The bond markets, public employee unions and city officials across California were focused intensely on U.S. Bankruptcy Judge Christopher Klein’s decision Monday allowing the city of Stockton to proceed with its bankruptcy, making it the largest city in the nation to take the Chapter 9 route after running out of money to pay its bills.
Bond investors should be worried, as they are likely to incur greater risk by lending to cities. Stockton’s creditors argued that the city of about 300,000 isn’t truly bankrupt – i.e., it has used the bankruptcy process to strategically ditch debts it doesn’t want to pay while protecting obligations, such as pensions, that are politically more sensitive.
Judge Klein rejected that argument: “It’s apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety, as well as other basic government services, without the ability to have the muscle of the contract-impairing power of federal bankruptcy law.”
Although we agree with critics who say that creditors knew the risk when they lent money to this city, we find the creditors’ contention more compelling than the city’s argument and believe that Judge Klein made the wrong decision.
Everyone involved agrees that Stockton officials, dating back to the 1990s, made a series of absurd spending decisions. They invested heavily in sports arenas and downtown redevelopment projects. They gave city employees the most generous retirement formulas in the state. As Councilwoman Kathy Miller said in a YouTube video discussed at the trial, “Stockton went even further than most other cities and granted things like unlimited vacation and sick time that could be cashed out when an employee retired, and added pay categories for almost everything imaginable.”
City officials now blame the crashing real estate market and the economic downturn of the previous decade. They say that, without bankruptcy, they cannot get out from under their debts. They say that they trimmed employee pay, but all they really did was bring it into line with somewhere around the state median for local governments – and they made no effort to address their biggest debt, the payments they make to the California Public Employees Retirement System. The city owes CalPERS about $900 million to cover pension promises.
In essence, the city has said that pensions – no matter how generous and how absurdly they have been boosted – cannot be touched under any circumstance. The folks who lent the city money wonder why they must lose their capital while CalPERS and the public-sector unions are made whole. They have a point.
By contrast, the bankrupt city of San Bernardino is not making its full payments to CalPERS, which is giving the giant retirement system fits.
It’s one thing to offer public employees a fair pension, quite another to insist that oversized pensions are the top priority for a city that can’t make ends meet. Unfortunately, Judge Klein has reaffirmed that distorted perspective.
