Pieces to the Puzzle

By Ed Mendel
October 6, 2014

A federal judge ruled last week that Stockton’s CalPERS pensions can be cut in bankruptcy. But Stockton does not want to cut pensions, and the lone holdout creditor says it can be paid without cutting pensions.

U.S. Bankruptcy Judge Christopher Klein may have clarified the legal issue of whether CalPERS pensions, widely regarded as untouchable, can be cut if any of the 1,581 local governments in the giant system take the drastic step of bankruptcy.

As CalPERS quickly pointed out in a news release, if the ruling is not put into effect, moved from theory to practice, it’s “not legally binding on any of the parties in the Stockton case or as precedent in any other bankruptcy proceeding.”

The judge is set to rule Oct. 30 on the Stockton “plan of adjustment” to cut debt and emerge from the bankruptcy filed in June 2012. The city has negotiated agreements with all major creditors, except two Franklin bond funds still owed $32 million.

Klein has said he can only confirm or deny the plan, not tell the city how to spend its money. And in a municipal bankruptcy only the city can propose a plan of adjustment, not creditors as in a private-sector bankruptcy.

An issue previously raised, but not much mentioned last week, is whether the Stockton plan cuts enough debt to restore the city’s solvency and avoid a lapse back into a second bankruptcy.

Last November Klein rejected a Franklin argument that the Stockton exit plan failed to disclose enough detail about creditor settlements. But he did say the 30-year plan should cite the “renewal risk” of a ¾-cent sales tax approved by voters that month.

“If I thought there was going to have to be another Chapter 9 (bankruptcy) case in 10 years, I probably would not confirm the plan,” Klein said. “I’m not sure any judge would.”

Last March Klein said he had seen news reports that Vallejo, which emerged from a 3½-year bankruptcy in November 2011 without cutting pensions, had a large budget deficit and possibly faced a second bankruptcy.

“The court has an independent duty to satisfy itself that the (Stockton) plan is going to work,” Klein said, the Stockton Record newspaper reported. “I’m probably going to have to be persuaded that the plan is going to work.”

A Wall Street credit-rating agency, Moody’s, said in February that without pension relief not only Vallejo, but also Stockton and San Bernardino ( which filed for bankruptcy a month after Stockton) are at risk of returning to insolvency.

Franklin did not argue last week that Stockton must cut pensions to avoid a “Chapter 18,” lawyer jargon for a second Chapter 9 bankruptcy. Instead, an attorney said Franklin wants to be a “partner” and let the “city’s rising tide” of prosperity lift all boats.

“It’s possible for the city to confirm a plan that leaves pensions unimpaired,” said Jim Johnston, a Franklin attorney. “It just has to treat Franklin as a dissenting creditor fairly.”

The Stockton long-range budget forecast issued last April (see chart) shows pensions are a key cost driver. The general fund reserve is expected to stay above a warning level of 5 percent, before climbing over three decades to the goal of 17 percent.

Franklin referred to the long-range forecast, with its sizeable planned reserve, when saying Stockton would not have to cut pensions to pay Franklin. The Stockton general fund spent about $183 million last fiscal year.

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