MuniLand

Despite neighborhood watch efforts, bankrupt Vallejo is still running defecits

Since going through a three-year bankruptcy process, a lot of wonderful initiatives have taken place in Vallejo, California – a city of 118,000 people in the northern end of the San Francisco Bay. After the city’s police force was cut down over 300 community watch groups formed to protect neighborhoods. The city recently launched Nextdoor, a private social network platform for neighborhood communication. In the most substantial move, the city has established a first in the nation “Participatory Budgeting” process. It was described by a participant as:

Funded by $3.2 million dollars allotted by a citywide sales tax passed by Vallejoans while still in bankruptcy, the city of Vallejo embarked on Participatory Budgeting (PB), the first US city to ever try PB citywide. PB Vallejo garners ideas from its stakeholders and citizenry with the goal of funding proposals that benefit the public, are a one-time expenditure, and are implemented by the city of Vallejo or other approved public agencies and nonprofits.

Did the city residents take it up?

Over 600 people assembled together at meetings across the city and online at www.pbvallejo.org to come up with over 800 ideas and suggestions on the well-being of Vallejo. 100+ volunteer budget delegates have worked together and with city staff to flesh out those ideas into viable proposals. These proposals will go onto a ballot in May where the citizens of Vallejo, ages 16 and above, will vote on which plans will go forward to the city council to fund and implement this fiscal year. The budget delegates are now preparing for three planned expos in April where they will present the proposals that will be on the ballot so the voters of Vallejo can interact, ask questions and walk away with what they need to make an informed vote.

Kudos to Vellejo’s residents for their momentum and spirit in helping their bankrupt city. It shows superior initiative. But the structural fiscal problems, which the city 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’s Gabriel Petek led a cost benefit analysis on Vallejo’s bankruptcy and determined (emphasis mine):

We think that evaluating the city’s 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.

California gets a little lovin’

The state of California received some good news this week when credit rating agency Standard & Poor’s upgraded the state’s long-term rating to “A” on its $73 billion in general obligation (GO) bonds (a single A rating is four notches below AAA). It’s certainly a feel-good moment for Governor Jerry Brown and other public officials. The municipal bond market has been anticipating the state’s improving credit position for the last year, as you can see in the chart above. It shows that the extra interest cost (over the AAA gold standard) on the state’s bonds has declined in the last year. The Golden State is getting some sunshine in muniland.

A single “A” rating is not great for a state, especially one as large as California, which has substantial debt to service and relatively volatile tax receipts. Among the positive praise that Standard & Poor’s gave the state, there were also reminders of the risks that the state faces in achieving real fiscal stability. These risks include lawmakers loosening their fiscal restraints and restoring the social spending that had been cut during the fiscal crisis. Translation: Politicians will revert to promising more than they can afford. S&P explains (requires free registration):

But another part of the answer likely rests with state lawmakers. Given that fiscal restraint has been a crucial ingredient to the state’s strengthening financial position, we think the budget process itself contains some risk.

Over-selling California’s recovery

The Golden State, under the leadership of Governor Jerry Brown, has done a remarkable job of managing its finances through the worst economic period since the Great Depression. Because the state was the epicenter of the housing bust, its fiscal meltdown was one of the most severe in the nation. Although three California cities have declared bankruptcy (with others to possibly come) the state deserves a lot of credit for getting through a very rough period.

The governor held a press conference touting the state’s recovery. However, fireworks and champagne to celebrate recovery would be a little premature. Adam Nagourney of the New York Times reported:

“The deficit is gone,” Mr. Brown proclaimed, standing in front of an array of that-was-then and this-is-now charts that illustrated what he said were dramatic changes in California’s fortunes.

California moves toward open source ratings for city bonds

In the past year, three California cities have filed for bankruptcy. This casts a pall on the bonds of other California cities, because investors wonder if they also contain buried fiscal issues. In an effort to create more transparency, a new open source ratings project was recently launched:

Responding to market concerns about municipal credit quality, the California State Treasurer’s Office has commissioned a San Jose State University economist and a government-bond research group, Public Sector Credit Solutions, to develop a default probability model for city bonds.

The “default probability model” (which is what most credit rating agencies use as a model) was created by former Moody’s executive Marc Joffe of Public Sector Credit Solutions. Here is what the California State Treasurer is hoping that it will do:

California’s budget clean-up

California narrowly averted its own fiscal cliff last week when voters approved a state ballot issue – Proposition 30 – that raised income and sales taxes. Income taxes will increase 3% for seven years on those earning over $250,000, and a supplemental 0.25% sales tax increase will take effect four years. Prop 30 is hoped to generate $8.5 billion in annual revenue and cover about half of the state’s deficit. The other half will be made up through budget cuts.

The state continues to have significant fiscal challenges, but it now has the revenue to meet its commitments through the end of the fiscal year 2013 if the economy stays on track. Fund and ETF manager Blackrock sum it up:

Following several years of fiscal stress that showcased dramatic mid-year deficits, California budgetary shortfalls have narrowed and longer-term structural balance may actually prove achievable.

Should bankrupt California cities disincorporate?

California State Comptroller John Chiang said in a press conference yesterday in San Francisco that he expected more municipal bankruptcies in the Golden State. Bloomberg has the details:

“We will start to see more bankruptcies, not necessarily because of pension issues,” Chiang said. “We need the state to participate in trying to prevent these bankruptcies.”

California cities that have hit their fiscal bottoms have been turning to the Chapter 9 municipal bankruptcy process. Recently, Stockton, Mammoth Lakes and San Bernardino voted to put themselves under the protection of a bankruptcy judge and shield themselves from new legal claims. Bankruptcy is a complex and expensive process. Fitch Ratings said in a recent report (page 5) that the state of California offers no other intervention process for broke cities.

Is spiking the biggest problem for public pensions?

The crisis that public pensions face over funding shortfalls is becoming increasingly important in the media. Add to that some concerns about the generous benefits that some public retirees receive. As state after state struggles with new controls on benefits and takes steps to address plan shortfalls, the issues become mired in more and more complexity.

There is one issue in the pension storm that is easy to understand; that is the issue of “pension spiking,” or an employee taking sometimes illegal steps to inflate the final salary on which their pension is based. California State Controller John Chiang has gone so far as to call spiking a “form of public theft.”

The Federal Reserve Bank of Cleveland defines pension spiking as:

The practice of inflating employees’ salaries to increase their benefit base. This can be accomplished through a last-day “promotion,” where the employee receives a new title and a salary far above what he earned in the previous 364 days, or where an employee nearing retirement receives the lion’s share of available overtime.

Why doesn’t Stockton challenge CalPERS in bankruptcy?

The public pension fund crisis is dire across most of America. Some states and local governments have well funded pension plans, but on a national basis pension plan shortfalls are estimated to be in the trillions of dollars. Public resources are increasingly being diverted to pay for pensions. Cities with large public pension plans had median contribution rates of 12.7 percent of payroll in 2009, up from 10.3 percent in 2002 (GAO page 15). This is projected to climb as more public workers retire. As pension costs rise, state and local governments either have fewer resources to spend or must raise taxes to maintain a steady level of services.

California has bestowed some of the most generous pensions in the country, and cities there are looking for ways to lower their contributions. Recent ballot initiatives passed in San Diego and San Jose will create modest reforms to those cities’ pension benefits. The San Francisco Chronicle reported that State Senate President Pro Tempore Darrell Steinberg (D-Sacramento) suggested there might be some “constitutional issues” at play since the San Diego and San Jose reforms affected the benefits of current public workers. The reforms are being challenged in court.

But there is one place, clearly within the law, that cities can make substantial and fiscally stabilizing changes to their workers’ pension benefits: Within the Chapter 9 municipal bankruptcy process. Cities like Stockton, Mammoth Lakes and San Bernardino have the opportunity to adjust their pension liability as they seek to adjust their other unsecured creditors.

Stockton wants to end generous healthcare benefits for its retirees

Some residents of Stockton, California are upset over the city’s decision to eliminate free healthcare benefits for public retirees. Michael Fitzgerald, a columnist for the Record, Stockton’s newspaper, wrote last week about the policy change:

The lavish perk that did the most to bankrupt Stockton is free lifetime medical care for some retired city employees and spouses. Now retirees are suing to keep it free.

And a commenter said in response:

You just wrote that retirees are the most responsible for the bankruptcy. The most? Really? Not an arena or a marina that has no fuel for boats or all the money the state raided to continue its programs, or……? About all that is left is retirees. And “unfunded liability.” Who even knew that arcane term before the City Manager started throwing it around, along with his other favorite, the Ponzi Scheme?

Do muniland’s flare-ups signal a bigger fire?

Now that three California towns have declared bankruptcy in the past few weeks, the mainstream media is abuzz with headlines of imminent doom for state and local governments. Adding fuel to the fire were Warren Buffett’s comments on Bloomberg TV about how cities may find it easier to declare bankruptcy after seeing others do it:

“The stigma has probably been reduced when you get very sizeable cities like Stockton or San Bernardino to do it,” Buffett, 81, said in an interview today on “In the Loop with Betty Liu” on Bloomberg Television. “The very fact they do it makes it more likely.”

He said the nation isn’t on the brink of hundreds of billions of dollars in defaults, as banking analyst Meredith Whitney predicted in 2010. “I don’t think we’re at the precipice,” Buffett said. “People will use the threat of bankruptcy to try and negotiate, particularly pension contracts, with their employees.”

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