Commentary: Stockton Shows That Bankruptcy Is Not the Answer

There have been days where readers in frustration about Davis’ fiscal situation have suggested that Davis simply declare bankruptcy and start over. However, the experience of Stockton suggests that a simple answer is elusive and that bankruptcy is wrought with its own perils and difficulties.

Teague Paterson, a Sacramento attorney, is no dispassionate bystander as he filed a brief in the Stockton case on behalf of the Peace Officers Research Association of California (PORAC). He noted “the consequences for a municipality [declaring bankruptcy] are 10 times as dangerous [as a private citizen].”

“Bankrupt cities,” he notes, “face soaring crime rates, shrinking property sales, and the reduction or elimination of basic public services. It’s is not a decision that an elected official or city manager would willingly make unless there were no other options, as the decision by a bankruptcy judge presiding over Stockton’s bankruptcy makes clear.”

While we can imagine that Mr. Paterson is not unbiased on this matter, we believe he is largely correct that “Judge Christopher Klein’s ruling Thursday to approve Stockton’s bankruptcy plan confirms that the situation in Stockton will have little impact over the larger national debate on public pensions. Municipalities will not be filing for bankruptcy in waves in efforts to jettison pension debt. “

“For the very few severely distressed cities that may consider bankruptcy, the question will not be whether they can reduce pensions, but whether they should,” he writes. “In Stockton, the answer to that question was clear to all with a stake in Stockton’s future – and after two years of litigation that cost tens of millions of taxpayer dollars, the bankruptcy judge agreed.”

He adds, “Throughout the bankruptcy process, the people of Stockton have been through hell and back. Judge Klein said that the length and cost of the bankruptcy process, and the likelihood of protracted litigation, will give any cash-strapped city considerable pause before considering a bankruptcy filing.”

It was not long ago, when Judge Klein’s ruling came out, that it appeared there might be a path forward to reduce pension obligations in the future in cases of bankruptcy. Previously, judges had ruled pensions to be vested rights, where cities could not reduce them even prospectively.

As CalPERS (California Public Employees’ Retirement System) notes, “The California Supreme Court long ago established that a promise of a pension made by a public employer to its employees is a promise the employer must keep. In other words, public employers in California are legally required to honor promises to current and former employees regardless of how much money they have set aside for that purpose.”

But Judge Klein’s ruling changed that – he was willing to declare that pension obligations are simply debts that could be trimmed. He went further and declared that the city of Stockton has the right to reduce pension payments and even sever ties with the powerful pension fund.

“The verbal ruling from U.S. Bankruptcy Judge Christopher Klein was groundbreaking,” the Bee wrote a month ago. “It pierced CalPERS’ aura of invincibility and made clear, for the first time, that public employee pensions in California aren’t sacred.”

That they decided not to go that way demonstrates the problem, going forward, that cities face.

The city of Davis does not face the type of debt that Stockton did and therefore bankruptcy has not really been an option. While Davis was slow to implement reforms to pensions, health care benefits, and even capping of salaries in the early days of the recession, Davis escaped without massive debt.

Right now it is plagued by a large amount of deferred maintenance on roads, parks, city buildings and other infrastructure. Perhaps its biggest problem is the sluggish growth in sales tax revenue resulting from its underdeveloped economy.

The path forward for Davis, however, is relatively straightforward.

First, it must continue to hold the line on, if not make further reductions to, employee compensation. The sales tax measure has given Davis the ability in the short-term to balance its budget. The sales tax offsets the increases to employee compensation costs plus it gives Davis about $3.9 million now in ongoing revenue to use for roads.

However, city staff and consultants have recommended the city bond to create about $25 million over two years that it can use to reduce the road maintenance backlog. Because of the double-whammy of road costs – asphalt inflation and road deterioration – the increased costs of road repair is actually greater than debt servicing costs.

In order to bond, the city will need a revenue stream to bond against and that will likely take the form of a parcel tax. There has been some debate as to the size of the needed parcel tax and what the city should pay for with that tax. Some have argued the city should just pay for roads, sidewalks and bike paths. Others like the mayor, want the city to address pool needs, parks and other infrastructure.

The third plank of this strategy is growing the economy. Former City Manager Steve Pinkerton in 2013 argued that the city did not have a spending problem anymore, it had a revenue problem. The city has an underdeveloped retail base that has led to a slow recovery after years of recession.

Going forward, the city is looking to generate new revenue through a Hotel Conference Center located on Richards Blvd, and the city is looking to develop innovation parks on Nishi, Mace Ranch Innovation Center and the Davis Innovation Center.

The city is looking at a 20-year build out of more than 7 million square feet of business space on the latter two sites. With one-time construction fees and anticipated property and sales tax enhancements, the city will be much better positioned economically after the build out.

But that is a long-term strategy. In the short term, the city is going to have to survive on a tight budget, which means holding the line on employee compensation, allowing turnover to gradually reduce both pension and health care costs, and passing temporary tax measures to bridge the gap.

It may not bring quick relief, but, over time, it will build a stronger and more sustainable system without the need for bankruptcy.

—David M. Greenwald reporting

About The Author

David Greenwald is the founder, editor, and executive director of the Davis Vanguard. He founded the Vanguard in 2006. David Greenwald moved to Davis in 1996 to attend Graduate School at UC Davis in Political Science. He lives in South Davis with his wife Cecilia Escamilla Greenwald and three children.

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  1. Jim Frame

    The sales tax offsets the increases to employee compensation costs

    I don’t think this statement should ever be made without the qualifier that those cost increases weren’t the result of new contract negotiations, but rather of impositions by CALPERS and/or health care providers, i.e. the increases were locked in by legacy contracts.  It’s important for readers to understand that the CC has been working hard to hold the line on staff salary and benefit increases.

  2. Gunrocik

    The path forward for Davis, however, is relatively straightforward.
    First, it must continue to hold the line on, if not make further reductions to, employee compensation.

    Well, the City Council has already made that a near impossibility by hiring a novice to run the City and then giving him a $50,000 raise.
    You have to be kidding if you a think a Craig Reynolds/Bobby Weist-controlled City Council is going to make the hard choices on employee compensation.

    And without more haircuts for the employees a parcel tax requiring a 2/3rds vote is dead.  Davis will not have to go bankrupt without the parcel tax but our quality of life will be irrevocably altered.

  3. Sam

    I agree that the city filing for bankruptcy is going to hurt, but with PERS only funded at about 50% it is going to be a struggle to pay when contribution rates are increased to meet this obligation. You also have an issue with unfunded OPEB. You can only approve so may parcel taxes. It will be interesting to see the first city to file for bankruptcy with the sole debt obligation being PERS. A city like Davis.


  4. Frankly

    This is typical.  Over compensate and fail to fund the true cost thus leading to financial difficulty and then create a crisis of service reduction and disruption to make a case for greater taxation to return to the over-compensation practices.

    If it wasn’t clear that we are grossly over-compensating, then the fear of service disruption would be a valid argument.  But it is a disingenuous tactic of the political power of the left to extract more money from the pockets of voters too easily spooked with visions of increased crime, etc.

    The REAL solution design is quite simple.

    1. Complete a mark-to-market study of city staff compensation compared to peers in the private sector.  Obviously safety employees are a different challenge because there are not strong private sector comparisons.  However, a compensation study can be competed based on supply and demand of qualified labor.   For example, it can be proven that a city firefighter compensation plan could be significantly less than it is today and the city would still attract plenty of qualified candidates.

    2. Renegotiate MOUs and labor contracts to bring compensation levels in line with the rest of the labor market.

    3. Convert all defined benefit retirement plans to defined contribution plans.

    4. Increase the retirement age to be more commensurate with the private sector.

    Hypothetically if this was done, we could afford more city staff to INCREASE service.

    The solution above, or something similar, will eventually be required due to math.  We are all just delaying the inevitable.  But the inevitable is likely going to require a complete transformation of states laws for unionized public-sector labor to right-to-work and maybe even abolition of the right for government employees to collectively bargain.  It was a bad idea and the fears of those that apposed this aspect of the federal NRLA legislation have come true.

    The first step in that direction might be the upcoming Supreme Court decision on the “fair share” fees practice where non-unionized workers have unions dues automatically deducted.  Once workers can effectively opt-out of union membership and dues obligation, the unions will discover that they must shift to an employee focus to attract and retain members.   And eventually it will be discovered that having internal Human Resource professionals employed is a much more effective and less expensive alternative.

    1. Davis Progressive

      “Renegotiate MOUs and labor contracts to bring compensation levels in line with the rest of the labor market.”

      the problem is that the city can’t do that in isolation, they are not competing with the rest of hte labor market for employees, they are competing with other cities.

      1. Sam

        Is that because the pipes in City Hall are different than in a private company building? Is the grass at City parks different than in front of a private companies building? Are the pools and paint different too?

        There is no job that the City has that you can’t find a reasonable equivalent in the private sector except for safety positions.

        1. Davis Progressive

          that’s an odd comment, because you probably named the few positions where there are equivalents, but what about a public works director?  planning director?  finance director?

        2. Sam

          A finance director would be the same as an accounting manager, controller or CFO.

          I am sure there are a few people working for Teichert and other construction companies that would make great public works directors.

          I also think that there are a lot of engineering firms that employ people that would make perfectly good planning directors.

          City employees have the same skill sets as people that work in other private jobs. A building is a building, money is money, managing a business is managing a business, private or public.


        3. Davis Progressive

          “A finance director would be the same as an accounting manager, controller or CFO.”

          the underlying skills might be similar, but they are not the same.  there are specialties involved.

        4. Sam

          There is nothing special or different about a City budget compared to a companies budget.

          Sure there are tiny differences, just like there are tiny differences between Google’s accounting department and the one at Apple. But it is nothing big enough to prevent someone from doing a good job.


        5. Frankly

          Completely agree with SAM here.  Take a controller of a 350 employee company and he/she could pick up the pubic side financing is just a couple of months… and also think out of the box and bring new ideas to the table… and would be happy to do the job for less total compensation… especially considering the retirement benefits.

        6. Sam

          You are missing the 40-45 hour work week with 14 holidays and 11 paid “Management days” vs. 60-80 hour weeks for maybe the same or less pay and terrible benefits.

      2. Davis Progressive

        “There is nothing special or different about a City budget compared to a companies budget.”

        of course there is, you would have to understand how municipal financing works.  my guess is it would take at least two years for someone from the private sector to get up to speed.  it’d be like asking me to try a personal injury case.  yeah i’m a lawyer, but i haven’t read most of that law since law school

        1. Sam

          Yes, municipal financing is fund accounting and that is slightly different. It would take about two weeks to adapt, not two years. Plus the expertise that the CFO brings is being able to create budgets and projections of the City finances, not where to deposit parking ticket money.

  5. Frankly

    Something else that everyone needs to understand.  As the city has reduced its workforce, the number of retirees has increased.   In 2011 there were 389 city employees, and 239 retirees (628).   Last year there were 362 city employees, and 277 retirees (639).

    Retirees cost something less than they did as employees, but we are not getting the value of their labor.

    So, staff reductions that force early retirement is actually bad for the budget in consideration of service level need and demand in terms of true cost accounting.  It is more convoluted due to the way retirement costs are accounted for versus worker compensation costs, but the bottom line is that service impacts are a function of the city being unable to do more with less because of the stupid labor contracts.

    1. South of Davis

      Frankly wrote:

      > Last year there were 362 city employees, and 277 retirees (639).

      Any idea how Davis compares to other cities in the “City Employee/City Resident Ratio”?

      1. Frankly

        I would like to know that too.  I was surprised at our numbers.  I would imagine similar ratios for cities having budget problems and reducing staff.

        But this just illustrates the mounting pain caused by such a low retirement age.  At the poling place today I say the five new young firefighters meeting with the more senior guys.  The all look to be in their young 20s.  They will likley all retire in their young 50s and live another 40 or more years.  We have created a big bullble of retirees simple because we allow them all to retire too early.  There is no reason that a firefighter today cannot work up until late 50s and maybe 60.  The same for police.  The rest of us should make 65 or 67 before we retire.

        Just making that change we would singificantly cut down on the population of retirees as a result of standard mortality.

        We don’t give retirement… we give a 10-year end of career paid vacation before retirement kicks in.

        It is absurd that we are not all outraged and demanding it change.

  6. Sam

    If you took the unfunded employee compensation from FY12, this number is going to be lower than normal because of the amount of staff that has been cut over the previous year, you have a total unfunded amount of $10,700,000. ($8.5M pension & $2.2M OPEB). To pay for this you would need to pass a parcel tax of about $535 per house and $250 per apartment. Next you would have to figure out how big of a parcel tax you need to pass in order to pay for prior year unfunded amounts. Also, if you increase staffing levels to pre-recession levels, this number is going to increase dramatically.

    How many years can we not pay a $10,700,000 liability and expect to build a business park or pass a parcel tax in order to pay for it? When enough time passes and these liabilities are too large bankruptcy court is going to be the only option Davis has.

      1. Sam

        No, CALPERS uses a continuous 30 year roll to pay down market losses. There is a big difference between that and paying down the liability in 30 years. If they were actually going to do that the rates would be so high many cities would be forced to file bankruptcy immediately.

        1. Frankly

          I know the city is paying down its OPEB over 30 years, and I think too that it is paying down the pension liability too.  I will follow up on that to confirm.

          Related to the pension benefits, as I understand, as of today, the total net pension liability is $167 million and the unfunded portion is $89 million.  And that $89 million in unfunded liability will be zeroed out by FY2045.

        2. Sam

          From page 107 of the FY12 CAFR:

          “The Plan’s annual OPEB costs and actual contributions for the last three fiscal years are set forth below”

          Then you see that they UNDERFUNDED the plan by a total of $2,177,426 for the year and currently have a Net OPEB Obligation of $14,470,000.

          If they are not providing adequate funding for a current year benefit how are they paying down the obligation?

          The unfunded pension amount of $89 million is using the 30 year rolling at 7.75 percent. Wait until CALPERS discloses the obligation using the new GASB rules that went into effect last year. That number is going to soar!

        3. South of Davis

          Sam wrote:

          > Wait until CALPERS discloses the obligation using the new

          > GASB rules that went into effect last year. That number is

          > going to soar!

          Thanks for your post.  It is important to get real numbers to people especially the younger union members so everyone knows that while it would be great to let everyone retire with the pension and benefits that were promised there just is not enough money to do it.

    1. Gunrocik

      Where did  you come up with that number for OPEB?  Yes, they are paying it down over 30 years, but the number is more like $50 million, not $10 million for OPEB.  As far as PERS goes, nobody really knows what the unfunded liability really is — what we do know is that rates are projected to go up at least 7% per year for the rest of the decade.

      And Frankly has also hit on the other problem with these unfunded liabilities.  Staff cutting and early retirements don’t help the bottom line very much.  Most of the unfunded liability remains whether you cut staff or not.  You still have $6 to $7 million in OPEB payments each year, you now have fewer employees to spread this cost across–meaning your personnel cost per employee goes up.

      And when folks retire early, that just shifts them over to retirement side where you aren’t getting any productivity out of them — but you are still paying their medical.

      When you get to the point where you have more retirees than employees, it gets very expensive on a per employee basis to fund your OPEB liability.

      The City is addressing the issue, but they aren’t even close to being out of the woods yet.  In fact, if they raise wages, they are just digging a deeper hole that they may never dig out of…just as they are doing with the roads.

        1. South of Davis

          Sam wrote:

          >  I looked at the City’s CAFR. OPEB was underfunded by

          > about $2.2M and PERS by about $8.5M in FY12.

          So we need about a $700 per YEAR parcel tax to cover the annual shortfall (call it $1,000/per home per year if we want to fix the roads and pools)…

          and Frankly wrote:

          > I think the current OPEB unfunded liability is

          > around $60 million of a total $80 million liability.

          Plus a one time payment of about $4,750 from every homeowner in town to catch up (and we all need to pray that the stock market averages 7%+ for the next 30 years)…


    1. South of Davis

      DP wrote:

      > i’m pretty sure that the city is now on the trajectory to

      > reach fully-funded status on opeb by 2030, no?

      The projection that the city of Davis will reach “fully-funded” status in 16 years is even more funny than this quote from the LA Times 14 years ago:

      “President Clinton said Tuesday that the budget he will send Congress on Feb. 7 will propose paying off the entire $3.6-trillion national debt by 2013–two years earlier than had been expected even a few months ago.”

      P.S. For those who are not keeping track the National debt was not paid off in 2013 as projected by President Clinton and is currently over $17 Trillion (that is over $50K for each and every one of us and just includes actual debt NOT any unfunded promises)…

      P.P.S. Just like I’m not anti-pension I’m not anti-social security, but since we don’t have a “trust fund” and the kids today with $100K+ in student loan debt are not in any place to fund all the boomers in retirement I’m sure myself and other young boomers won’t see a penny of social security just like all the young union members who are paying for the current retired union members (not saving for their own retirement)…

  7. Frankly

    Now for some good news, it looks like the Sharon Angle mistake is finally being resolved that the Senate will go back to adults that can get something done.

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