Pain for Stockton taxpayers
After proving it was insolvent, the city of Stockton, California entered the municipal bankruptcy process last week. The judge hasn’t yet delivered his formal ruling, but here are some of the most relevant reasons for the city’s insolvency, according to Judge Christopher Klein (page 556 most of which you have read here at MuniLand over the past year):
Excessive public employee compensation levels:
Some of the problems were also the incrustation of a multi-decade, largely invisible or non-transparent pattern of above-market compensation for public employees. Among other things, the City offered generous health care benefits, to which employees did not contribute. Retirees had their entire health bills paid for by the City. The City permitted, to an unusual degree, so-called “Add Pays” for various jobs that allowed nominal salaries to be increased to totals greater than those prevailing for other municipalities.
The enormous explosion of retirement liabilities:
Some of the problems were also rooted in generous retirement practices. The pensions, of course, are themselves a form of implicit compensation. Pensions were allowed to be based on the final year of compensation, and only the final year of compensation, and that compensation could include essentially an unlimited accrued vacation and sick leave. So it was possible to engage in the phenomenon that’s become known as ‘pension spiking,’ in which a pension can wind up being substantially greater than the annual salary that the retiree ever had.
There’s been a number of those situations that have come into public view, generally, not entirely from Stockton, as part of a debate that seems to be going on in the larger community. In any event, pension spiking was an issue in Stockton because Stockton’s obligations to CalPERS were based on the amount of pensions that were having to be paid out. So projected pension expenses in particular were soaring.
How police staffing levels had been cut to very low levels:
The Police Chief, Eric Jones, pointed out that even without a 15 percent reduction in police, the Stockton crime situation was a very difficult environment. The Stockton Police Department had — without the 15 percent cut — had about 1.10 officers per 1,000 residents, which is a standard or mode of analysis that U.S. Department of Justice applies. And when you look at the comparable national standard per 1,000 residents for cities of comparable size, it is not 1.1; it is 2.7 police.
How public unions and stakeholders – and not bondholders and insurers — agreed to changes during the mediation process (the judge stated specifically that bondholders played unfairly during the mediation process):
The neutral evaluation process that was conducted by Judge Mabey did, however, achieve substantial agreements regarding, as I indicated, all unexpired collective bargaining agreements and substantial progress in discussions with other stakeholders.
Klein goes to the heart of the bankruptcy process with the impairment of contracts (emphasis mine):
[W]hat chapter 9 brings to the table that is not in state law is the exclusive power of the Congress under the Constitution to make uniform laws concerning bankruptcy. And uniform laws concerning bankruptcy mean impairment of contracts. The contracts clause of the United States Constitution says that no state may make a law impairing the obligation of contracts. And that limitation does not apply to Congress.
And, for the reasons I explained in that decision, the asymmetry is absolutely intentional on the part of the founders, the framers of the Constitution, because bankruptcy is nothing but the impairment of contracts. I’ve been doing this job for more than 25 years. I’ve had more than 138,000 bankruptcy cases. I’ve been party to impairment of millions of contracts and it’s all constitutional.
As to the question of Stockton not attempting to reduce it’s massive liability to CalPERS — the statewide pension system that manages the benefits for 2,400 Stockton retirees (page 590):
This does not mean that there’s not potentially a serious issue involving CalPERS. But at this point, I do not know what that is. I do not know whether spiked pensions can be reeled back in. There are very complex and difficult questions of law that I could see out there on the horizon, but no plan of adjustment can be confirmed unless — no plan of adjustment can be confirmed over the rejection by a particular class unless that plan does not discriminate unfairly and is fair and equitable with respect to each class of claims that is impaired under or has not accepted a plan. That’s section 1129(b)(1) of the Bankruptcy Code, which, by virtue of section 901, applies in chapter 9 cases.
Bondholders’ efforts to include CalPERS in the reduction of liabilities will be an upcoming issue:
The protection for the Capital Market Creditors is in the plan confirmation process. If a plan is proposed that does not deal with CalPERS and if the Capital Market Creditors reject their treatment under the proposed plan, then I will have to focus on the question of unfair discrimination.
The glaring issue of CalPERS remains, and I think it relates to fairness for taxpayers as much as for bondholders. By continuing to pay high pensions based on high salaries, Stockton taxpayers are squeezed in paying for crucial services such as police and fire. Look at the chart at the top of this post and focus on the red line, which is the median income of Stockton residents. A large percentage of pension holders are receiving more in retiree benefits than Stockton residents have in earned income.
The city admits with its proposed budget and debt payment reductions that it will still run a $100 million cumulative deficit over the next eight years (with no reductions to CalPERS). This is from the city’s “Ask” document filed as exhibit 50 in the trial proceeds (page 60):
The challenge is that the total savings from the City’s proposals, alone, is not enough to get the City to financial health, and indeed is not even enough to match our best-case projected deficit. Further, none of these outcomes produces sufficient net resources for a General Fund reserve, which is essential for the City’s fundamental fiscal security. Finally, even if the City were to achieve a balanced budget at the ‘stabilized’ level (‘baseline plus adds’), that budget would remain insolvent in terms of service delivery because it continues the current inadequately low level of City services, and does not allow for increased service levels to meet a growing population and needs in future years.
As I wrote previously, in fairness to taxpayers, Stockton needs to cut pension benefits as part of its bankruptcy efforts. The city becoming fiscally sustainable is required by law, so it must either raise taxes or cut more expenses. Cutting pensions should be preferred to cutting police on the streets.