By Ryan C. Wood
On June 28, 2012, the City of Stockton, California, filed for bankruptcy protection under Chapter 9 of the Bankruptcy Code, Bankruptcy Case Number 12-32118, in the Bankruptcy Court for the Eastern District of California. After complying with California Government Code Section 53760 they were unable to negotiate with creditors and avoid filing bankruptcy. So what happened here? Why did Stockton California file bankruptcy?
In court documents the city refers to the collapse of the housing market and calls the mortgage crisis the Great Recession. Like many individuals that choose to file bankruptcy Stockton tried to work things out. The city renegotiated labor agreements, depleted reserves, imposed compensation reductions, reduced and eliminated services, missed bond payments and even deferred payments to retiring employees in an attempt to avoid bankruptcy. Sounds like what an individual does to avoid bankruptcy too. Many of our clients have sold jewelry, depleted their retirement accounts, cut back on bills such as cable or internet, missed payments on credit cards and anything else to avoid filing bankruptcy. Unfortunately bankruptcy does become the best financial decision at some point.
Stockton’s retirement costs are out of control and have been for some time. Stockton’s largest creditor by far is the California Public Employees Retirement System. They owe PERS an estimated $147 million in unfunded retirement benefits. The next largest creditor is Wells Fargo Bank. The city owes Wells Fargo Bank approximately $126 million for pension obligation bonds. What are pension obligations bonds? Pension obligation bonds are basically a way to fund retirement benefits when a city does not actually have the money to pay for the benefits. The bonds pass on the cost to future generations in the hope that the public entity will be able to continue to make the monthly payment for the bonds and continue to operate normally. If a city does not set aside enough money during an employee’s career so that the employees lifetime retirement benefits are paid in full by the time the employee retires the city has to find the money somewhere. It is more or less a Ponzi scheme at the tax payers’ expense.
Pension obligation bonds usually have low percentage rates. The rate could be as low as 4 percent or as high as 7 percent. Some government entities have even used these borrowed funds to invest and obtain a higher rate of return, say 8 percent, and in theory make money and be able to fund their retirement costs in the future. It is basically gambling with borrowed money. This is a recipe for disaster when property taxes and general funds do not continue to grow. Many other municipalities across the United States are and will face the same problems Stockton is facing.