Thread: Stockton, Calif., to become largest city to declare bankruptcy

June 27, 2012 12:06 AM

Stockton, Calif., to become largest city to declare bankruptcy

(CBS/AP)

STOCKTON, Calif. - Officials in Stockton said Tuesday that mediation with creditors has failed, meaning the Central California city is set to become the largest American city ever to declare bankruptcy.

A source confirmed with CBS affiliate KOVR in Sacramento on Tuesday prior to the City Council meeting that Stockton will indeed file for Chapter 9 bankruptcy protection.

City Manager Bob Deis said officials were unable to reach a deal to restructure hundreds of millions of dollars of debt under a new state law designed to help municipalities avoid bankruptcy.

Monday marked the three-month deadline for negotiations.

"Unfortunately we have no comprehensive set of agreements with our creditors that would eliminate the deficit and avoid insolvency," Deis said at a City Council meeting. He said, however, that the city was still negotiating with some creditors and could reach deals with as many as one-third of them.

"We think Chapter 9 protection is the only choice left. If we get any agreements, those will be honored in Chapter 9," Deis said.

The Council was expected to vote later Tuesday on a special bankruptcy budget to plug next year's anticipated $26 million deficit, and city lawyers could file for Chapter 9 protection in court as soon as Wednesday.

The river port city of 290,000 in Central California has seen its property taxes and other revenues decline, while expensive investments and generous retiree benefits drained city coffers.

In the past three years, officials in the city that was slammed by the collapse of the housing market dealt with $90 million in deficits through a series of drastic cuts.

They eliminated one-fourth of the city's police officers, one-third of the fire staff, and 40 percent of all other employees. They also cut wages and medical benefits.

To plug next year's anticipated $26 million shortfall, the proposed budget would suspend payments for debts and legal claims, reduce payments for retiree medical benefits, further cut some pay and benefits, and increase revenue through code enforcement and parking citations.

The proposed budget includes no major service reductions, Deis said earlier.

"The whole purpose of filing Chapter 9 is to avoid an uncontrolled chaotic situation," he said. "Bankruptcy provides the equivalent of a pause button. It retains services and provides structure so you don't have a bunch of lawsuits."

In a standing-room only chambers Tuesday, former city employees told council members about their life-threatening medical conditions and said benefit cuts meant they would effectively lose their health insurance.

"For me, bankruptcy might as well be a life sentence," said Gary Jones, a retiree who used to be a police officer in Stockton and said he was diagnosed with a brain tumor.

Other residents complained about plummeting property values, and recurring break-ins and robberies.

"The average citizen will not put up with this. Their home prices have plummeted, they have no jobs, a lot of people are getting fed up so that they have to resort to crime." said Gregory Pitsch, a 22-year-old unemployed resident who made an unsuccessful run for mayor. "I'm asking you to make the right decision, not destroy the property values in this city, which bankruptcy will do."

But city officials say Stockton has run out of options. In recent years, thousands of new homes mushroomed in Stockton, part of a suburban housing boom that attracted buyers from the San Francisco Bay area and beyond.

When the economy crashed and the construction bubble burst, Stockton was battered by foreclosures and lost income from property taxes and other fees.

Multi-year labor contracts for city workers carrying escalating costs and generous retirement plans added to the burden.

In addition, expensive city investments — a promenade, sports arena and hotel — failed to produce an economic boon.

The unemployment rate has doubled in Stockton over the past decade and now hovers around 16 percent. One-fifth of residents live below the poverty line, and the city has twice topped Forbes magazine's list of "America's most miserable cities."

Under a bankruptcy filing, officials would retain power over day-to-day city operations and staffing, but a judge would take over all decisions concerning the city's debts, said Robert Benedetti, professor of political science at the University of the Pacific in Stockton.

The judge would decide which creditors should be paid, how much and in what order. He would make allowances for expenditures needed by the city to function, and it would be up to city officials to decide how to spend that money.

"One of the reasons a city might want to go the bankruptcy route is that they don't want a situation where they have to pay out debts and have to close the police or fire department," Benedetti said. "Filing for Chapter 9 means you're asking the court to protect you against lawsuits from people who hold your debt."

Stockton's bankruptcy would make it the largest city by population to file for Chapter 9 protection, according to Jim Spiotto, a Chicago bankruptcy lawyer who tracks such cases. He said Bridgeport, Conn., was the largest city to file for bankruptcy, which it did in 1991, followed by Vallejo, Calif., which filed in 2008.

Jefferson County in Alabama is the largest local government bankruptcy filing to date in terms of the size of its debt. It occurred in November 2011 and was followed by Orange County, Calif., in 1994.

If a judge approves a bankruptcy plan, money to pay creditors would come from Stockton's general fund, which pays chiefly for public safety, including police and fire protection.

Experts say the bankruptcy filing, while protecting the city from catastrophe in the short run, should not be seen as Stockton's panacea.

"Bankruptcy won't take away Stockton's underlying financial problems, one of which is the economy, the high unemployment rate and the high foreclosure rate," Benedetti said. "It will take years for them to come out of this."

Stockton was the first city to test a new state mediation law, Assembly Bill 506, which is less than 6 months old.

Under the law, municipalities considering bankruptcy must first negotiate behind closed doors with creditors for up to three months, with the goal of settling debts without filing for Chapter 9 protection.

Stockton officials have said that even with a bankruptcy, they are optimistic. They point to Vallejo, a smaller California city that filed for Chapter 9 protection in 2008 and emerged from bankruptcy last year.

"Vallejo is leaner, smarter and they've got the confidence of their citizenry," Deis said. "I think Stockton will be doing the same."

Benedetti said Stockton has some things going for it: An excellent location, successful inland port and good university.

"It has some promising economic resources, so it's not all down and out," he said.

Stockton, Calif., to become largest city to declare bankruptcy - CBS News

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SINCE 1980 . . .

How Stockton went broke: A 15-year spending binge

By Jim Christie | Reuters – 1 hr 21 mins ago...

SAN FRANCISCO (Reuters) - The man in charge of the biggest U.S. city ever to file for bankruptcy is clear about the root of the crisis.

It was a decision that gave firefighters full healthcare in retirement starting on January 1, 1996, said Bob Deis, the city manager of Stockton, California.

At the time, the move seemed cheaper than giving pay raises sought by unions, officials involved in the decision said. When other Stockton employees demanded the same healthcare deal in following years, the city agreed.

Deis, who signed Stockton's bankruptcy filing last Thursday, slammed the decision to provide free healthcare to retirees as a "Ponzi scheme" that eventually left the city with a whopping $417 million liability.

Before the turn of the millennium, things looked very different in California.

The U.S. stock market was booming, bolstering Stockton's pension funds. Real estate values were about to soar, too, bringing a flood of new tax revenue to the once quiet farming town of about 300,000 people - about 85 miles east of San Francisco - in California's Central Valley.

THE TRADE-OFF

To counter demands for wage hikes from city workers in the 1990s, Stockton offered to extend their health insurance in retirement past age 65 - a benefit they embraced and assumed to be rock solid until the insolvent city's officials put it on the chopping block in a bankruptcy plan last week.

"It was a balancing act," said Dwane Milnes, Stockton's city manager at the time. "The unions wanted retiree medical ... We said if you want to continue your medical for current employees and retirees, you'll have to do it through wage containment."

Milnes, who represented Stockton's retirees in recent talks with City Hall, said the strategy was sound at the time.

"We were satisfied that based on a conservative view of the economy and based on the medical inflation rate we were experiencing in the 1990s, the city could adequately fund retiree medical."

Detective Mark McLaughlin said Stockton's labor unions embraced the trade-off, which in the police department's case helped with recruiting and retention.

"It was an easy sell," he said, adding that city workers believed the money they gave up in pay increases would be able to pay for the health benefit.

SPEND, SPEND, SPEND

Other U.S. cities have also experienced boom and bust like Stockton.

But analysts and investors generally see Stockton as an extreme case of fiscal mismanagement over the past two decades.

Daniel Berger, a senior market analyst at Municipal Market Data, a unit of Thomson Reuters, said last week, before the bankruptcy filing, that the municipal bond market had viewed Stockton's fiscal problems as "a slow-moving train wreck." The possible bankruptcy filing, he said at the time, was seen as an "isolated occurrence."

As the 2000s advanced, Stockton continued to spend freely with the support of voters, politicians from both parties, employees and bondholders. Rating agencies were quiet about any risks and only started to downgrade the city's creditworthiness two years ago.

Generous pension deals were offered in the early 2000s.

City officials, looking to transform their sleepy downtown, approved spending on large projects to raise Stockton's profile and turn it into a bedroom community for San Francisco and the Bay Area.

Homebuilding went into overdrive. Home prices skyrocketed to a median of nearly $400,000 in 2006 from a median of $110,000 in 2000.

Stockton's revenues jumped, too. Its general fund, which pays the city's operating costs, swelled to $186.4 million in 2007 from $139.1 million in the 2001 fiscal year.

ROYAL PENSIONS

Like other cities in California, Stockton chose to offer many public safety workers the same benefits as those mandated by a state law for highway patrol officers. The change allowed police officers to retire at 50 with pensions based on 3 percent of final pay for each year in service, up from 2 percent before.

City employees in other unions also received more generous pensions with eligibility to retire at age 55 - with 2 percent of final pay multiplied by the number of years of service.

This is in contrast to the vast majority of private-sector workers who cannot receive Social Security payments before they are at least 62.

By the 2000s, Stockton's full-time employees were also entitled to free healthcare for life.

Still, there seemed little cause for concern.

With huge stock market gains from the 1990s, city officials were confident about meeting pension costs. After all, the Standard & Poor's 500 Index index quadrupled between early January 1990 and late March 2000.

Police and firefighters continued to win further concessions. Generous allowances were offered to police officers to buy their uniforms, bonuses were introduced based on years of service, and retiring officers claimed cash payments for unused vacation days - accumulated over years in some cases.

Warning signs grew that retiree healthcare costs were rising fast. The city miscalculated the rate of inflation for medical costs during the 2000s.

But Stockton's leaders burned through their reserves and began planning new construction projects to make the city more appealing to new residents.

A $47 million bond issue in 2004 was meant to finance construction of a sports and concert arena to revitalize the city's downtown. The arena was built, but it ended up losing money.

A downtown high-rise building was acquired for a new City Hall. A revamp of Stockton's downtown riverfront was financed, along with other projects, by more than $100 million in debt between 2004 and 2006 by the city's redevelopment agency.

Stockton ended up absorbing that debt after California's governor eliminated local redevelopment agencies last year.

It seems unlikely that Stockton will be able to sell those real estate assets at a gain.

"Most of the assets that look nice are under water," said Deis, the city manager.

A $125 million pension obligation bond sold by Stockton in 2007 also backfired. Stockton passed the proceeds to the California Public Employees' Retirement System, or Calpers, to pay down unfunded liabilities at the pension fund. Then the fund suffered steep losses when financial markets plunged in 2008 and early 2009 and left Stockton with a 23 percent loss on its invested proceeds and in debt to investors who bought the bonds.

HOUSING BUST'S TRAIL OF PAIN

The worst damage was done by the housing crash. Median home prices in Stockton slumped to $110,000 in 2009, erasing nearly a decade's gains. General fund revenues in the current fiscal year are projected at $155 million, just above their level in 2001.

The real estate bust made Stockton one of the foreclosure capitals of the United States. Property-tax revenues tumbled. The city began its new fiscal year on July 1 with its 1,420-strong workforce down by a quarter from three years earlier.

Debt service has ballooned to $17.2 million a year from $3 million just six years ago.

Stockton has already defaulted on about $2 million in bond payments since February.

Recriminations about Stockton's budget need to be set aside to avoid the kind of lengthy bankruptcy suffered by Vallejo, another California casualty of the boom-to-bust cycle. It emerged from bankruptcy last year after three years in Chapter 9 that cost it $10 million in legal fees.

Stockton has earmarked $3.5 million for bankruptcy court expenses because it hopes for a quick exit from Chapter 9.

Bondholders, employees and retirees will be hurt in the process. Axing retiree medical benefits is now central to efforts to restructure Stockton's finances, Deis said.

Many retirees are in a state of shock about that.

"I believed the city would honor its commitments," said Geri Ridge, 56.

The former clerk retired last year after 26 years with Stockton's police following a second heart attack.

Ridge lives off a monthly pension of $1,895. She learned on Friday that she now faces a $576 monthly premium for her health coverage - or $1,277 a month if she keeps her daughter on her plan.

She has no idea of how to pay for the coverage, which the city will fully eliminate in a year. And she has harsh words for Deis.

"I want him gone. I'm hoping whoever gets elected into office fires him, bankruptcy or not," Ridge said.

How Stockton went broke: A 15-year spending binge - Yahoo! News