Historical Empiricism and the Schleicher Trilemma

Guest Blogger

For the Balkinization symposium on David Schleicher, In a Bad State: Responding to State and Local Budget Crises (Oxford University Press, 2023).

Vince Buccola

The principal object of David Schleicher’s slim, new book, In a Bad State, is to set out a conceptual schema for mapping policy options with respect to state and local financial distress. The Schleicher Trilemma states that no policy response can simultaneously vindicate each of three commonsense values that (national) political actors are apt to hold, and the book is devoted to elaborating this core insight. There is much more to the work, of course. As anyone who knows Schleicher even a bit will expect, the book’s 171 pages (sans notes) brim with fascinating data and anecdotes. (Schleicher aficionados will, however, be disappointed not to find an index entry for “Stillman, Whit.”) By word count, much of the book (pp. 33–117) is historical. Schleicher offers a fresh account of each major wave of state and local financial distress in the United States, from the aftermath of the Revolutionary War through Covid-19. The historical vignettes alone more than justify the cover price. In the context of the book’s analytical purpose, though, they serve didactic and argumentative functions, on one hand to illustrate the Trilemma through real-world application and on the other to verify the causal relationships it posits.

The Schleicher Trilemma turns on a mismatch between policy levers and policy goals. In Schleicher’s typology, there are three generic strategies national policy can pursue in relation to local (in which category I’ll include state) government financial distress. The national government can (1) bail out the local government and its creditors; (2) encourage the local government to default on its creditors; or (3) force the local government to pursue an austerity path—raising taxes, cutting spending—to pay its creditors. And there are three generic political values at stake. National policy makers will want to (A) reduce moral hazard (for future leaders of, and lenders to, local governments); (B) encourage future lending to local governments (to further infrastructure investment); and (C) avoid social fallout from local collapse of services or tax hikes. The rub is that each policy attitude sacrifices one of the values. The choices are A(2,3), B(1,3), or C(1,2).

It is a tremendous heuristic. Like all great heuristics, it manages simultaneously to encompass the wide universe of relevant possibility and to be, for lack of a better word, true. One doesn’t need to indulge game-theoretic axioms or harbor an unrealistic notion of rational expectations to see that the trade-offs Schleicher posits are inevitable. Grasping them is fundamental for those interested in the connection between national policy and state and local investment, and I therefore predict that In a Bad State will long prove a starting point in policy analysis of local financial distress in the same way that Modigliani-Miller is still the beginning of interesting questions in corporate finance.

Having just said that Schleicher’s historical vignettes are largely illustrative, I hesitate to devote 1500 words to quibbling about the municipal bond cases. But I’ll do so anyway in service of a larger thought about the relationship between politico-economic theories, such as the Schleicher Trilemma, and historical empiricism. My conclusion is that Schleicher’s characterization of the municipal bond cases is debatable, but that it doesn’t detract from the praise I have already lavished on the Trilemma.

The second half of the nineteenth century saw repeated waves of distress in Midwestern and Western cities and counties. Infrastructure financed by long-dated bonds, especially railroads, failed to generate the revenues promoters had hoped for and led to widespread budgetary (and other) problems. Hundreds of municipalities repudiated their bonds, arguing that they had been issued ultra vires and that the holders, capitalists in Europe and the American Northeast, weren’t owed a dime. Litigation in the federal courts was frequent, with several hundred disputes reaching the Supreme Court between 1859–1899.

Schleicher characterizes the period as an episode of local financial distress in which national political actors—a stable majority of justices of the Supreme Court—chose to force austerity (pp. 41–56). In his words, “[t]he Court effectively served as the enforcer of part of the federal government’s pro-railroad policy” (p. 52). So characterized, the municipal bond cases help to establish the Schleicher Trilemma as an empirical fact. By forcing local governments to pay their debts (without assistance from the national government), Schleicher concludes, the justices caused near-term hardship in the locations forced to pay but also preserved capitalists’ willingness to lend, and thus helped to bring forth a subsequent era in which municipal infrastructure projects flourished while moral hazard was cabined.

To me the characterization rings only half right. I’ll set aside my objection to Schleicher casting the post-bellum justices as legally unbound agents exercising a free hand in domestic financial policy. Whether the Court was the kind of willful institution imagined by the Realists or instead largely adhered to legal doctrine is irrelevant to the effects of the Court’s judgments on local finance. My relevant objection is to the notion that the Court’s decisions collectively should be described as having forced an austerity path on would-be repudiators. Three points to note:

First, the Court allowed many municipalities to repudiate. Allison Buccola and I coded every Supreme Court decision testing the validity of a municipal bond between 1859–1899.  We found that the Court ruled for the repudiating municipality in fully one-third of the unique validity cases (57 out of 172). As early as 1860, in just the second railroad-bond case to reach the Court, the justices concluded that a bond would be held unenforceable, even in the hands of a bona fide purchaser, if it had been issued without valid legislative authorization or if any statutory conditions on issuance had not been satisfied (and the issuer was not estopped by its own representations to the contrary). To be sure, the ratio of wins and losses was not constant over the period. Municipalities prevailed in just one of fifteen cases of repudiation between 1859-1869 and in almost half of the cases after 1879. One could make out a debatable case that some of the decisions in the 1860s were especially momentous, on account of the generality of their rationales, or especially willful, on account of their inconsistency with prevailing legal principles. But the justices’ willingness in the right case to tell investors to take a zero is hardly what one would expect from devoted champions of capital.

Second, the Court did not go as far as it might have in providing a remedy to disappointed bondholders. To hold a bond valid—to say that it could not be repudiated—was only the first step in forcing austerity. Unless bondholders have a practically realizable way to collect, a local government that prefers to default can do whether or not courts hold the bond valid. Schleicher correctly notes that the Court took some bold remedial steps (pp. 49–50). In Knox Couty v. Aspinwall, for example, the justices held that federal courts could issue writs of mandamus to local government officials, ordering them to impose taxes sufficient to pay valid bonds. The justices went as far as to allow a federal court to appoint a receiver to collect local tax where the relevant state law explicitly authorized that remedy. But the justices maintained a limited view of what federal courts could do in respect of collection. They repeatedly held that federal courts had no equitable power to impose a tax or appoint a receiver to do the same or to collect a tax validly imposed. These limits were immensely important, because they allowed local officials to avoid actually paying valid bonds by dodging service of mandamus or resigning office upon being served, two tactics recalcitrant officials frequently employed (p. 50). The Court’s decisions thus were some distance from imposing maximum austerity.  

Third, the justices’ application of prevailing legal principles was not so obviously result-oriented as Schleicher suggests. Schleicher, like many historians before him, points to the infamous Gelpcke v. City of Dubuque as the prime example of Supreme Court willfulness (pp. 45–48). Gelpcke held that bonds issued by the city to fund local railroad construction were valid notwithstanding a decision of the Iowa supreme court opining that the state constitution forbade the legislation under which the bonds had been issued. Schleicher sees Gelpcke as a marker of economic policy because it so obviously violated prevailing legal principles. So strong was the justices’ will that “[l]egal niceties … could not stop the Court from enforcing debts and protecting bondholders” (p. 48). In my view, though, Gelpcke is eminently defensible on purely formal grounds. Justice Swayne’s opinion is regrettably opaque, leading commentators over the years incorrectly to understand it as a perversion of Swift v. Tyson or a confused application of the Constitution’s contracts clause. But the decision ought rather to be read as standing for a (sensible) plausibility limitation to the proposition that the justices will defer to a state supreme court’s interpretation of its own state’s law. This is what Swayne meant with his hyperbolic promise that the Court “shall never immolate truth, justice, and the law, because a State tribunal has erected the altar and decreed the sacrifice.” In Swayne’s view, to apply the logic of Wapello would have been to “immolate” Iowa law. The Iowa constitution did not, in fact, bar the legislature from allowing Dubuque to issue its bonds, whatever some elected judges who had campaigned on a repudiation platform might say. And Swayne was right. Wapello was implausible. No concrete provision in Iowa’s constitution forbade public subsidy of infrastructure built by corporations. The text was as blank on that score as every other state’s constitution was. And the issue had been judicially decided many times, in many states—including in eight decisions of the Iowa supreme court—over 30 years. Unless one thinks the justices bound even by bad-faith decisions, for example on a post-Erie-ish theory that what a state supreme court says about state law just is the law, Gelpcke was not only reasonable but probably correct.

Do these complications cast doubt on the validity of Schleicher’s schema? No, not in the least, but because the kind of historical storytelling on offer, while illuminating in many ways, can neither verify nor falsify the type of causal account the Trilemma provides. The forces underlying the Trilemma are marginal forces. Local governments’ propensity to default makes lenders less willing to provide capital; their propensity to repay has the opposite effect; bailouts made moral hazard worse. In each case, the effect is compared to a counterfactual, hypothetical, ceteris paribus world. If Schleicher’s characterization of the municipal bond cases is right—if, that is, the Supreme Court’s decisions implemented a kind of austerity policy on municipal governments—then the Trilemma says that local governments in the 1880s and 1890s, say, should have been able to borrow more cheaply than they otherwise could have. What do we know about that claim? What can we know? Schleicher points out that the last decades of the nineteenth century saw local governments financing infrastructure projects on an outstanding scale. So they did. But that compares the period to other times rather than to a different version of the same time. The level of financial activity in Period n alone can’t tell us anything about the policies implemented in n-1 or about those policies’ marginal effects.

To my mind, a different kind of empiricism is called for. I accept, or better said admire, the Schleicher Trilemma effectively a priori. The direction of the effects it posits have to be right. What is left open are what we might call the elasticities associated with each horn of the Trilemma. When a medium-sized city facing financial distress gives its bondholders a fifty-cent haircut, how much do the future borrowing costs of similarly situated governments increase? (For that matter, which governments are similarly situated?) Questions like these might be answerable and could help to calibrate Schleicher’s schema.

Which brings me to where I began. When David Schleicher publishes 170 pages about state and local budget crises, it underscores the wisdom of the old adage that you don’t have to have read a book to have an opinion on it. In a Bad State delivers what I expect will for a long while be the organizing framework for serious thought about local government financial distress. In that sense, Schleicher leaves his readers In a Much Better State.

Vince Buccola is Associate Professor of Legal Studies & Business Ethics at The Wharton School of the University of Pennsylvania. Comments welcome: buccola@wharton.upenn.edu.