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What the Stockton Bankruptcy Means



June 28, 2012 – Comments (4)

Board: Macro Economics

Author: yodaorange

Tonight the Stockton city council voted 6 to 1 to declare Chapter 9 bankruptcy. Instead of reading news reports, I decided to view the meeting myself attempting to get the full story. I did learn several points. Some of them are very specific to Stockton. However if you look at the cumulative effect of the Stockton bankruptcy plus the San Jose/San Diego pension reduction votes, it starts to paint a picture. Here are a few points that I thought were the most significant.

1) Unfunded medical liabilities- I have known about this for a while but have never written it up. Long story short with a broad brush, municipalities have set aside ZERO reserves to pay retiree medical benefits. This is going to be a major issue in many places across the county. This is as opposed to pension benefits where they have set aside reserves. The pension plans might be underfunded but that is NOT as bad as being ZERO funded.

In Stockton’s case, they have an unfunded $417 million medical shortfall with ZERO reserves. You are probably saying: “Yoda, you must have heard that wrong.” Unfortunately, I have read the same number from several sources. What the public broadly does not understand is the retiree medical costs can start at age 51. If all of it started at age 65 when Medicare kicks in, the liability would be much lower. But when you pay 100% of all medical with zero deductible, zero copays plus spouse coverage from age 51 thorough 65 it can be a big chunk. The Stockton city manager estimates the minimum liability per employee of $600k and a typical of $1 million.

2) Stockton is the only city I know of that had its city hall foreclosed upon. They stopped making bond payments a few months ago and lost both city hall and three parking garages. They built the city hall in boom times, but I don’t think they ever had the money to occupy it.

3) Stockton has already laid off 25% of police, 30% of fire and 43% of other employees. Everyone that remained took pay cuts ranging from 9% to 22%. I did not hear over what time period, but the Stockton HR director said that inflation went up 60% while employee salaries went up 100%. In addition since the early 90’s, Stockton paid 100% of the employee contribution to retirement plans (Calpers).

4) Stockton MUST present a balanced budget by the July 1st start of the next fiscal year. The two largest items they cut are: ZERO payments to all bondholders and severe cuts to retiree healthcare. They did not give a percentage cut on the healthcare cuts, but I am guessing it is 90% or greater.

5) BOND DEFAULTS- They did not specify if they are going to continue paying on any bonds or not. It was NOT clear if the bonds were General Obligations or General Fund Securities. In either case, bond holders clearly thought the city was behind the bonds and the city is going to default.

6) PENSIONS- Stockton was very clear that they were NOT attempting to reduce anyone’s CALPER’s pension. This is different from what I heard several months ago. The stated reason was something along the lines of “We don’t want to get into a big fight with CALPERS.”

7) AB506 is a new law that the California legislature passed last year. It went into effect on January 1st 2012. It called for all parties to attempt a mediated solution BEFORE a city would be allowed to declare bankruptcy. Stockton was the first city to use it. IT FAILED and I see no reason to think it will work for any other municipality.

8) Stockton is probably one of the worst case cities from a financial standpoint. The city revenues dropped about 25% from peak to today. Not many cities have 25% extra floating around in their budget. A large part of the problem is that the median house price dropped from $407k to $118k. Recall that California has Proposition 13 (Howard Jarvis- “I am made as h**l”) which limits property taxes to 1% of the appraised value. Not many cities have been hit as hard.

9) MUNI BOND HOLDERS BEWARE- About 15 citizens got up to speak about the bankruptcy. One fellow said: “I could care less if any of the bond holders are paid.” For some reason, not a single bond holder, stood up to protest. Every single comment was about doing away with retiree health care.

10) The mayor asked the city manager, Bob Deis, if declaring bankruptcy would solve all of the problems ad infinitem. He gave what I thought was a great answer, that bankruptcy was like hitting the reset button. All of the permanent, long term answers are TBD and nobody could how the problem(s) will be fixed.

BOTTOM LINE is that I think Stockton’s bankruptcy will make it easier for other distressed municipalities to follow the same path.

An independent organization, California Common Sense, did a great report on how Stockton got into this mess entitled: How Stockton Went Bust: A California City’s Decade of Policies and the Financial Crisis that Followed.

An interesting side note: the city of North Las Vegas is in dire financial shape. They just voted to close their city jail and layoff most of the jailers. The big difference is that Nevada law does NOT allow municipal bankruptcies. So it will be interesting to see how they work through their issues as compared to Stockton.



4 Comments – Post Your Own

#1) On June 28, 2012 at 8:01 PM, Borbality (45.89) wrote:

to the original poster: Interesting stuff and thanks for the link. 

 to the secondary poster: thanks for making it a post of the day.

I live (and have all my life) not too far from Stockton in a similarly depressed and sized city, one that also sold lots and lots of bonds for things it didn't need and is now having a hard time making its obligations on.

 Can only hope we aren't headed in the same direction.  I think we've been not quite as bad as stockton over the last couple decades, and I hope that's enough.


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#2) On June 29, 2012 at 10:42 AM, Schmacko (79.83) wrote:

The link is a pretty interesting read.  I went back to the cacs main website and they have another article on The University of California that is also pretty interesting.

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#3) On June 29, 2012 at 11:24 AM, 2trpop (94.13) wrote:

One fellow said: “I could care less if any of the bond holders are paid.” For some reason, not a single bond holder, stood up to protest.

Is there any way of knowing who the largest holders of these bonds are?   Might they be held in CALPERS?

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#4) On June 29, 2012 at 12:50 PM, leohaas (35.73) wrote:

I agree more municipalities in CA will follow. Proposition 13 is the main reason. In many other states the tax rate would go up to keep the income stream about the same. You can argue that this is good or bad, by the way.

Not setting money apart for future medical liabilities is very common, also in the private sector. It is the main reason many companies have stopped offering health benefits to retirees.

For us as investors this means: stay away from munis, especially Californian munis.

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