By Ed Mendel | 07/22/13 5:00 AM PST

Bond insurers who walked away from mediation last year before Stockton filed for bankruptcy are at the table this summer. A deal could avoid a precedent-setting legal showdown on whether public pensions can be cut in bankruptcy.

Attorneys for the city and bond insurers told U.S. Bankruptcy Judge Christopher Klein last week that mediation, presided over by Judge Elizabeth Perris, is an “uphill battle.”

But the brief update hearing was held on the day that Stockton, which had been the largest city to file for bankruptcy, was bigfooted by the bankruptcy filing of a much larger city known around the world, Detroit.

Now will the big national bond insurers, who lost the first round when Stockton was ruled eligible for bankruptcy in April, decide the main battle has shifted to Detroit and cut a deal with Stockton, where they have less exposure and a weaker hand?

In Detroit, city officials propose cutting the pensions of current workers and retirees. A state judge quickly ruled after the bankruptcy filing that pensions are protected by the state constitution, triggering an appeal that may yield a precedent-setting ruling.

In Stockton, city officials do not want to cut pensions, saying they are needed to recruit and retain workers, particularly police. Bond insurers facing major losses under the city’s plan argue that pensions should be treated like ordinary debt.

Bond insurer losses in the bankruptcy presumably would be reduced if the city spreads the pain, getting more of the savings needed for solvency by cutting pension debt owed to the California Public Employees Retirement System.

Judge Klein told the bond insurers the pension issue may be raised in a ruling on whether creditors are treated fairly by the city’s proposal for a “plan of adjustment” to cut debt, expected in September.

To read entire story, click here.