MuniLand

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.

Klein: apparent city will not be able to perform obligation to citizens if case is dismissed

— Ben Eisen (@BenEisen) April 1, 2013

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:

Klein: CalPERS is a garden variety crditor that bears risk of loss #muniland

— Ben Eisen (@BenEisen) April 1, 2013

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):

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.

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.

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?

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.

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.