “the only proven way for assuring payment of unsecured municipal obligations. ‘ The traditional remedy of mandamus, the Court said, was “empty.”‘ And indeed, the municipal bonds in question increased in value from sixty-nine to more than ninety cents on the dollar after the plan of adjustment went into effect. Thus the state law, much like the federal, was premised on the notion that both creditor and debtor would be made better off by allowing refinancing of the debt, if only the problem of minority holdouts could be overcome.

    “…Does this proposal return to the other horn of the old constitutional dilemma: that the Contracts Clause prohibits states from passing effective bankruptcy laws? We think not. First, the Supreme Court rejected that argument in Faitoute which appears still to be good law. Faitoute stands for the proposition that the Contracts Clause is not violated if-as a practical and not a technical matter-the state substitutes a remedy that is as valuable as the one that had been contracted for. In effect, the Contracts Clause allows state municipal bankruptcy laws but constitutionalizes a “best interest of the creditors” test, preventing the states from adopting debt adjustment programs that benefit the municipal debtor at the expense of the creditors.

    “Second, in Faitoute, New Jersey added the state insolvency legislation after the bonds had been created and it was that feature which raised an impairment problem. The Contracts Clause itself does not bar a before-the-fact state insolvency scheme, as it would be incorporated into the contract.

    “Third, even if it were true that the Contracts Clause bars any state from imposing involuntary debt adjustments, there is no reason Congress could not substitute for Chapter 9 framework legislation that uses the federal power to abrogate contracts solely as an adjunct to state-ordered plans under state law. The only legal bar, ironically, is the Bankruptcy Code itself, which prevents states from ordering debt adjustment plans, undoing the states’ victory in Faitoute. It seems to us that the reverse is more desirable: state bankruptcy law is both more consistent with our constitutional structure and more likely to be effective on the merits than federal bankruptcy law.

    “One might object that states would choose not to enact adequate municipal bankruptcy laws. That is always a risk when decisions are decentralized. But states have a strong incentive (stronger than the federal government) to protect and strengthen the financial stability of their cities. A municipal default of one city will have a serious impact on the rest of the state. We have no reason to believe that states would be recalcitrant. The lack of state municipal bankruptcy laws prior to the federal act does not prove that states were unwilling, but only that they were then thought to be barred by the Contracts Clause.”

    August 23, 2013 Reply
  11. Tough Love

    To Harry Lewis, Nice to hear opinions from someone working professionally in the field. You said ….

    “… A federal bankruptcy judge oversees the process, in which all creditors are subject to the jurisdiction of the court, and a plan for reorganizing and rescheduling debts is negotiated among the creditors. Essential municipal assets necessary for delivering services cannot be sold off.”

    Where does that “legally” leave the huge Detroit art collection ? All but perhaps an art professor or connoisseur would certainly argue that the collection is not a “necessary asset” for delivering services, yet is it “fair” to the totality of Detroit’s taxpayers (75+ of whom are not public Sector workers or retirees) that it be sold to prop-up pensions promises that, in the absence of the decades-long collusion between the Public Sector Unions and Detroit’s elected representatives, would have be FAR less generous and therefore far less costly?

    August 23, 2013 Reply
  12. law office

    I thoroughly enjoyed reading this blog post

    August 29, 2013 Reply

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