In Slate, Christopher Beam describes why California cannot declare bankruptcy:
Chapter 9 of the U.S. bankruptcy code allows individuals and municipalities (cities, towns, villages, etc.) to declare bankruptcy. But that doesn't include states. (The statute defines "municipality" as a "political subdivision or public agency or instrumentality of a State"--that is, not a state itself.) For one thing, states are said to have sovereign immunity, as protected by the 11th Amendment, which means they can't be sued. In other words, they don't need any protection from angry creditors who would take them to court for failing to pay their debts. As a result, states can simply borrow money ad infinitum.
If I follow the logic, states do not need bankruptcy. They can simply repudiate debts at will. That's what sovereign immunity means. Here's my logic. Law, by its nature, seeks to balance problems and remedies. Clearly, states may sometimes borrow more money than they can repay. What, therefore, is the remedy in such cases? If not bankruptcy, and if the states have sovereign immunity, that suggests to me that the states may simply repudiate debts as they choose.
If states may do that, why would anyone lend them money, or sign a contract with them? The same reason that people lend money to the federal government (which also has sovereign immunity), or lend it money: they expect to be repaid. As a general rule, in other words, it is a terrible and dangerous thing for any government to repudiate its debts. That does not mean it is illegal, and it does not mean it would never be necessary. Indeed, the threat of repudiating debts could be used to renegotiate contracts and debts.