In a closely watched case, a federal judge on Thursday is expected to decide whether the bankrupt city of Stockton can continue to pay employees generous pensions that soon could consume one-fifth of municipal revenues.
The ruling has been much anticipated since U.S. Bankruptcy Judge Christopher M. Klein recently said that California's rich and powerful public pension system should be treated like all other creditors — with no special protection.
His comments stunned state and local officials and public employee unions, who had long considered pensions untouchable, even in bankruptcy.
But Thursday's ruling may not be as far-reaching as the judge hinted. Despite his qualms, Klein could approve Stockton's city-approved plan for ending its bankruptcy. It calls for more cuts in public services — but preserves current employee pension benefits.
In contrast, a decision by Klein to reject Stockton's plan — opening the door for the city to slash retirement checks — "would create shock waves throughout California" and to a lesser degree across the country, said Michelle Wilde Anderson, a Stanford Law School professor who specializes in local government and finance.
"It would have immediate implications," she said. "First and foremost, Stockton retirees would see pension benefits reduced."
Meanwhile, San Bernardino, another bankrupt California city, might decide not to honor its commitments to the California Public Employees' Retirement System. And other fiscally shaky cities might seek bankruptcy protection so they could get out from under pension liabilities.
In recent years, pensions have been a political hot potato in Stockton. Overly large pensions approved by city officials for employees are among the reasons Stockton found it could no longer pay its bills, critics say.
In court, the city has repeatedly argued that employees have suffered enough in the bankruptcy. The city no longer gives retirees free medical care.
Salaries have been cut for some employees by as much as 23%. New hires now get sharply reduced pensions. Many of the bonuses have been eliminated. And employees must now pay for part of their pensions — rather than having the city pick up their share.
It was a different story beginning in the 1990s when the city and employee unions negotiated such high salaries and benefits that pay packages were more than 25% above what other cities were offering, said Kathy Miller, a Stockton city councilwoman.
Police officers and firefighters could retire at 50, and other city employees could retire at 55. All employees received free medical care in retirement with plans that didn't require co-pays.
There were bonuses "for almost everything imaginable," Miller explained in a video she created in 2012 to explain why the city had been forced to seek bankruptcy protection. "If you drove the front of a fire truck, if you drove the back of a fire truck, if you got a degree or certificate, even if it was for something that had nothing to do with your job. "
Stockton employees made pension spiking into an "art form," she explained, "using overtime and add pays in their final working years to secure much larger pensions for the rest of their lives."
As a result, the city now pays the equivalent of 41% of police salaries to CalPERS for future pensions — an amount that will increase to 57% in five years, said Charles Moore of Conway MacKenzie, a Michigan consulting firm hired by Franklin Templeton Investments, a party in the bankruptcy case.
Using the city's own long-range estimates, Moore showed that by 2019, the city would be paying 18.5% of its general revenues to CalPERS — up from about 11% today.
Those high and growing pension costs, he warned, could lead to Stockton being forced to declare a second bankruptcy.
The city's pending bankruptcy-recovery plan should be rejected, contends creditor Franklin Templeton Investments, because it is discriminatory. Franklin, an unsecured bondholder, would recover only pennies on the dollar while CalPERS would get billions of dollars, the company argues.
If the bankruptcy judge sides with Franklin and rejects the city bankruptcy plan, experts said, it could have far-reaching effects.
While not binding on other Bankruptcy Court judges, it still would have "persuasive authority" that could affect colleagues' thinking in other jurisdictions.
What's more, the effect would probably be compounded in early November when a judge is expected to approve a Detroit bankruptcy plan that includes steep reductions in pension payments.
Judge Klein's position that there's nothing sacred about CalPERS' pension contract with Stockton is firmly rooted in federal law, said Kenneth Klee. He is a retired UCLA law professor and a partner in a Los Angeles law firm that handles major corporate and municipal bankruptcy cases.
Bankruptcy protection, he said, means that all contracts, including pensions, can be abrogated.
If pensions are cut, the city says, Stockton faces the prospect of widespread resignations. Funding employees' full pensions is essential, officials say, to retain and hire key fire and police personnel, essential to any return to stability.
They defend the city's bankruptcy protection plan before Klein, and estimate that it would keep the city solvent for at least the next three decades.
CalPERS says bankruptcy is not a sensible option for most California local governments. "Bankruptcy damages a city's reputation," said spokesman Brad Pacheco. "Employees will leave, services are reduced, it increases borrowing costs and will lead to large legal fees."
But allowing cities, such as Stockton, to continue piling up unsustainable pension obligations is an impending disaster that Klein will want to avoid, cautioned Dan Pellissier, president of California Pension Reform, a group working to overhaul state and local government retirement systems.
"The judge has to believe that the plan works," he said, "and doesn't put them on a course back to Bankruptcy Court."