Welcome to Thoughts on the market. I'm Michael Zezes, head the Public Policy Research and Municipal Strategy for Morgan Stanley.

Along with my colleagues bring you a variety of perspectives, I'll be talking about the intersection between US public

policy and financial markets. It's Wednesday, April 29th at 11 a.m. Eastern.

Are state governments going bankrupt? That was the question on investors minds

last week after Senate Majority Leader Mitch McConnell,

suggested in an interview that he preferred bankruptcy to more federal government aid for states

dealing with the economic fallout of COVID-19. The concern of course for Munnie investors is that their

state bonds would default. For investors of all stripes, the concern is that a lack of federal

aid would further depress state spending and drag on economic growth.

To be clear, we wouldn't worry about states declaring bankruptcy anytime soon, but the risks

of states coping with budget stress do need to be accounted for.

Let's first dispel the notion of bankruptcy risk for states.

Currently, states cannot legally declare bankruptcy. It would require Congress to change the laws,

and we don't see Democrats who are currently pushing a $500 billion aid package to states going along with a plan that would put government employees and pensions at risk.

Second, it's not clear a law allowing states to go bankrupt as constitutional as it would permit states to give up their sovereignty.

Third, even if a law were passed and stood, states, like companies, can't declare bankruptcy just because they want to.

They have to prove their insolvent, which most Munn investors can tell you is easier said than done, given the history of cities petitioning and being kicked out a bankruptcy court.

Taken together, this suggests that the bankruptcy proposal is perhaps just part of the negotiation around the next federal stimulus, and an attempt to limit money heading the states to ease the concerns of fiscal conservatives.

All that said, it doesn't mean that the risks from state government budget stress aren't real.

With GDP set to be done substantially in the second quarter,

states are already talking about revenue shortfalls, cutting services, deferring capital spending, and furlowing employees.

For economists, that means that the state and local sector is likely to drag on the

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