April 1, 2013

“Judge to announce if Stockton will become most populous US city to enter bankruptcy”

It’s a brave new world, one in which failing localities who’ve run out of other people’s money to hand out to favored constituencies will either fail, find additional revenue streams, or rely on the federal courts to save them from their own stupid decisions — like, for instance, the California law that says debts to the state’s pension fund must be honored.  With bankruptcy protection granted by the courts, these failing cities can shortchange their creditors (or in this case, insurers of those creditors), continue to guarantee payment to their cronies, and essentially steal the money they borrowed to keep solvent and send it to the constituencies they rely on for re-election.

And many CA government employees — long part of the collusion between the Democrat representatives they support and the favorable legislation they receive in return for that support — aren’t about to hand back any part of the special treatment they spent good political capital to buy. FOX News:

After a three-day trial last week, U.S. Bankruptcy Judge Christopher Klein is to decide whether Stockton becomes the most populous city in the nation to enter bankruptcy, despite the objection of creditors who argued the city failed to pursue all other avenues for straightening out its financial affairs.

If it receives bankruptcy protection, the city begins a months-long process of negotiations over debt repayment that some say could end up in the U.S. Supreme Court.

“This case is worthy because of the conflict between the U.S. Bankruptcy Code and the state statutes governing CalPERS and the importance of the issue being decided,” said attorney Karol Denniston, a municipal restructuring expert who monitored the trial.

The $900 million Stockton owes to the California Public Employees’ Retirement System to cover pension promises is its biggest debt –as is the case with many struggling cities across California. So far Stockton has kept up with pension payments while it has reneged on other debts, maintaining that it needs a strong pension plan to retain its pared-down workforce.

The creditors who challenged Stockton’s bankruptcy petition are the bond insurers who guaranteed $165 million in loans the city secured in 2007 to pay its contributions to CalPERS. That debt got out of hand as property tax values plummeted during the recession, and money to pay the pension obligation fell short.

Attorneys for the creditors argued that it was unfair for them to be paid 17-cents on the dollar for the loans while the retirement fund negotiated in flush times remains untouched.

Legal observers expect the creditors aggressively to challenge Stockton’s repayment plan in the next phase of the process.

“That’s where it will be precedent-setting. Does bankruptcy code apply to CalPERS or not? If bankruptcy code trumps state law, then that’s huge and it has huge implications in terms of what happens next for other municipalities across California,” said Denniston.

The city of nearly 300,000 has become emblematic of both government excess and of the financial calamity that resulted when the nation’s housing bubble burst. Its salaries, benefits and borrowing were based on anticipated long-term developer fees and increasing property tax revenue. But those were lost in a flurry of foreclosures beginning in the mid-2000s and a loss of 70 percent of the city’s tax base.

By 2009 Stockton had accumulated nearly $1 billion in debt on civic improvements, money owed to pay pension contributions and the most generous health care benefit in the state — coverage for life for all retirees plus a dependent, no matter how long they had worked for the city.

Since cities can’t be liquidated, Stockton has attempted to restructure some debt by renegotiating labor contracts and cutting the health benefit for retirees, but creditors argued that by ignoring bond debt they haven’t created a plan that shares the pain equitably, as required under bankruptcy code.

Attorney Guy Neal, who represents creditors, spent a good deal of his trial time showing that for years Stockton had granted bloated labor contracts and benefits, and then allowed employees to boost their retirement benefits further by cashing out vacation time and sick leave in their last year of employment, thus raising their benchmark annual salary for retirement benefit purposes.

He argued that employees who shared in the wealth during good times should have to equally share the pain now, including cuts to CalPERS.

“The city simply wants to wipe out its debt but hold onto the benefits that the proceeds of that debt provided,” Neal argued.

Stockton’s City Manager Bob Deis testified that CalPERS is a trustee for city employees, not a creditor.

[...]

The state pension plan manages $255 billion in assets today but was underfunded by $87 billion in 2011, the last time calculations were made. CalPERS is in the process of setting new rates to close the liability, said spokeswoman Amy Norris, which could further strain cities in financial peril such as San Bernardino, San Jose Compton, Fairfield, Watsonville, Atwater and at least two dozen other cities.

“Just about everybody has an unfunded liability,” said Norris.

Attorneys watching the case expect that this first-ever Chapter 9 bankruptcy case questioning state pension obligations will be appealed to decide whether the 10th Amendment giving rights to states is more powerful than federal bankruptcy code. Even Klein, who was inclined at first to approve bankruptcy without a trial, said he was going forward with the hearing to create an appellate record.

“You might have the court not approve the plan because the bondholders keep raising objections until CalPERS is impaired in some way. That will be cutting edge. That’s where this case will get interesting,” said bankruptcy attorney Michael Sweet.

Actually, what is interesting here — to me, at least — are the future ramifications of such a decision.  I pity every creditor or insurer who was called upon to keep California cities going, because they’ll be screwed in order to save Democrat voters’ government pensions.   But that’s in the short term.

In the long term, the ability of Democrat-led cities to secure private creditors, or of private creditors to receive insurance, may be severely weakened, at which point it will be California (or NY or Chicago) claiming that the federal government — using our tax dollars — is required (under the “too big to fail” theory of statist governance) to bail out the Democrat constituencies in their cities who state law says is entitled to full payout, even if the money for that payout has already been pilfered and spent elsewhere by those who made the promises.

At which point, I expect we’ll see tea floating in every body of water in the country.

(h/t Terry H)

Posted by Jeff G. @ 2:59pm
20 comments | Trackback

Comments (20)

  1. Of note is that the plaintiffs aren’t those who bought the City’s debt; it’s the bond insurers who sold insurance to those who bought the City’s debt. These guys figured it was “free money” to insure debts that had “zero” probability of default. They figured wrong.

    Gotta love a story where there are no good guys on any side.

  2. All the credit default swaps our there will eventually come due. That’s when it finally comes to an end.

  3. What’s amazing is that after 230+ years of sophisticated jurisprudence nobody can reliably predict what happens when the law is applied to this very basic situation.

    Rule of law, my ass.

  4. I’m starting to feel like a real sucker for continuing to pay this friggin’ mortgage.

  5. Speaking as someone with a knowledge of bankruptcy law, that is, before the latest breakout of “it’s not really a rule of law, it’s more like a guideline”, federal bankruptcy law generally trumps state law. That pesky article 1 of the late, lamented Constitution, ya see.
    Of course, in light of the GM bankruptcy, all the rules are off now.

  6. it will be California (or NY or Chicago) claiming that the federal government — using our tax dollars — is required (under the “too big to fail” theory of statist governance) to bail out the Democrat constituencies in their cities who state law says is entitled to full payout

    Red already touched on it, but if federal law requiring certain classes of creditors to be paid off can be overruled by executive fiat, who cares what any silly old state law says?

  7. What’s amazing is that after 230+ years of sophisticated jurisprudence nobody can reliably predict what happens when the law is applied to this very basic situation.

    That’s because nobody ever thought to tell legislators and rule-writers there was a limit to how many words they could stuff into the Federal Register before it loses all meaning — even to those who don’t care about authorial intent.

  8. McGehee, no, I think they have known exactly what they were doing. It allows them to put the veneer of justice over their tyrannical acts.

  9. Red already touched on it, but if federal law requiring certain classes of creditors to be paid off can be overruled by executive fiat, who cares what any silly old state law says?

    States have executives too! Don’t you feel better now?

  10. Don’t you feel better now?

    Sure, yep. Awaiting the newly minted reality tv show “Clash of the Executives!”

  11. I’m starting to feel like a real sucker for continuing to pay this friggin’ mortgage.

    The more you pay, the more right you have to lay claim to your house.

    Because of the rehypothication.

  12. Except that the state ultimately owns your house, not you.

    Try not paying property taxes and see what happens.

  13. Yeah, but if you don’t pay your mortgage for 90 days, you get rewarded with a lower interest rate.

    Talk about your perverse incentives.

    Nah, I’ll keep paying it. As long as I can.

  14. “Try not paying property taxes and see what happens.”

    Well, around these parts it goes on the auction block 30 days after the tax due date.

  15. Charlesaustin, until somebody tells them, they can pretend not to know it.

  16. SBP, that depends on two things: One, can they find any bidders, and two, who gets to take repossession of the house while leaving it marginally intact.

  17. McGehee, fair enough, but I resist underestimating the enemy. They are not innocent or misguided. They have a goal and a plan to acheive it.

  18. They are — unwisely, I believe — ignoring the prospect of all this power ever being used against them. They are — stupidly, I think — assuming they can prevent that from occurring.

    The alert and deliberate would not make such mistakes.

Leave a Reply