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Latest Update on California’s Bankruptcy Brouhaha

Rick Roeder       April 2013

On April 1, after a three-day trial, Judge Christopher Klein affirmed the City of Stockton's ability to make a Chapter 9 bankruptcy filing. The Judge's decision offered financially distressed cities some daylight and upset creditors. The Judge admonished creditors for not participating in good faith in previous negotiations.

Creditors were upset on two fronts. First, they claimed that payments could be made by the City by a combination of revenue raising and asset sales. Second, creditors are upset that Stockton's unfunded pension liabilities of $900 million may not subject to the same "potential hair cut" that could apply to other creditors in the bankruptcy process. CalPERS has adamantly relied on state law in claiming its immune to any City contribution reductions. As indicated in a previous Ramble, the rub is that bankruptcy laws are federal. There is scant law available as to which jurisdiction supercedes.

The decision was a blow to municipal bond holders and bond insurers, such as the entity leading the fight against the bankruptcy process, Assured Guaranty. Indirectly, there is danger to the City's biggest sole creditor - CalPERS. CalPERS is already dealing with another bankruptcy filer, City of San Bernardino, that is not paying the contributions required by CalPERS.

Four years ago, in the Ramble, we accurately predicted that other entities would follow in the footsteps of Vallejo and make a filing if there remained any legal wiggle room to do so. Judge Klein's decision is the latest element in providing such wiggle room. Downtown Stockton, which never evoked memories of Paris, even in its best days, has turned ghostly and ghastly. The City's sky-high crime rate makes the recent Safety employee cuts even more painful to endure. That the bankruptcy option remains open means others will likely follow the lead of Vallejo, Stockton, San Bernardino and Mammoth Lakes. The pension contributions are gobbling up enormous amounts of many cities' general funds. We expect the legal issues may not be fully resolved four years hence. No less an expert than Judge Klein opined that the legal issues to be sorted out are difficult and complex.

We are surprised that the middle ground of protecting the accrued pensions of all public employees but scaling back future accruals, even for existing employees, to pre-2000 levels has not gained more momentum. Regrettably, our surprise is limited in a political environment which is not conducive to rational compromise.

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