Michael: What if the most famous line from the musical Hamilton—'I'm not throwing away my shot'—is the root cause of why your city might go broke? We're talking about a 200-year-old decision that set up an impossible choice for America's cities, a choice they still face today. Kevin: Wait, Hamilton? The ten-dollar founding father? I thought his whole deal was saving the American economy, not setting it up for failure. The musical makes him out to be a financial superhero. Michael: He was, in a way. But in saving the young nation's finances, he accidentally created a puzzle, a kind of political physics problem that has haunted America ever since. This whole idea comes from a fascinating and widely acclaimed book called In a Bad State by David Schleicher. Kevin: Right, and Schleicher is the perfect person to write this. He's a top law professor at Yale who specializes in exactly this stuff—local government, cities, and how they pay their bills. It's not some abstract economic theory; it's grounded in law and history, which is why it's so compelling. Michael: Exactly. And the puzzle he identifies is what he calls the 'Fiscal Trilemma.' It's the reason why, when a state or a major city is about to go belly-up, Washington D.C. becomes completely paralyzed, trapped in a game it can't win.

Kevin: Trilemma? Okay, that sounds more complicated than a dilemma. Break it down for me. Why can't the federal government just... fix it when a city is in trouble? Michael: Because they want to achieve three things at once, and it's impossible. First, they want to avoid macroeconomic harm. That means they don't want a state or city to fire thousands of teachers, cops, and firefighters, slash services, and raise taxes in the middle of a recession. That kind of austerity can turn a downturn into a depression. Kevin: Okay, that makes sense. Don't make a bad situation worse. What's the second thing? Michael: They want to prevent 'moral hazard.' This is the big one. If the federal government bails out every city that spends irresponsibly, then what's the incentive for any mayor or governor to ever balance a budget again? Lenders will also give money to anyone, knowing the feds will cover the losses. It creates a system where bad behavior is rewarded. Kevin: Ah, the 'too big to fail' problem, but for cities. And the third goal? Michael: They want to preserve the ability of states and cities to borrow money for infrastructure. Almost everything useful in this country—roads, schools, water systems, bridges—is built with money borrowed through the municipal bond market. If a major state or city defaults on its debts, it could cause that market to collapse. No one would lend money to any city, and we'd stop being able to build or maintain anything. Kevin: Wow. So let me see if I've got this. The options are basically: cause a mini-depression, reward bad behavior, or stop fixing roads forever. That's... not a great set of choices. Michael: It’s a terrible set of choices! And that's the trilemma. You can only pick two of those three goals. Schleicher illustrates this perfectly with a hypothetical. Imagine the Governor of Illinois and the Mayor of Chicago hold a joint press conference. They look into the camera and say, 'We're flat broke. We're about to default on our debts. We're firing 20% of all public workers unless Washington sends a massive check, right now.' Kevin: Okay, I can picture the chaos. The President immediately calls her advisors into the Oval Office. The Chair of the Council of Economic Advisers is probably panicking, saying, 'Mr. President, you can't let them do that! The layoffs alone will trigger a national recession! We have to send the money!' That's goal number one, avoiding economic pain. Michael: Exactly. But then a powerful Senator from Texas storms in and says, 'Absolutely not! My constituents in Houston are not paying for Chicago's decades of mismanagement! If you give them a bailout, every governor in the country will know they can spend wildly with no consequences. Let them make the cuts or let them default. No bailouts!' That's goal number two, preventing moral hazard. Kevin: And just as the President is weighing those two, the Secretary of the Treasury quietly leans in and says, 'Whatever we do, we can't let them default. If Illinois goes down, the entire municipal bond market might freeze. States and cities across the country won't be able to borrow for anything. The future of our national economy depends on Illinois paying its bills.' And that's goal number three. Michael: And boom. That's the trap. That's the trilemma. You can bail them out, which saves the economy and the bond market, but you create massive moral hazard. You can force them into austerity, which avoids moral hazard and protects bondholders, but you cause a depression. Or you can let them default, which avoids a bailout, but you risk destroying the country's ability to build infrastructure. There is no good move. Kevin: That is a brutal, brutal choice. It feels like a very modern problem, this web of finance and politics. Has it always been this way?

Michael: That's the most mind-blowing part of the book. Schleicher's core argument is that this isn't new at all. We've been trapped on this hamster wheel of bad choices for over 200 years. And it all starts with your guy, Alexander Hamilton. Kevin: My guy? I mean, I like the musical, but I'm not on his payroll. What did he do? Michael: After the Revolutionary War, the states were drowning in debt. Hamilton's big, famous idea was for the new federal government to 'assume' all that debt. In other words, a massive bailout. He chose to prioritize a strong national economy and ensure the states could borrow again. He achieved goals one and three. But what did he sacrifice? Kevin: Moral hazard. He basically taught every state, and every person who lends money to a state, that when things get really bad, Uncle Sam will eventually step in and pay the bill. Michael: Precisely. He set a precedent. Now, let's fast-forward about 80 years to the late 1800s. It was the age of railroads, and cities and counties across the American West went absolutely wild borrowing money to get a railroad line to their town. They issued bonds like they were printing flyers. Kevin: I can imagine. A railroad was like getting an Amazon headquarters today. It meant you were on the map. Michael: It was everything. But many of these railroads were scams or just failed. And suddenly, hundreds of little towns in Iowa and Wisconsin were on the hook for enormous debts they couldn't possibly pay. So what did the federal government do this time? They didn't bail them out. Instead, the Supreme Court stepped in. Kevin: The Supreme Court? What do they have to do with local debt? Michael: In a series of shocking decisions, the Court essentially became a debt collector for the wealthy bondholders on the East Coast. They ruled that these towns had to pay back every single penny, no matter what. They issued orders forcing local officials to raise taxes to crushing levels, even if it meant gutting every single public service. Kevin: Hold on. So the highest court in the land forced small towns into brutal, economy-crushing austerity just to make sure rich investors got their money back? That's unbelievable. Michael: It is. They chose to prevent moral hazard and protect the sanctity of the bond market. They sacrificed goal number one—avoiding economic pain. The book describes how this caused immense suffering and prolonged local depressions. But here's the twist, the deal with the devil. Kevin: There's a twist? Michael: Because the Supreme Court was so aggressive in protecting investors, it created absolute, ironclad confidence in American municipal bonds. It made it the safest investment in the world. And that gusher of capital is what allowed American cities to build the modern world. The Brooklyn Bridge, the aqueducts that brought water to Los Angeles, the incredible project that reversed the flow of the Chicago River—all of it was financed by a bond market that was built on the backs of those suffering towns. Kevin: Wow. So, short-term economic devastation for some led to long-term national growth. That's a heavy trade-off. It really shows there's no clean answer. Okay, so we're trapped in this cycle of making terrible choices. Is there any way out? Does Schleicher offer any hope, or is the book just... profoundly depressing?

Michael: It's not depressing, it's realistic. He argues we can't solve the trilemma, but we can manage the crash landing better. He offers four guiding principles for designing less-damaging responses. They are Prudence, Balance, Spreading, and Resilience. Let's focus on two of the most powerful ones: 'Spreading' and 'Balance'. Kevin: Okay, 'Spreading' sounds interesting. What does that actually look like? You can't just send a bill to the neighboring town, can you? Michael: Almost! Think about the Detroit bankruptcy in 2013. It was a huge, painful process. The city government went through hell, and city pensioners took a haircut on their benefits. But at the same time, the Detroit Public School system, which is a legally separate government entity serving the exact same people in the exact same geographic area, was facing its own crisis. And the state of Michigan bailed the school system out. Kevin: So wait. A retired city police officer might have had his pension cut, but a retired teacher living next door had hers fully protected? Even though they both served the same community? Michael: Exactly. Schleicher says this is insane. The economic pain that hit Detroit hit everyone. The principle of 'Spreading' says the response should be spread across all the overlapping governments. Instead of one entity taking a catastrophic 50% cut, maybe the city, the county, and the school district all take a more manageable 15% cut. It's still painful, but it's not concentrated in a way that destroys one specific service or group of people. Kevin: That makes so much sense. It treats a regional problem like a regional problem, not a bunch of separate ones. Okay, what about 'Balance'? And you mentioned a radical idea. Michael: The principle of 'Balance' is about not picking just one extreme solution. Instead of a pure bailout or pure austerity, you create a process that forces a mix. And this leads to his most controversial and interesting proposal: extending Chapter 9 bankruptcy, the legal process cities like Detroit use, to the states themselves. Kevin: Whoa, hold on. A state can go bankrupt? You're telling me California or Texas could file for bankruptcy? Is that even possible? Michael: Right now, no, they can't. There's no legal mechanism for it. But Schleicher argues there should be. If a state like Illinois is truly insolvent, a state bankruptcy process would create an orderly, court-supervised forum to restructure its debts. It would force everyone—bondholders, public employee unions, politicians—to come to the table and negotiate a 'balanced' solution. Kevin: So it would be a way to force a compromise. It avoids a pure bailout from Washington, but it also avoids the chaos of a disorderly default. It forces everyone to take a little bit of the pain. Michael: Precisely. It's a tool for achieving 'Balance.' It's not a get-out-of-jail-free card; it's a structured process for dealing with an impossible situation. It’s about designing a better way to handle the inevitable crisis.

Kevin: So the big takeaway here is that there's no magic wand for a city or state in crisis. It's not as simple as pundits on TV make it sound. You can't just 'be more fiscally responsible' or 'print more money' and fix it. You're always caught in this trilemma. Michael: Exactly. The genius of In a Bad State is that it completely reframes the debate. It's not about good guys versus bad guys, or responsible red states versus profligate blue cities. It's about political leaders navigating a set of fundamentally awful trade-offs. The goal isn't to win the game, because you can't. The goal is to design a system where losing doesn't mean total social and economic collapse. Kevin: And it makes you realize that every time you read a headline about a city's budget crisis or a state's pension problem, it's not just numbers on a spreadsheet. It's a mayor, a governor, a president, trapped in this impossible choice, with real people's jobs, retirements, and essential services hanging in the balance. It gives you a lot more empathy for how hard these decisions are. Michael: It really does. It makes you look at local and state politics with a completely different, and I think much smarter, lens. And on that note, we'd love to hear from our listeners—have you ever seen a fiscal crisis play out in your own town or state? What did it look like on the ground? Let us know on our social channels. Kevin: Yeah, I'm genuinely curious to hear those stories now. It's a hidden part of American life that affects everyone. Michael: This is Aibrary, signing off.