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There are U-Turns in Downtown Stockton!

Rick Roeder       October 2014

On October 30, Judge Christopher Klein approved the City of Stockton’s bankruptcy plan. Numerous creditors balked because the plan favored CalPERS over other creditors – many who will be receiving significant hair cuts in the Stockton proposal. CalPERS will still be entitled to full payments from the City. The City of Stockton filling did not include any impairment of pensions for plan participants. The City is on the hook for a $29 million dollar annual contribution to CalPERS, as well as $200 million in bond debt. The City is pleading poverty and points to a sky high crime rate as one reason to husband its financial resources.

Five weeks ago, the Klein ruling would not have been surprising but the Judge opined that “pensions could be subject to adjustment.” This had set the pension world in a tizzy that many financially strapped entities would have an expensive, but possible, salvation in bankruptcy. Then, Judge Klein did a head feint and changed course in a manner which would have made Barry Sanders proud.

This comes as a mild surprise to the Ramble as we felt pensions would ultimately not be treated differently than other contracts. In future years, this may still prove to be the case. Klein had earlier said, “The United States constitution reigns supreme over any state laws protecting pensions.” Klein also said the City could sever ties with CalPERS. CalPERS, in turn, put a gun to the City, saying, “if you leave CalPERS, you will owe us an exit fee of $1.6 billion to cover the value of all potential benefits to participants.”

CalPERS was never going to go quietly in the night on this issue, even if Judge Klein ruled against them. In addition to pointing to the state constitutional protection of pensions, the argument will be made that pensions represent deferred compensation and thus should not be commingled with the claims of other creditors. In justifying his ruling, Klein felt that the affected plan participants had already taken a hit.

Another interesting question existed which may now become moot. Is there any possibility that the court will allow the pensioners not to take a haircut but leave the CalPERS trust holding the bag for unfunded liabilities of entities filing for bankruptcy? While I doubt this outcome could happen, such eventuality would have been a measure of poetic justice. Rampant optimism permeated CalPERS communications toward the end of the raging, 1983–2000 bull market. CalPERS actuarial reports often used the term “superfunded” if a contract agency’s assets exceeded certain benchmarks relative to its liabilities. When Governor Davis signed SB–400, permitting contract agencies to adopt pension benefits at unprecedented levels, who could blame “super funded” entities to think all would be well, even after a marked benefit hike?

Franklin Templeton loaned $36 million to Stockton and was upset that the City proposed to repay only four million dollars in their filing. After all, the crux of any bankruptcy process is the breaking and parsing of existing contracts. So, unless there is an argument that public entities are ineligible to file for bankruptcy, I still think that there will be ongoing debate on the issue of pension “haircuts” for financially strapped entities across the country.

Curious minds will wonder why Judge Klein made his earlier comments in light of his final decision. Was he warning the public that this was a very close case? Did he think that pension contracts were not fundamentally different than other contracts but that it cause too much tumult? Did he become subject to the immense clout CalPERS has? We may never know..

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