Will Stockton go the way of Vallejo?
Late Friday, the City of Stockton, California released its ‚ÄúPlan of Adjustment‚ÄĚ for how it intends to treat its creditors in bankruptcy. The plan has been in the works since the city filed for protection under chapter 9 of the United States Bankruptcy Code on June 28, 2012. Stockton‚Äôs City Council will vote on the plan this week, on October 3rd.
On inspection, the plan looks a lot like the failed adjustment for formerly bankrupt Vallejo, California, which continues to suffer massive operating deficits. The lead bankruptcy attorney for both Stockton and Vallejo is Sacramento-based lawyer¬†Marc Levinson, who¬†seems to be failing both cities by not using bankruptcy to create a stable fiscal base. If it is approved by Federal Bankruptcy Judge Christopher Klein, the plan will keep Stockton perennially saddled with massive pension liabilities. I wrote in May about Vallejo:
The structural fiscal problems, which [Vallejo] could have addressed through the bankruptcy process and chose not to, remain. Even after spending an estimated $12 million on bankruptcy and legal fees, the city has fiscal problems. Standard & Poor‚Äôs Gabriel Petek led a cost benefit analysis on Vallejo‚Äôs bankruptcy and determined (emphasis mine):
‘We think that evaluating the city‚Äôs bankruptcy solely on its fiscal merits, therefore, renders an equivocal verdict. When indirect and long-term costs are added to the equation, based on our estimate, it becomes even less likely that the benefits of bankruptcy will come near the costs.’
Levinson‚Äôs efforts in Vallejo have added little value to the city‚Äôs long-term fiscal stability. A big issue is that he refuses challenge CalPERS, the powerful statewide pension system, and attempt to haircut pension payments for city retirees. Judge Klein said in his eligibility ruling that retirement liabilities for the city were astronomical (page 556):
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‚Äôs become known as ‚Äėpension spiking,‚Äô in which a pension can wind up being substantially greater than the annual salary that the retiree ever had.
There‚Äôs 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‚Äôs 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.
Klein opened the door to pension cuts via bankruptcy in the eligibility ruling (page 590):
This does not mean that there‚Äôs 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 ‚ÄĒ 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‚Äôs section 1129(b)(1) of the Bankruptcy Code, which, by virtue of section 901, applies in chapter 9 cases.
What is Levinson waiting for? The economic conditions of Stockton have collapsed:
Median home prices fell from a peak of $400,000 in December 2005 to $118,500 in February 2012, a decline of 70 percent. Home sale prices have begun to recover over the past year, but given the time lag in property tax administration this will not be immediately realized in terms of higher tax revenues.
City revenues have withered:
Since FY07-08, the City has suffered significant revenue losses due to the deteriorated local economy. Total ongoing General Fund revenues have dropped from approximately $192.9 million in FY07-08 to $157.7 million in FY12-13.¬† Even with enactment of the proposed 0.75 percent sales tax, FY14-15 revenues would total $189.9 million, which is still below the FY07-08 level.
There are plenty of reports in the media about the proposed treatment of bondholders. If investors hold bonds for secured, essential assets, then the city proposes to continue making principal and interest payments. For non-essential assets, bondholders will likely face a reduced recovery.
In Stockton, where the median household income in 2011 was $44,310, public pension payments are very rich:
The average pension among 112 Stockton safety employees retired for under five years was $88,091 a year, up from an average of $73,522 for the 65 safety workers retired for five to nine years.
Compare that to pension payments in Sacramento, a much larger city:
The average pension among 190 Sacramento safety employees retired for under five years was $70,348 a year, up from an average of $68,948 for the 190 safety workers retired for five to nine years.
Stockton will pay 8.8 percent of general fund revenues, or $17.75 million to CalPERS in fiscal year 2013/14. Since Levinson will not challenge CalPERS, this payment will rise to $35.9 million in 2020/21 and consume 18.8 percent of projected general fund revenues.
With the proposed plan of adjustment, Stockton will be drowning in pension liabilities for decades. Stockton deserves a better outcome than Vallejo, which, according to Standard & Poor’s, didn‚Äôt get a lot of value for the legal fees it paid during the bankruptcy. Judge Klein has signaled that he is willing to get down into the ‚Äúnitty-gritty‚ÄĚ of the pension issue. From Calpensions:
The judge said the Capital Market Creditors claim of ‚Äėunfair discrimination‚Äô is not an eligibility question, but by law must be considered when the city proposes a plan of adjustment to reduce its debt before emerging from bankruptcy.
‚ÄėThe city is going to have a difficult time confirming a plan over an objection and claim of unfair discrimination without being able to explain that problem away,‚Äô the judge was quoted as saying in a court transcript posted by the city.
‚ÄėAnd that problem is probably going to require me to get down into the nitty-gritty of the CalPERS situation. And I, at this point, have no clue how that‚Äôs going to come out, but that is the protection (for the creditors),‚Äô the judge said.
Stockton deserves better than this plan of adjustment. Levinson should go back to the drawing board.