Stockton hits the wall
LA trader: “if stockton was a surprise, i dont know where you’ve been for the last 3 months.” Still, a LOT of stockton bonds put out to bid
— Taylor Riggs (@TaylorRiggs_BB) June 27, 2012
The City Council of Stockton, California voted this week to adopt a “pendency budget” in preparation for filing for Chapter 9 bankruptcy, which will place the city under the protection of the bankruptcy court and stay all legal actions against it. This maneuver gives the city some breathing room to come to an agreement with its creditors, especially bondholders and retirees, over how to reduce what the city owes them. This comes after months of Stockton being under a state-imposed “mediation period” in which these kinds of negotiations were voluntary.
Reuters’ Jim Christie reports on the background of the story:
Stockton’s city council voted six to one in favor of the 2012-2013 budget after a contentious five-hour meeting where angry retired city workers pressed council members to reject the $155 million spending plan. It proposes eliminating retirees’ medical benefits to help fill a $26 million budget deficit…
…Stockton officials have said since February their city’s finances are suffering the combined effects of fiscal mismanagement over two decades, too much debt taken on in good times and generous pay and unsustainable benefits for city employees and retirees.
Stockton has also suffered a sharp drop in revenue since the collapse of its once red-hot housing market. The housing boom transformed the farming city into a distant bedroom community of the San Francisco Bay area and its bust put Stockton at or near the top of national foreclosure rankings in recent years.
To keep its budget in balance, Stockton has cut more than $90 million in spending in recent years and slashed its work force, including a quarter of its police officers, a pressing concern with a surge in violent crime in the city.
It’s very hard to forecast the outcome of Stockton’s bankruptcy proceedings. Chapter 9 bankruptcy law was written at the national level but must take into account the treatment of pensions and bondholders under state laws. These rights vary by state, and in California they have not been fully clarified. Although Vallejo, another indebted California town, entered Chapter 9 bankruptcy in 2008, it’s not so clear that that case sets a precedent for Stockton.
When Vallejo gave its bondholders a haircut in Chapter 9, it did not cut payments to their public pension manager, CalPERS. The reason why Vallejo opted not to cut its pension payments seems to be mainly political, as a ruling of the Vallejo bankruptcy judge permitted the town to slash these payments. This was surprising because, in general, all creditors suffer losses in Chapter 9 proceedings. From the WSJ:
To permanently bring its spending in line with its tax base, however, at some point Vallejo will have to do something about its pensions. U.S. bankruptcy judge Michael McManus, as the National Law Journal reported last March, “held the city of Vallejo, Calif., has the authority to void its existing union contracts in its effort to reorganize.”
But when it came to voiding those contracts on pensions – a major driver of public expenses – the city blinked. The “workout plan” the city approved in December calls for cuts in services, staff and even some benefits, such as health benefits for retirees. However, it does not touch public-employee pensions. Indeed, it increases the pension contributions the city pays.
Some have suggested that CalPERS bullied Vallejo into not challenging city employee pensions during the bankruptcy proceedings. Given the statements of the Vallejo bankruptcy judge, it seems that it would be legal for Stockton to reduce pension liabilities. But a recent Reuters analysis suggested that Stockton also has no interest in going that route:
For Stockton’s city workers, the only silver lining in the Vallejo case is that Vallejo chose not to challenge payments to the California Public Employees’ Retirement System (Calpers), which handles employee pension plans for many cities and counties around the state.
Calpers has made it clear it believes pensions have iron-clad legal protection even in a bankruptcy. That belief has never been tested in court – but with the same bankruptcy lawyers who represented Vallejo now acting for Stockton, pensions may again be off the table.
“It’s left off the table because they knew they would lose the fight,” said Mark McLaughlin, a Stockton detective and board member of the city’s police officers union.
There is another party that has financial interests in this fight that hasn’t yet been discussed: the bondholders. After Stockton missed several bond payments, the bank representing bondholders seized three city-owned parking garages and the city hall. They look prepared to protect their interests.
With the bankruptcy court ruling in the Vallejo case I can imagine that bondholders, or the bond insurers more particularly, may be ready to face off against retirees and CalPERS. CalPERS makes a formidable opponent, but bondholders might have sufficient resources and incentives to fight the pension behemoth.
Bloomberg: Pension reforms have their day in court
New York Times: Untouchable pensions may be tested in California
The Atlantic: A bankrupt city, by the numbers
City of Stockton: 2010 Comprehensive Annual Financial Report