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.