Bankruptcy Won’t Help Cities Unless Courts Permit Reduced Pension Benefits

Bankruptcy Won’t Help Cities Unless Courts Permit Reduced Pension Benefits

Municipal bonds have long been among the safest investments, but a coming wave of municipal bankruptcies in California – and the disturbing way one of those cities is stiffing its bondholders – could change perceptions about the wisdom of lending money to cities.

The struggling port city of Stockton has declared bankruptcy after a spending spree where officials granted city workers an absurdly generous lifetime medical care benefit, dramatically increased pensions and floated debt to finance dubious downtown redevelopment projects.

When the city couldn’t make its pension payments in 2007, it borrowed $125 million – by selling bonds – to cover the mess it created by its pension increases. Now the city government is as upside-down as many Stockton homeowners, and officials are blaming the foreclosure crisis, conveniently neglecting that the current reduction in property tax revenue followed years of dramatic revenue increases.

Now, Stockton officials want to stiff Assured Guaranty, a Bermuda-based bond insurance company, for about $103 million. The company – noting that Stockton is going under in part because it can’t make its pension payments to the California Public Employees Retirement System – argued in a statement, “If Stockton is disappointed with CalPERS’ investment performance, it should be taking that up with CalPERS rather than reneging on the city’s obligation to holders of the pension bonds.”

Stockton City Manager Bob Deis accused Assured Guaranty of “bad faith” and “whining” even as he whined that Assured Guaranty doesn’t care about anarchy in Stockton’s streets, as the city’s crime rate soars following policing cutbacks.

But it’s not the fault of lenders that city officials were so unconcerned about their residents that public safety concerns were placed behind the demands of wealthy city pensioners. Like many cities in this state, Stockton’s infrastructure is crumbling as government becomes more a benefit provider to current and retired city employees.

Deis sounds like a wastrel who spent 10 years running up debt on luxurious living, then gets mad at his bank for wanting to get paid back: “Hey, you don’t care that I can’t feed my kids!”

Of course, it’s hard to top the arrogance of CalPERS, which has responded to Assured Guaranty’s complaints by insisting that “obligations owed to the public workers of the city have priority” over creditors such as Assured Guaranty. CalPERS also insists the media is “hyping” the idea that pension promises have anything to do with cities going belly-up. CalPERS, which in 1999 advocated retroactive pension increases based on assumed rates of investment returns that essentially required the Dow Jones industrial average to reach 25,000 by 2009, is backed by taxpayers whether its projections are right or wrong.

As cities run out of money, and pension obligations grow, we can expect to see more local officials faced with the choice of protecting city workers or taxpayers. It’s not hard to understand why the politically powerful CalPERS is so confident that the demands of public employees always come first.

As the Stockton Record reported recently, CalPERS “dwarfs all other creditors with a $245 million liability in the city over the next decade. Yet National Public Finance Guarantee Corp., an insurer of several Stockton bonds, contends in court papers that CalPERS is conspicuously missing from the list of those Stockton engaged in pre-bankruptcy negotiations.”

That insurer argues persuasively that Stockton never had any intention to seek reduced payments from CalPERS. Typically in bankruptcies, the debtor can’t pay everyone what’s owed, so then the creditors fight it out. Here, it seems like city officials cherry-picked which creditors to stiff, which certainly backs the insurer’s contention that Stockton officials have showed bias, a distortion of the bankruptcy process.

While the municipal bond markets aren’t yet spooked, they do have reason for concern, given that pension debts are growing, and there are few other places to trim if public employee retirement plans are off the table.

Even the feds are sounding some warning bells. As Bloomberg reported last month, “The U.S. Securities and Exchange Commission said it plans to seek power to force better disclosures from states and cities participating in the $3.7 trillion municipal bond market.” The SEC should add this disclosure: Your retirement investments will always lose out to public employee pension demands.

Those of us who have viewed Chapter 9 bankruptcy as a useful option to help troubled cities get their books in order have miscalculated.

Public employee unions and their allies in the courts and the retirement systems are so powerful that even during dire financial circumstances, their selfish demands trump everything else. Although bankruptcy can be a valuable tool, as Orange County’s 1994 bankruptcy made clear, the process is no panacea for incorrigibly wasteful, union-controlled local governments.

The crisis is not going away, despite CalPERS’ insistence otherwise.

Former Los Angeles Mayor Richard Riordan, for instance, said this week that the state’s largest city faces “disaster” if officials there don’t fix L.A.’s underfunded pension system.

We should closely watch the unfolding proceedings in Bankruptcy court, as Stockton goes through this process. But a more significant battle is being fought in San Jose, as courts determine whether voters’ support for a June ballot measure that cuts pensions for existing city workers is legal. The key is pensions for current workers, given that simply cutting retirement benefits only for new hires will not defuse the pension-debt time bomb.

If the courts side with reformers, there may be hope for rolling back pension costs and saving city services. If not, Californians better get ready for even higher taxes and fewer municipal services, given that there are precious few options left. And without a reform path that touches pensions for existing workers, investors might want to rethink the long-term safety of their municipal bond holdings, which will become an even bigger target.

<em>Steven Greenhut is vice president of journalism at the Franklin Center for Government and Public Integrity.</em>

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