Debt holders in the Stockton bankruptcy proceedings were none too happy when the city presented its plan to spare pensioners in the California Public Employees’ Retirement System (CalPERS) while asking creditors to take a major haircut.

On Wednesday, U.S. Bankruptcy Judge Christopher Klein said that might not happen.

For the first time, a judge ruled that California state law requiring cities to make good on their pension obligations to CalPERS is superseded by U.S. bankruptcy law that says everyone can be dinged. If Stockton were to renege on its pension obligations, it could face a $1.6-billion balloon payment or see worker pensions slashed 60%. Stockton said it could not leave CalPERS because it is incapable of creating a cheaper retirement plan.

Stockton does not have $1.6 billion. The city declared bankruptcy two years ago, owing more than $900 million in bond debt. Franklin Templeton Investments was owed $36 million of that, but the city only offered to pay them $3.6 million. The company protested and Wednesday the judge made an oral ruling in their favor.

“I've concluded the pension could be adjusted,” Judge Klein said, but did not say he would actually do that. He can leave the city's plan intact or make other adjustments. Some of the creditors in the Stockton plan would receive 50% to 100% of what they are owed, while others, like Franklin, would get pennies on the dollar. The bondholders and insurers wanted Stockton to raise taxes, curtail city services, sell municipal property and bail on its obligations to CalPERS.

The judge may have more to say about the Stockton plan at the court's next session October 30.

While pensions are not specifically protected by bankruptcy rules, it is not unusual for them to receive special consideration during negotiations. To some extent that is because of the human element; worker retirements could be decimated if the city broke contractual promises it made to them for decades. But an equally compelling consideration is the havoc it could wreak on municipal services.

If Stockton doesn't fulfill its pension obligations and has to reduce benefits, municipal workers would flee. Poverty-ridden Stockton, which has a very high crime rate, has already seen an exodus of police. The average tenure of a cop there is nine years, compared to 14 just a few years ago, according to the Los Angeles Times. The city told the judge it could not function if pensions are whacked.

Stockton (pop. 300,000) was the largest city in the nation to declare bankruptcy until Detroit (pop. 700,000) filed for Chapter 9 protection in July 2012. Cities like Stockton across the country have been villainized for the economic hits they took when the housing and Wall Street crash in 2008 exposed the precarious condition they had been put in by decades of globalization, de-industrialization and shifts in political power. Their problems are often blamed on the presence of unions, lack of privatization, corruption and incompetence.

Stockton spent millions of dollars before the recession on a new City Hall, a marina, a sports arena and a ballpark. The Associated Press described police wages and health benefits as premium.

A three-audit report on Stockton by State Controller John Chiang last year identified chaotic mismanagement in the swirl of economic upheaval. The three reports focused on fiscal management practices, misplaced cash from Stockton’s gas tax fund and the unlawful holding of redevelopment assets, respectively.

They also blamed the city for failing to recognize that the housing market was beginning to tank in 2006, thus endangering its tax base. That was an oversight shared by just about every mainstream observer of the economy in the media, up and down Wall Street, and in and out of government that year.

‒Ken Broder

To Learn More:

CalPERS Gets Decision: Judge Rules Stockton Can Sever Its City Pensions (by Dale Kasler, Sacramento Bee)

Stockton Bankruptcy Ruling Could Deal Blow to CalPERS, Public Pensions (by Chris Megerian and Melody Petersen, Los Angeles Times)

Lawyer Warns of 60 Percent Pension Cuts in Stockton Bankruptcy Case (by Don Thompson Associated Press)

Bankrupt Stockton “Throws Down the Gauntlet,” Favors Retirees over Creditors (by Ken Broder, AllGov California)