Who takes hit in city bankruptcies: bondholders or workers?


The municipal-debt market has always rested on a simple notion — that local governments would do whatever they must to repay borrowed money.

Cities wouldn’t want to default on their bonds, some of which are owned by their own citizens. And they wouldn’t want to alienate Wall Street, which finances many of their civic projects.

The bankruptcies of Stockton and San Bernardino have shaken the decades-old faith in that premise, and turned the California cities into closely watched test cases for how municipalities grapple with deep-rooted financial problems.


“I don’t think I’ve gone to a professional conference in the last three years where the issue of Stockton and San Bernardino has not been high on the agenda,” said Joe Rosenblum, director of municipal credit research at investment firm AllianceBernstein in New York. “There’s tremendous interest.”

The two cities each sought bankruptcy protection last year after being squeezed by a familiar mix of economic hardship, slumping property values and skidding tax receipts.

The filings have trained a spotlight on a crucial issue facing many California cities — who should bear the pain when municipalities hit financial straits, bondholders or city employees through their pension plans?

Even as the cities stopped meeting bond obligations, they have gone out of their way to make good on payments to CalPERS, the giant state pension fund. These are the monthly contributions that cities make toward the pensions of workers that will be paid out in retirement.

Stockton has made regular contributions to CalPERS throughout its bankruptcy. San Bernardino stopped the payments initially but announced plans to resume them in July.

That has led to a bitter legal showdown with creditors, primarily bond-insurance companies that guaranteed the cities’ securities years ago.


Creditors say the cities are stiffing bondholders rather than making politically painful but necessary financial reforms.

The biggest reform, they say, would be reducing the generous pension benefits that cities across California have bestowed on employees for years. Cities can’t touch accrued benefits, but they could adjust future benefits, creditors say.

“The City Council has not engaged in any meaningful effort to initiate revenue enhancement, asset sales or pension reform,” Assured Guaranty, which insures some of Stockton’s bonds, said in a statement.

This is a huge issue, experts say, especially if it sets a precedent in which troubled cities — or jilted creditors — try to scrape money out of pension plans.

“These pension plans have always been considered sacrosanct,” said Gary Klausner, a municipal bankruptcy specialist at Stutman Treister & Glatt in Los Angeles.

The risk for CalPERS is being drawn into financial battles between cities and bondholders. CalPERS was barred by a federal bankruptcy judge from suing San Bernardino to force the city to make its $1.7-million-a-month payment.

Creditors say pension funds should suffer alongside bondholders and any other entities owed money by troubled cities.

A CalPERS spokesman said the fund is required by state law to collect full pension contributions from cities and can’t “voluntarily take a lesser amount.”

“It’s not matter of choice for CalPERS to say, ‘OK, we’ll voluntarily take a haircut.’ We don’t have that ability,” said Robert Glazier, the fund’s deputy executive officer. “We are an arm of state government, and state law requires that the pension system be run in a fiduciarily and actuarily sound manner.”

Connie Cochran, a spokeswoman for Stockton, said the city has made enormous financial cuts, including trimming staff and reducing services. But it’s important to keep making pension contributions, she said, to “remain competitive as an employer.”

“We have to have a [pension] plan that can allow us to keep people and to attract people,” Cochran said.

A broader issue is whether the bankruptcy filings could be seen as a way to reduce the stigma of budget shortfalls in general.

Investors fear that could prompt other cities to view bankruptcy as a suddenly legitimate antidote for long-nagging financial problems.

“Are cities that are struggling — Chicago, Los Angeles, you name it — going to look at this as their playbook?” said Marilyn Cohen, founder of Los Angeles bond investment firm Envision Capital Management Inc. “That’s what we’re all worried about.”