There is no "Chapter 8" in the U.S. Bankruptcy Code. But like a phantom limb, the nonexistent "Chapter 8"-a proposed option to allow states to default on their debts-is already aggravating the municipal bond market.

The bad news began in November; as the market reacted to the Fed's plan to buy $600 billion in Treasuries over the next eight months, bond prices fell and yields moved up. Then, in late January, The Wall Street Journal estimated that states had $3.5 trillion in unfunded public pension liabilities. A few days later, The New York Times blared "Plans Being Drawn Up to Let States Declare Bankruptcy."

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