Distressed City Exits Bankruptcy, But More Distress Ahead
Steven Greenhut
by

Sacramento

Officials for the decrepit city of San Bernardino are touting the great news that, after five long and tumultuous years, the city this week officially exited bankruptcy. Starting next month, it will begin paying its debts again. Of course, it pulled off this miracle by stiffing creditors — many of whom will receive only one cent on the dollar.

I suppose that’s the expected risk for anyone who invests in a California municipality these days. But keep in mind the one group that didn’t take a haircut: the city’s highly paid public employees and those who already have retired from public employment.

San Bernardino stiffed everyone it could — including taxpayers, who saw a hike in parcel taxes — but didn’t touch pensions, even though a federal bankruptcy judge (in a similar case in Stockton) gave the greenlight to do so. The real news came in a KPCC public-radio headline this week: “San Bernardino: Out of bankruptcy but not out of the woods.”

Like other bankrupt California cities, San Bernardino’s problems don’t end with its exit plan, even though city boosters dismissed the report and prattle about the great new economic times that are sure to come. In April, Moody’s Investor Service explained that the exit plan says the city will “leave bankruptcy with increased revenues and an improved balance sheet, but the city will retain significant unfunded and rapidly rising pension obligations.”

While the city budget is doing better and public employees can rely on their large lifetime pensions, it’s not such a rosy picture for residents. In addition to higher taxes, they face “challenges associated with deferred maintenance and potential service shortfalls.” In other words, locals will continue to put up with crumbling roads and insufficient public services. Moody’s pointed to the “probability of continued financial distress and possibly even a return to bankruptcy.”

The median household income in this impoverished inland city is just shy of $39,000. City employees there earn average compensation packages above $114,000. The Transparent California database shows page after page of CEO-level salaries for public employees in San Bernardino, and the city has promised to go on a police hiring binge now that it’s out of hot water.

Those mega-salaries don’t go just to the top-level positions, like police chief and city manager. The list includes 17 police sergeants with total compensation packages ranging from $220,000 to $269,000. Moreover, those numbers don’t include the unfunded portion of the city’s pension promises, for which taxpayers are on the hook. Is it any wonder that San Bernardino’s problems might not be ending?

This situation is not a new one for California municipalities. Stockton filed for bankruptcy in 2013 after its myriad big-spending redevelopment programs and lush pensions (along with its Lamborghini-style lifetime medical benefits for employees) pushed it to the brink. Back then, I reported on an internal city forecast showing that, within four years of exiting bankruptcy, it could face similar financial problems again. In a closely watched 2014 case, Judge Christopher Klein ruled that the California Public Employees’ Retirement System (CalPERS), which had argued that pensions were inviolable even in bankruptcy, “has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable.”

Though Klein ruled that pensions could be abrogated in bankruptcy, he nevertheless approved a city plan that didn’t touch pensions for current employees and retirees, but trimmed them for new hires. The end result: Stockton didn’t really deal with its pension problems. It also raised taxes on its largely lower-income residents. Same goes for Vallejo, a ramshackle city on the eastern edge of the San Francisco Bay Area, which exited bankruptcy in 2011.

“Vallejo got court approval to exit from bankruptcy last week with a plan that includes a sharp increase in pension payments to CalPERS — the opposite of what many expected when the city declared bankruptcy in May 2008,” reported Ed Mendel in Calpensions. It’s not a surprise that, by 2014, there was talk of the city struggling to make ends meet because of “ballooning pension costs,” as CNN-Money reported. The website noted that Vallejo’s recent public-safety retirees have annual pension benefits that top $100,000 a year.

These are all rough, older cities. Big affluent cities such as San Jose also have seen pension costs skyrocket, but they have the means to pay the bills, albeit with depleted services for city residents. Earlier this year, the WalletHub financial website declared Vallejo the “second least recession-recovered city.” There no doubt are many reasons for that, but it’s nonetheless astounding, given its proximity to some of the nation’s most-booming Bay Area cities.

Vallejo actually is an interesting historic town, an hour’s ferry-ride from San Francisco’s Embarcadero, but years of poor spending priorities make it tough for the city to fight crime and upgrade its infrastructure. Those conditions make the city a far less desirable place to live than the myriad tony suburbs not far away. Richmond, another rough nearby city, was rated in February by the California state auditor as one of six cities at risk of bankruptcy.

“A major cause of Richmond’s problems: relentless growth in pension costs,” according to CALmatters’ Judy Lin. “Payments for employee pensions, pension-related debt and retiree healthcare have climbed from $25 million to $44 million in the last five years, outpacing all other expenses.” Total retirement costs, Lin reported, could by 2021 top $70 million and consume 41 percent of the city’s general fund. And the city tried but failed to raise taxes on residents.

With unions solidly in control in the state Capitol, there are few efforts to rein in pension costs, which increasingly are borne by residents of municipalities who pay higher taxes and endure fewer services, as CalPERS sticks cities with bigger pension bills to pay for the pensions it manages on their behalf. Pension debts are rising as CalPERS’ rate of return from last year fell below 1 percent — despite its predictions of 7.5 percent returns.

The Legislature and Gov. Jerry Brown’s recently passed budget borrows $6 billion from a low-yielding state fund to pay toward the pension debt. This shell game promises to save $11 billion over 20 years, but it mainly helps CalPERS prop up its investments and protect public employees from having to contemplate reduced benefit levels.

Meanwhile, pension reformers stake their hopes on a handful of court cases making their way to the state Supreme Court. They involve something called the “California Rule” — a series of court precedents that prevent government employers from reducing pension formulas, even going forward.

Without the ability to trim benefits for current employees, there are few options to keep pensions from gobbling up bigger chunks of public budgets. All that’s left are tax hikes, service cuts and, perhaps, bankruptcy. But even when cities take the extreme latter course, they’ve yet to confront the pension monster; they prefer to take it out of the hide of creditors.

I know people who are convinced that if things get bad enough, state officials will come to their senses and reform the current system. That won’t happen. Instead, we’re likely to see the slow-motion destruction of many California cities (starting with those that are least affluent) and a further transfer of wealth from the private sector to public employees.

Steven Greenhut
Steven Greenhut
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Steven Greenhut is a senior fellow and Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.
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