If States Declare Bankruptcy, Look Out! (MUB, SPY, DIA)

There's a New York Times article that's being rehashed about a potential plan for state to declare bankruptcy.

There was speculation out earlier this week, but the reposting of the article now actually gives credence to this. If this actually happens, David Tepper and his "balls to the wall" mantra will be so far off base, it won't be funny.

We could hundreds of billions in lost assets, as these states are allowed to get out of crushing debt. If this were to happen, it would be a crushing blow to confidence at home, abroad and for every individual around the world. All asset classes would drop drastically, the value of the U.S. dollar would soar, as investors seek safety, and the burgeoning economic recovery that's currently taking place, would be dethrottled, in a way no one could imagine.

Newt Gingrich, former Speaker of the House, is currently trying to get a bill that would allow states to be removed of their debt obligations, and there are others supporting the bill.

“It's in the short-term and long-term interests of government workers and taxpayers to start those reforms now, rather than having to pick up the pieces after a crash landing,” ATR President Grover Nor-quist said in an interview.

“We are working with people inside and outside of Congress on this issue,” said Joe DeSantis, a spokes-man for Mr. Gingrich.

If even one state were allowed to default on its debt and declare bankruptcy, it would issue a trigger of unimaginable consequences in the credit default market on these bonds, which would bring down every asset class, including stocks, commodities, and anything else you could think of. The S&P 500 (NYSE: SPY) would plummet while this happening.

Investors if they believe this will eventually happen, can short municipal bond related equities, as mentioned here, or short any broad equity ETF, and they will be fine. Eventually the government will figure a way out of this, and then it begins the time to ride up the wave.

States are trying to get out of crushing pension and other obligations, which they can't ever afford, unless taxes are raised drastically and spending is cut drastically, something not many governors are will to do.

Some, including Zero Hedge, believe that another round of quantitative easing is inevitable to prevent this kind of catastrophe from happening. The next round will include Treasury debt, mortgage backed securities, and municipal debt. If that does happen, municipal bond ETFs like (NYSE: MUB) would rise sharply, but not after taking a major haircut first.

This is going to be the story of 2011, and could be a huge story for years to come if states are allowed to default.

Disclosure: no position in names mentioned