San Bernardino’s Bankruptcy Should Be a Cautionary Tale

The news this week that the city of San Bernardino declared bankruptcy ought to have a stunning impact on the rest of the state.  The basic problem that San Bernardino faces, as one analyst suggested, is that they ignored their economic hole for the last fifteen years and it ultimately resulted in municipal insolvency.

Over the last few years, people have attempted to ignore the specter of bankruptcy facing the city of Davis because the other communities’ problems were sufficiently different so as to have their impact minimized.

The city of Mammoth Lakes, for example, a resort-town, declared bankruptcy due to a $42 million legal settlement in a town whose general fund budget is only $19 million.

Stockton, on the other hand, depleted their coffers through ambitious development that saddled the city with mortgages that ultimately it would be unable to pay, while at the same time offering pension benefits that would come due in time and threaten their sustainability as CalPERS contributions increased.

San Bernardino was different.  The city’s deficit represented 38 percent of its general fund budget.  As PublicCEO.com, the news site focusing on local government, reported on Thursday, “If the city cancelled all of its municipal functions other than public safety, they would still be left with a deficit and have to cut public safety funding.”

Instead of dealing with the structural deficit head on, the city employed one-time budgetary gimmicks that would include the sale of assets, internal borrowing and depleted reserve accounts.  Moreover, the city misrepresented the state of the city’s fiscal condition.

In 2009, the city staff had underreported the fund balance by a modest $150,000 but two years later there was a disparity of more than $3 million.  The staff told their council that their General Fund would start with a $2 million surplus while the city actually was over one million in debt.

Writes the PublicCEO: “The city’s unwillingness to reconsider city services on an ongoing basis, instead opting for one-time ‘fixes,’ left a city that continued digging itself deeper into the hole. While many didn’t predict that the current economic recession would be so long, most cities in California didn’t gamble their futures on a quick recovery.”

San Bernardino was left with just $150,000 in the bank – barely enough to cover their upcoming payroll.

The amazing thing is that city employees gave huge concessions of about $10 million per year and suffered reductions in staff of nearly 20 percent.

San Bernardino is an extreme example. The city faces $45 million per year deficits until at least 2016 which would put them in a debt of more than $200 million.

Moreover, pensions and retirement benefits are contributing factors.  To cover those obligations the city issued pension obligation bonds at the costs of $3.5 million, a number that figures to double over the next ten years.  In 2006, the city spent 9 percent of its budget on retirement costs. By 2016, that number is forecasted to reach 15 percent .

The PublicCEO reports that San Jose, “where pension reform was linked to avoiding insolvency – spends about 20 percent of its general fund on pension related costs” and Stockton “anticipated paying as much as 19 percent towards their pensions.”

San Bernardino did a lot of bad things that Davis never did.  But there are some alarming similarities that, had the current council not stepped in, it is difficult to know which path we were taking.

While the city of Davis, to our knowledge, was not underreporting end-of-the-year debt, we did cut into the reserves due in part to the overly-rosy budgeting.  Had council not stepped in two years ago, our reserve may be have been completely depleted.

While the city never sold off its assets, it did rely rather heavily on one-time funds in order to fund things like infrastructure and routine road maintenance.  As that funding disappeared, the city’s ability to fund road repair disappeared with it.  The city managed to balance the budget on appearances by putting such work into unfunded needs categories.

But it meant that the city was actually creating a debt that would have to be paid back.  At this point we have perhaps $20 million in deferred maintenance costs, not counting the needed upgrades and repair to water lines that are funded on the Enterprise fund.

The concerns are substantial enough that the city is now proposing diverting $3 million a year in general fund money to shore it up.  However, previous councils prior to 2010 completely ignored the problem when it came to budgeting time.  They were content to underfund road repairs by allocating $800,000 in one-time monies to do so.  Last year, that one-time money dried up and the city only spent $300,000.

The biggest problem the city faces is on retirement.  The city has two huge retirement obligations – pensions and Other Post Employment Benefits. OPEB is primarily a retiree health plan that within two years will represent about 24% of the city’s payroll.  Add to that the amount the city is paying for pensions, and the city may be paying as much as 40% of their general fund payroll for retirement.

This is actually starting to be an area of improvement because the city’s unfunded liabilities for OPEB are around $60 to $65 million and there is another chunk unfunded for pensions as well.

The city really did very little to shore up the long-term structural problems prior to 2010.  Budget cutting processes were primarily achieved through temporary fixes such as attrition and reduction in service hours.  The meat of the retirement obligations were not dealt with until the current budget.

To fix these problems, the city has undertaken a massive shock therapy through roughly $8 million in cuts this year.  And it may need additional cuts to fully shore things up.

The city has undertaken, in the last six months, massive reorganization.  But the heaviest lifting will be in the MOUs that seek to cut $4 million from a budget, after the city failed in 2009 to act more strongly to cut less than $1 million and after it again failed to act in 2011 when council approved $2.5 million in cuts.

These cuts represent more than 20% and less than 25% of the general fund budget.  That means that, of the money remaining, probably 40% will end up going for people who are no longer working or when the current employees are retired.

Because of the strong actions of the current council, bankruptcy is probably not a realistic fear anymore, but we need to worry about the long-term ability of an organization to function and provide services when huge percentages are going for retirement.

At least in the short term, the city is going to move toward outsourcing and more private contracts.  The community really needs to have a discussion on this issue and determine if that is the way to go.

—David M. Greenwald reporting