The federal judge who opened the door this month to stiffing Stockton pensioners and the pension system as the city exits bankruptcy, did not walk through it on Thursday.

Instead, U.S. Bankruptcy Chief Judge Christopher M. Klein accepted Stockton’s plan that raises taxes, reduces employee compensation and pays creditors a percentage owed, but does not disable the defined-benefit pension plan. Klein introduced that as a real possibility earlier in the month when he ruled that federal bankruptcy laws outranked state law, which requires cities to make good on their pension obligations to the California Public Employees’ Retirement System (CalPERS).

Stockton (pop. 300,000) filed for Chapter 9 protection in July 2012. Wall Street helped guide the city’s ambitious infrastructure and development plans―funded through bond sales―during the booming real estate years before the recession. Stockton also shared some of the expected wealth with city employees.

The housing crash, beginning in 2006, whacked property tax revenues and the boom turned to bust overnight. Foreclosures hit record highs. Piling up debt to pay for a new sports arena, city hall, a marina and a ballpark suddenly didn’t look too savvy.       

When Stockton declared bankruptcy, bondholders and insurers wanted the city to raise taxes, curtail city services, sell municipal property and bail on its obligations to CalPERS before asking them to take a haircut on $900 million in debt. The bankruptcy plan ultimately included a heavy dose of austerity, including, what the judge called, “significant concessions” by workers.

Their retiree health plan went away. That cost them $550 million. City workers were laid off, including 25% of the police, as city services declined. Workers in general took pay and benefit cuts. And a lesser pension plan was instituted for new employees.

But Stockton’s unwillingness to write pension defaults into its bankruptcy plan was more than an issue of fairness as Wall Street negotiated with labor and government over who should pay for the trashed economy. Defaulting on an obligation to CalPERS threatened to ripple through the pension system and was sure to meet fierce and expensive resistance.

When Judge Klein ruled earlier that bankruptcy court could trump multiple state Supreme Court decisions affirming the inviolate nature of CalPERS agreements, he implied the agency could become just another unsecured creditor that might have to settle for something less than the $1.6 billion Stockton was on the hook for. That has never happened before.

But still could in the future.

Stockton reached agreement with all its creditors except for one before taking its plan to the judge. Franklin Templeton Investment fought the good fight to strip worker pensions after getting around 1% of $32.5 million it was owed. But Thursday, the judge, who sits in the Federal Bankruptcy Court for the Eastern District of California in Sacramento, said Stockton was free to execute the plan.

Judge Klein’s ruling can be appealed. 

–Ken Broder

To Learn More:

Judge Approves Bankruptcy Exit for Stockton, Calif. (by Mary Williams Walsh, New York Times)        

Judge Approves Stockton’s Plan to Repay Creditors (by Dale Kasler, Sacramento Bee)

Judge Keeps Pensions Out of Stockton Bankruptcy Deals (by Seth Sandronsky, Capital & Main)

Judge Approves California City's Bankruptcy Plan (by Scott Smith, Associated Press)

Can Employees' Pension Benefits be Cut? (Los Angeles Times editorial)

Stockton Bankruptcy Judge Opens Door to 60% Cut in Public Pensions (by Ken Broder, AllGov California)