Stockton, CA–a courtroom battle with uncertain (but maybe big) consequences

Stockton, CA

Stockton, California is a town of just under 300,000 citizens, located about 80 miles east of San Francisco.  Stockton has recently achieved two unenviable distinctions:

—it’s a repeat “winner” of the Forbes prize as the “most miserable city” in the US, although it has fallen/improved to #8 in this year’s poll (in case you’re interested, Detroit is the current champ; Modesto has replaced Stockton as #worst in CA).

—it’s also the largest US city (so far) to have filed for bankruptcy.  Stockton did last year to deal with fiscal troubles that a welter of bad decisions it made during the housing bubble caused.

the bankruptcy:  


The city has two big creditors:

–the CalPERS state pension system for government workers, to which it owes $900 million or so; and

–municipal bondholders, who own $600+ million of Stockton paper.  Of that, about a quarter is insured, meaning the insurance companies–not bondholders–are on the hook for any losses.

–last week

The bond insurers, along with Franklin Advisors and Wells Fargo representing bondholders, went to court to try to prevent Stockton from entering bankruptcy.  They argued two points:

1.  that Stockton was not really insolvent, and

2.  that the city’s proposed plan of adjustment discriminates unfairly against bondholders because it leaves its debt to CalPERS untouched, meaning the bondholders and insurers would absorb 100% of any losses.

Last week a US court said Stockton could declare bankruptcy.  Judge Christopher Klein ruled that:

1.  Stockton is insolvent, and

2.  the discrimination issue doesn’t need to be addressed before Stockton can enter bankruptcy.  It does, however, need to be dealt it can exit bankruptcy.  Judge Klein wrote, “And that problem is probably going to require me to get down into the nitty-gritty of the CalPERS situation. And I, at this point, have no clue how that’s going to come out.”

–what I find worth watching

To me, the biggest issues are:

–whether government employee healthcare or retirement benefits are subject to renegotiation in bankruptcy;

–whether any court action hinges on the judge’s description of Stockton benefits as overly generous and subject to upward manipulation through “pension spiking,” or whether it will have more general application, and

–whether CalPERS will be forced to share in any pain.

The whole question of guaranteed lifetime benefits–something that has virtually ceased to exist in the corporate world in the US–is a highly emotionally and politically charged one, as you can see from just about any internet discussion you find about Stockton.  The Stockton case could have an outsized ripple effect on public debate.   It may also end up influencing Californians about where they choose to live and work.

I don’t think it’s yet clear what the real position of the Stockton city government is on after-the-fact reductions in employee benefits is.  If you hope to be reelected, it would be much better to be “forced” by a court to make cuts than to volunteer to make them yourself.  CalPERS has already made it clear, though, that it regards the $900 million Stockton pension shortfall to be solely the city’s problem.

This case will also doubtless also have consequences in the arcane world of municipal bond insurance, where premiums are very small because claims almost never happen.  A large loss from Stockton bonds may dampen insurance companies’ enthusiasm for guaranteeing the offerings of iffier credits.

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