MuniLand

Will Stockton get pension reform in bankruptcy?

 

Although the Detroit bankruptcy case gets the lion’s share of media attention, the bankruptcy proceedings in Stockton, California might have longer-term implications for muniland.

Detroit’s federal bankruptcy judge Stephen Rhodes quickly determined in his eligibility ruling that the city may reduce retiree pensions. But Stockton’s judge, Christopher Klein, has been making his way to a decision about the legality of cutting pensions for two years. Klein has set October 1 as the next date to possibly rule on the issue.

In Detroit there are essentially two parties involved in a reduction of pensions: the city and the retirees. Technically there are also service corporations, but in reality these are just legal shells to pass the city’s pensions payments through.

In Stockton there are three parties involved in the pension issue: the city, the retirees and a powerful state retirement system [CalPERS]. CalPERS has fought against a reduction of pensions in Chapter 9 bankruptcy proceedings in three California cities: Vallejo, Stockton and San Bernardino. CalPERS has even gone so far as to file an amicus brief for an appeal in the Detroit case.

Will Stockton go the way of Vallejo?

Late Friday, the City of Stockton, California released its “Plan of Adjustment” 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’s 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’s Gabriel Petek led a cost benefit analysis on Vallejo’s bankruptcy and determined (emphasis mine):

Stockton proposes sales tax hike to put police on the street

Stockton, California was a topic on Morgan Spurlock’s Inside Man program on CNN this week. The focus was on the increase in crime since the city slashed spending on police and fire in its bankruptcy proceeding. 70 percent of the city’s budget is spent on “safety” needs, and the city is broke.

After the housing crisis cut property tax collections, the ax in Stockton had to fall on the next-largest area of spending. City employee payrolls were cut 25-30 percent for public safety and 40 percent for non-safety positions. Now the city has a 3/4 cent sales tax increase on the ballot for November to add police to the streets. The proposed tax would raise an estimated $28 million dollars the first year. It’s an excellent idea, but not a panacea for the city’s deep fiscal problems.

Stockton pays very high salaries to city employees, especially to fire and police workers. As I wrote in March:

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.

Time for Stockton to wrestle with CalPERS

Muniland turned a very big corner today when U.S. Bankruptcy Court Judge Christopher Klein determined that the insolvent city of Stockton, California had met the criteria for municipal bankruptcy. Stockton became the largest city ever to enter Chapter 9 bankruptcy. The admittance of Stockton to the protection of the court does nothing to address the central question of Stockton’s solvency: what can be done with the massive unfunded pension liability owed to CalPERS, the statewide pension system? Stockton itself has done nothing to address the problem. Judge Klein did have one very important thing to say:

With this statement he mirrored the ruling of the Vallejo, California bankruptcy judge, Michael S. McManus, Jr., who specifically said in his 2009 ruling (page 73, clause 3102.1):

This is why Stockton is broke

Stockton, California is in federal bankruptcy court trying to make the case that it is insolvent and should be taken into the protection of the court to sort out its debts and obligations. Meanwhile, bond holders and bond insurers say it hasn’t tried hard enough to meet the requirements of Chapter 9 bankruptcy. They say the city overpays its employees and has not negotiated with CalPERS, the statewide pension system for public employees. Over 75 percent of Stockton’s general fund expenses go to pay police and fire salaries and pensions, much higher than in most communities.

On the question of overpaying its employees, Stockton’s city manager, Bob Deis, wrote in an OpEd for the Wall Street Journal last year:

Also painful is our public safety situation. We are the 10th-most violent city in America. Rates of violence are increasing by double digits, with our murder rate on track to surpass last year’s record of 58 murders. We have the second-lowest police staffing levels in the country for a large city, and often Stockton Police can respond only to “in-progress” crimes. Oakland, a nearby city with similar crime challenges, has 44 percent more police officers per capita. With high poverty rates and gang activity, we cannot turn our back on public safety due to creditor pressure.

How bankrupt Stockton, CA was sold pension obligation bonds

Mary Williams Walsh of The New York Times recently dove into the issue of pension obligation bonds (POB), and she came up empty-handed. In her piece on bankrupt Stockton, CA’s POBs, Walsh relied on the analysis of an academic, Jeffrey A. Michael, with little background in municipal bonds, to claim that Stockton was duped into issuing $125 million of these bonds in 2007. Michael contends that the POB underwriter, Lehman Brothers, did not adequately disclose the risks associated with issuing POBs. Walsh writes:

After reviewing an analysis of the bond deal, underwritten by the ill-fated investment bank, Lehman Brothers, and watching a recording of the Stockton City Council meeting where Lehman bankers pitched the deal, Mr. Michael concluded that “Stockton is entitled to some relief, due to deceptive and misleading sales practices that understated the risk.

Lehman Brothers just didn’t disclose all the risks of the transaction,” he said. “Their product didn’t work, in the same way as if they had built a marina for the city and then the marina collapsed.

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?

Did the police and fire departments sink Stockton?

How does a bankrupt city pay its public safety workers twice the median household income of the area’s residents? More important, why haven’t the city manager and council stopped this wage bonanza?

In Stockton, California, public safety workers earn on average 126 percent of the maximum salary and at least 200 percent of the minimum wage for their respective wage categories. The California State Controller’s Office has all the data, and it’s not pretty.

Stockton’s median household income was $50,011 in 2010. In contrast, the average total wage paid to a city police worker was $93,111. For employees of the fire department, it was $110,303. Admittedly, these are dangerous professions, but surely they are not so dangerous as to require pay of double the median household income of the entire community.

Why Stockton is broke

Stockton Vice-Mayor Kathy Miller talks about the exorbitant salaries paid to city workers and why the city is filing bankruptcy.

The media has described the problems of Stockton, California as being caused by the housing crisis and economic recession. A non-profit, California Common Sense, points to another reason for the city’s bankruptcy: its extraordinarily generous employee compensation agreements (emphasis mine):

[Stockton] employee salaries are scheduled to automatically increase 2.5-7%, depending on General Fund revenue growth. Consequently, employee salaries increase 2.5% even if the General Fund shrinks compared to the previous year.

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