States can't file for bankruptcy protection under current law. But conservatives, including possible presidential contender Newt Gingrich, are pushing for federal legislation to make that possible.
And that, reports columnist Tom Petruno of the Los Angeles Times, is already taking a toll on the municipal bond market. "The bankruptcy option for states still is in the realm of the hypothetical, but the rising debate already may be costing investors in the $2.9-trillion municipal bond market real money. Lobbying efforts for a law making state bankruptcies possible are further eroding investor confidence amid what is already the worst sell-off in tax-free muni bonds since the financial-system meltdown in late 2008."
What does this mean? With investors fleeing the bond markets, it will cost more for states in fiscal trouble, such as California, to borrow. Which could make the fiscal crisis worse -- and improve the case for state bankruptcy.
In this way, talk of state bankruptcy could become a self-fulfilling prophecy.