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Saturday, August 21, 2010

“Van Buren to Pennsylvania: Drop Dead”

In these troubled fiscal times, it would be fitting to remember President Martin Van Buren who presided over the nation during a similar economic crisis. Like President Obama, Van Buren came to the Presidency right at the onset of a financial panic due to the bursting of a real estate bubble (the Panic of 1837). When this panic turned into a prolonged depression (by 1840), states' toll revenue from their internal improvements -- canals, roads, etc -- plummeted, and states faced a budgetary crisis. The states begged for federal assistance to avoid default on their bonds used to build those improvements (bonds held mostly by British creditors). Van Buren and the Democratic Party refused to bail the states out (the Whigs wanted the feds to assume the debt), and eventually nine states defaulted in part or in whole. (The default by Pennsylvania inspired Wordsworth, infuriated at his losses from investing in Pennsylvania bonds, to pen the only romantic poem about the bond market of which I am aware, decrying the Pennsylvanians for their perfidy).

Should Obama follow Van Buren's example and let California, Illinois, and other deeply indebted states twist in the wind without federal aid? The history of the 1840s suggests one benefit of such tough love: By forcing states to decide how to accommodate or resist their bondholders, the 1840s Democrats also forced the states' citizens to take responsibility for the spending incurred in their name. Maybe the 2010 Democrats could induce the citizens of California, Illinois, and New York to act with similar maturity.

New York's 1842 "Stop and Tax" law, for instance, imposed a one-mill levy to pay off the debt but also enacted a state constitutional amendment banning further expenditures for canals. Other states amended their constitutions during the 1840s to limit or ban aid to private corporations or subject bond issues to referenda. Some states avoided taxation by insulting their British creditors with nationalistic rhetoric ("slap John Bull in the face" said one Mississippi politician), but, as Jay Sexton's history, Debtor Diplomacy explains, those states eventually backed down after they were thereby foreclosed from further borrowing in London. "You can tell your government," said James de Rothschild to an American envoy, "that they cannot borrow one dollar, not a dollar"). The reputational costs of thumbing one's nose at the international bond market proved higher than the political benefits of xenophobic political posturing.

According to Jonathan Rodden, Stanford political scientist and author of Hamilton’s Paradox, the federal government's refusal to bail out defaulting states sent a credible signal to bondbuyers to monitor states' fiscal, legal, and political decisions carefully and set interest rates by the default risk of individual states. Those interest rates served as a wake-up call for citizens who were otherwise inclined to engage in infantile populism -- insult the British, sell short-term notes for systemic expenses, etc. In short, by treating the states as grown-ups, the feds induced the states' citizens to act with a modicum of political maturity, accepting responsibility for their spending choices by either curtailing the spending or raising revenue.

Is there a moral here for us Americans today? Consider this hypothesis (which I will state with perhaps exaggerated starkness for clarity's sake): In debt-swamped states like California, New York, and Illinois, the two major parties represent two streaks of political infantilism. The Republicans cater to suburban homeowners who resist all tax increases without any credible plan to cut spending; The Democrats cater to public employees who resist any practical productivity measures or any realistic cut in unsustainable labor -- especially pension -- costs without any credible plan to raise revenue. Both sides engage in petulant gestures rather than meaningful negotiation.

Perhaps they both need a shove from bondholders to jolt them out of their complacently intransigent rhetoric. If default really loomed, then perhaps we would see the modern equivalent of New York's 1842 "stop and tax" laws that (a) raised revenue through visible and broadly applicable taxes but (b) forced future spending obligations like collective bargaining agreements to be subject to processes that would make them equally visible -- fiscal notes, referenda, genuine and accesible up-front review. In short, We the People could act like grownups who take responsibility for our spending decisions, either by raising revenue or monitoring spending.

It happened in the 1840s: Why not today?

Posted by Rick Hills on August 21, 2010 at 08:00 AM | Permalink


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"unrepentant Whigs" don't vote for balanced tickets for the sake of electoral success? Well, maybe if they realize the top of the ticket will die by the month's end.

Posted by: Joe | Aug 23, 2010 6:58:57 PM

Not Tyler, too, Petronius! Certainly not if you are an "unrepentant Whig," as you say: Tyler was a renegade turncoat as far as the Whigs were concerned -- a pseudo Whig who embraced the party just because he disliked Jackson's nationalism on the S.C. tariff issue and who alienated all of the real "Henry Clay" Whigs (with the exception of Daniel Webster, they resigned en masse from his cabinet). Tyler would not (among other things) allow distribution of western land to states to help bail 'em out. (Webster was a big fan of bailing out the states by having the feds assume the debts and pay off Baring Bank, but this proposal -- pressed by a Maryland Whig -- was a political non-starter).

Posted by: Rick Hills | Aug 23, 2010 1:32:53 PM

So, uh, Obama should imitate a one-termer who has gone down into the historical record as worse than average? For the sake of, um... having a really hard time with this one... what could it be? What COULD it be? For the sake of ensuring his defeat in 2012? For the sake of not-so-gently persuading the more (allegedly) financially footloose states to take stern financial discipline measures that might... somehow... get us out of this mess in, oh, say, twenty or thirty years?

Howzabout doing what conservatives proclaim must be done, and cutting federal spending on all those "red states" that have been getting the lion's share for the last fifty years or so?

Hey, just call me an unrepentant Whig. Tippecanoe and Tyler too!

Posted by: Petronius Arbiter II | Aug 23, 2010 1:19:49 PM

As soon as I surfed to the stunning The End Of Nations Hub on Hubpages I convinced myself that PrawfsBlawg blog's readers really must have their say on this link! http://hubpages.com/hub/Global-Union-The-End-Of-Nations

Posted by: bhanu Tiwari | Aug 23, 2010 1:03:54 AM

[This comment is actually an e-mail from my colleague, Clay Gillette, who knows bonds better than I. It is posted with his permission]:

"Ah, if only it were so simple as abandoning the states to their fates and turning bondholders into monitors. The problem is twofold:

"1) the dramatic consequences of default by the states is probably much greater than in 1837 or 1873. Bondholders are a much more varied group now, with many more individual investors, either directly in bonds or through mutual funds and retirement funds. So the externalities will be more significant than was previously the case.

"2) The incentive for bondholder monitoring has been dramatically diluted by (a) very low rates of default that make monitoring inefficient for individual investors, (b) the availability of diversification and bond insurance, which make monitoring inefficient for institutional investors, (c) reliance (mistaken, perhaps) on rating agencies.

"So, what is to be done? You can't throw the states into Chapter 9, though you may get some action involving municipalities there. Bankruptcy judges can't directly impose tax increases on municipalities, but perhaps can refuse to approve a plan submitted by the municipality that does not include a tax increase. That's a lovely topic on which some, but not much has been written.

"Maybe conditional federal aid makes sense. My annoyance with the bailout of banks was not that it happened, but that it happened in a manner that did not effectively remove or punish current management. When states have bailed out localities, they have typically done so only after putting the locality into effective receivership, e.g., through financial control boards. Perhaps (10th Amendment considerations aside), the feds could condition state bailouts on something similar, such as a combined tax increase requirement, replacement of certain officials, a requirement that the state's budget be submitted to a federal control board for a certain number of years after the bailout, etc. The federalist folks will complain about more federal control, but I'm with Hamilton on much of this."

Posted by: Rick Hills | Aug 21, 2010 6:09:00 PM

I'd like to propose a parallel issue that exists in most (if not all) of the worst "debtor states": de facto feudal power structures. The proportion of major officeholders who have relatives (by blood or by marriage) in other offices or as high-powered adjuncts to other offices is more than merely paralyzing.

Consider, for example, Illinois.
There's a Daley sitting in the mayor's office of the state's biggest city, and has been for quite a while. Meanwhile, his brother ended up as Secretary of Commerce under President Clinton... thanks, in part, to the personal loyalty of Hilary Clinton to the Chicago b/a/r/o/n/i/a/l/ Democratic Party (remember where she grew up?)
The unelected-by-the-public leader of the Illinois government -- Speaker of the House Michael Madigan -- is part of three generations of party power brokers... and his daughter is the Attorney General, and was considering a run for the governorship until convinced otherwise (whether because it wasn't her turn yet or because people were afraid it would look bad remains uncertain).
Most county-level, expenditure-controlling, elective posts in this state (regardless of party, regardless of region within the state) are held by relatives of persons who have previously held county-level or dominant-city-within-the-county-level elective office.

I've been led to believe it's no better in California, although I'm not as familiar with the personalities. It was certainly no better in Washington State when I was growing up, at least outside of King County (Seattle/Bellevue); the hostile-to-city-folk-and-concerns leader of the State Senate was a third-generation elected official.

And do I even need to say "Kennedy," "Rockefeller," or "Pendergast"?

Now what we do about this is another question entirely; tongue-in-cheekunfortunately, the Bill of Attainder clause prevents us from barring later generations from office.../tongue-in-cheek

Posted by: C.E. Petit | Aug 21, 2010 12:02:04 PM

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