Third California City Files for Bankruptcy

On August 1, 2012, San Bernardino, California filed for bankruptcy protection.  This California City, consisting of 210,000 residents, is the third in the State to recently file, following Stockton and Mammoth Lakes.  More details regarding Stockton’s filing as well as municipal bankruptcies in general can be seen in earlier submissions to this site.  See California City Declares BankruptcyWould Filing Bankruptcy Help DetroitChapter 9 – Bankruptcy of a Municipality.  In its filing, the City disclosed that it had over $1 billion in assets and liabilities.English: San Bernardino, CA

Last month, the San Bernardino declared a fiscal crisis, when a report reflected that the local government had exhausted its reserves and projected spending would exceed revenue by $45 million in the current fiscal year.  San Bernardino’s city council voted on July 24 to adopt an emergency three-month plan that would suspend debt payments, freeze vacant jobs and quit paying into a retiree health fund while city staff produce a more detailed restructuring plan.  According to a City spokeperson, “the bankruptcy filing was just to get protection in place to,kick the process off.”

In late July, San Bernardino reported it had $56 million in indebtedness payable from its general fund, the main budget, including payments on a $50 million pension bond. There is an additional $195 million in unfunded pension obligations, $61 million in unfunded retiree healthcare, and $40 million of workers compensation, compensated absences and general liabilities.  Pension obligations will also reach $25 million this year, which is double the 2006 level.

Unlike private pensions, public pensions are not regulated by the Employee Retirement Income Security Act of 1974 and, therefore, are not subject to the rigorous vesting and funding rules imposed by ERISA.  Similarly, public pension participants do not enjoy the protections of the Pension Benefit Guaranty Corporation.  Thus, municipalities, like San Bernardino, have been free to make their own choices about vesting, benefits, qualifications, and funding, which has resulted in several decades of increasingly rich benefits packages.

The question remains, however, whether chapter 9 provides an opportunity to expand the circumstances under which the pension liability problems can be addressed.  Few municipalities, thus far, have truly tested these laws.  In the City of Vallejo’s bankruptcy–filed several years ago–the city was successful in achieving relief from burdensome collective bargaining agreements and retiree medical benefits, and had proposed a plan of adjustment to reduce its pension obligations.  But, the political capital required to deal with these issues has been extremely high.

To add to San Bernardino’s financial problems, the City has a 15 percent unemployment rate, which along with the housing crash, has significantly impacted the tax revenues that the City has been able collect.  Without such revenues, the City cannot meet its existing pension obligations along with its general liabilities.  For example, the City estimates that public safety spending accounts for 73 percent of the general fund obligations.

San Bernardino’s, Stockton’s and Lake Mammoth’s filings will assuredly be closely watched by other California cities as well as investors and markets, who are all interested in seeing whether a municipality can restructure its bond debt and pension obligations.  Already this year, auditors for Compton and Victorville forecasted that those cities may also need to file bankruptcy this year.

While there have only been approximately 640 municipal filings since 1937, when such protection was first authorized, we might be seeing a change in the popularity of such relief, lead by the cities in California, amongst others.