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  • Bill would make it easier to renege pension obligations
  • Worries about need for state bailout loom over Congress
  • States, investors unhappy with possibility
Legislation that would allow U.S. states to file for bankruptcy will likely be introduced in Congress within the next month, Newt Gingrich, the former speaker of the House of Representatives and a powerful Republican party figure, told Reuters on Friday.

Although Gingrich, considered responsible for the "Republican Revolution" of the 1990's, is no longer in office, he has deep ties to Congress and is frequently named as a potential presidential contender in 2012.

For months he has championed letting states file for bankruptcy in order to handle their long-term budget problems despite resistance from states and investors in the $2.8 trillion municipal bond market.

"We're faced with the danger that the states are going to try to show up and say to Washington: You have to give us money," Gingrich said. "And I think we have to have an alternative that allows us to say no."

While he declined to comment on who might introduce legislation, Gingrich said there was support in both the House and the Senate. He said lawmakers have been looking into the idea for three or four months.

Gingrich first publicly broached the idea in November, the same month the Republican party won control of the House in mid-term elections, largely on promises of reducing spending.

But the legislation will likely face an uphill battle with Democrats still in control of the Senate and the White House.

Because states are sovereign, they cannot declare bankruptcy as cities can, and most have provisions in their constitutions that make defaulting on debt next to impossible.

And California -- a state which Gingrich said would likely turn to Congress for financial help along with New York and Illinois -- said on Friday it has no interest in using bankruptcy to solve its fiscal problems.

California, the eighth largest economy in the world, would not benefit from the legislation, Treasurer Bill Lockyer said.

"States didn't ask for it. We don't want it. We don't need it," Lockyer said. "Bankruptcy would devastate states' ability to recover from the recession and make the infrastructure investments that create good jobs."

Struggling to close a $25 billion budget gap, California already holds Moody's Investors Service's lowest state credit rating -- a distinction it shares with Illinois.

"Just the availability of a bankruptcy option and the potential bond default could severely damage state credit ratings and destroy the trust of bondholders," said New York State Comptroller Thomas P. DiNapoli.

Last week, the municipal bond market suffered a sharp sell-off on fears of defaults by cities and other issuers.

Representative Xavier Becerra, a member of the House Democratic leadership, said the bankruptcy idea is not new.

"But it has never been taken seriously until now because Republicans are insistent on doing nothing to help the states," he told reporters on Friday. "I don't think that is a realistic solution. I don't believe it is a necessary solution."

Hit hard by the deepest recession since the Great Depression, states' economies remain weak, even though the recession ended in mid-2009. State revenues are well below the levels reached before the recession, and high unemployment has driven up spending on public services.

Lawmakers from both parties are concerned Congress may have to step in again with an expensive fix. There is little appetite on Capitol Hill for a repeat of the $814 billion economic stimulus plan passed in 2009.

But along with the recession states are faced with permanent budget problems, including pension obligations they cannot cover estimated to total at least $700 billion.

Filing for bankruptcy would allow them to renege on their pension promises and other obligations to state employees.

"The very fact of the bill existing... allows governors to sit down with unions and say: 'Look you, negotiate with us or I'm taking the state into bankruptcy,'" Gingrich said.

Under bankruptcy an employer can negate labor contract provisions, and state bankruptcy "may be a way to put additional pressure on public employee service unions to negotiate," said Howard Cure, director of municipal research at Evercore Wealth Management in New York.

Still, said National Governors Association Executive Director Raymond Scheppach, no state is asking for the option of filing for bankruptcy in court.

"The state would be tied up in terms of its own budgeting and running of state government. And who wants to give the responsibility of running state government to the courts?" he said.