Pension Funds Wary as Bankrupt City Goes to Trial

March 25, 2013 – In The News
The New York Times

Wall Street is taking America’s biggest pension fund to court for a long-awaited battle over who takes the losses when a city goes bust – workers and retirees, municipal bondholders, or both.

The city of Stockton, California declared Chapter 9 bankruptcy last year after suffering one of the country’s sharpest riches-to-rags swings when the mortgage bubble burst. Stockton slashed tens of millions of dollars’ worth of city services and said it would cut its municipal bond repayments to a degree never seen before in a municipal bankruptcy.

Mutual funds that hold the threatened bonds, and the insurers that guarantee them, have cried foul, citing the principle that in bankruptcy, similar classes of creditors must be treated the same way. Their objections have prompted the federal bankruptcy judge handling Stockton’s case to schedule a four-day trial.

The immediate question before the judge is whether Stockton qualifies for Chapter 9 at all; unlike companies, cities must meet certain criteria before they can get federal court protection from creditors.

“People will be watching very closely,” said Michael Sweet, a bankruptcy lawyer whose practice includes advising local governments on Chapter 9 issues.

Cities, school districts and local governments all over the country have promised their workers pensions that looked reasonable in better times however they have turned into budget busters since the financial crisis.

“Every member of every city council that’s struggling with these issues, who takes their job seriously, is looking for solutions,” Mr. Sweet said. “No one wants to talk about it, and no one really wants to go there. But if Calpers can be forced to take a haircut in Stockton, then what’s to stop another city from saying, ‘Gee we’ll file for bankruptcy and cut in half our $10 million pension contribution?’”

Sweet and other public finance lawyers said that what happens in Stockton could help guide Detroit, which is not in Chapter 9 but was recently put under emergency management by the state of Michigan.

In 2011, Stockton paid a little more than $20 million to Calpers. Its payments are expected to nearly double in the next 10 years, making Calpers the city’s biggest creditor. Stockton says it has no choice but to keep paying, even as it pares other costs, including its payments to bondholders.

Last year, Stockton asked Calpers for a “hardship exemption,” allowing it to slow down its contributions. Calpers said no, fearing that if Stockton fell behind, it might never catch up.

“They’re scared to death,” Sweet said. “Calpers says, ‘You can’t give us a haircut, because if you do, the world is going to collapse. If it happens to Stockton, it’s going to happen in San Bernardino, and if it happens in San Bernardino it’s going to happen in Modesto, and if it happens in Modesto it’s going to happen in Bakersfield, and if it happens in Bakersfield it’s going to happen in Fresno.

San Bernardnio filed for Chapter 9 bankruptcy not long after Stockton did and then simply stopped making its contributions to Calpers. Calpers threatened to sue, but the judge handling San Bernardino’s case stopped it, saying she would address the issue of pension contributions later in the bankruptcy.

This article also appeared in the International Herald Tribune, distributed in Paris, France and the Fresno Bee.