What Stockton's Bankruptcy Means for the Rest of Us

Odds are that similarly situated cities will go to the Obama administration and ask for free cash.

What happens when the government goes bankrupt? This question is one that sounds like a hypothetical exercise in a law school classroom from just a few years ago, where it might have been met with some derision. But today, it is a realistic and terrifying inquiry that many who have financial relationships with governments in America will need to make, and it will be answered with the gnashing of teeth.

calwest / photo on flickrcalwest / photo on flickrEarlier this week, a federal judge accepted the bankruptcy petition of Stockton, Calif., a city of about 300,000 residents northeast of San Francisco, over the objections of those who had loaned money to the city. The lenders -- called bondholders -- and their insurers saw this coming when the city stopped paying interest on their loans -- called bonds. In this connection, a bond is a loan made to a municipality, which pays the lender tax-free interest and returns the principal when it is due. Institutional lenders usually obtain insurance, which guarantees the repayment but puts the insurance carrier on the hook.

The due dates of many of these bonds have come and gone, and the bondholders and their insurers want Stockton to repay the loans. But the city lacks the money with which to make the repayments. It borrowed money from the bondholders during good financial times, when its real estate-generated tax receipts were greater than today, and when its advisers predicted no foreseeable end to the flow of cash to the city. The expected flow of that cash, the natural inclination of those in government to want to give away other people's money, and the self-serving manipulations of those in power who rewarded their friends and themselves with rich pensions combined to cause the city to make generous pension commitments to its employees.

It is politically easier to offer generous pension payments to municipal employees in the future than it is to raise their salaries today. The promise to pay a pension to qualifying retirees upon their entry into the retirement system, just like the promise to repay bondholders the money they loaned, is a legally enforceable contract.

So, confronted with an obligation to repay more than $200 million in loans to bondholders and more than $900 million to the California pension system for its current and former employees, and confounded by a serious reduction in real estate tax revenue, so serious that Stockton cannot afford to pay either the bondholders or the pension system, let alone both, the city that over-borrowed and over-spent and over-promised has sought the protection of a federal bankruptcy court.

Bankruptcy in America is a strange bird. It permits debtors to be relieved of their financial obligations by paying less, often far less, than they owe. It compels creditors to accept less, often far less, than they are due. It is generally an orderly and mechanical process presided over by a neutral judge without a jury. Its goal is to get the creditors something, leave the debtors with something, and let all parties go home in peace and resume their livelihoods.

But it rarely happens to the government. That's because the government, which has no competition, creates no wealth, doesn't produce anything of value and needn't attract clients, has a monopoly on the use of force with which it can extract what it needs to pay for its mistakes in the form of higher taxes. These extractions, of course, are not voluntary transactions as when you buy gas for your car or food for your table. They are mafia-style transactions: Pay us more, or else.

But there must be a limit even to the Stockton taxpayers' willingness to part with their wealth in the form of taxes, hence the filing for bankruptcy. The Stockton case presents a rare opportunity for a federal judge to interfere with the contractual obligations of a municipal government and actually modify or even nullify them.

It also presents a confluence of a culture in California of high taxes and generous -- often non-contributory -- pensions for even short-term government employees and a federal system that when it faces a shortfall simply goes to its banker -- the Federal Reserve -- and asks it to print more cash. Stockton cannot legally print cash the way the Fed can.

How does this affect the rest of us? Currently, state and local governments owe about $4 trillion in pension benefits that they do not have to current and former employees, and they know they cannot politically acquire it by raising taxes. This affects all 50 states. So the odds are that the states and the similarly situated Stocktons in America will go to the Obama administration and ask for free cash. And the president will no doubt find it for them. That "found" cash will be borrowed from the Federal Reserve and, like all of the federal government's debts to the Fed, will never be repaid. But countless generations of American taxpayers will make enormous and endless interest payments on it.

Does that sound too apocalyptic for you? Well, consider this: The federal government is still paying interest on the $30 billion it borrowed to wage World War I nearly 100 years ago. So, to the feds, mortgaging your children's future to save the Stocktons of the country from the consequences of their own profligate ways is a no-brainer.

Should Americans yet unborn pay for all of this? Is this what you elected the government to do? What will it take to keep the government within the confines of the Constitution?

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  • Matrix||

    and here, people have been saying government bonds are a good investment when you near retirement.

  • Ted S.||

    This shit wasn't here when I started typing my comment!

  • db||

    It took you two minutes to type a line? You must be using the same smartphone as I.

  • Ted S.||

    No; I opened up a couple of pages in background tabs. I think I read the Brickbat first before commenting here.

  • Night Elf Mohawk||

    I doubt many people say muni bonds.

  • Ted S.||

    1th!

    Claw back the elected officials' wealth to pay down the debts.

  • VG Zaytsev||

    What happens when the government goes bankrupt?

    Only good things happen.

    1) The bloated pension contracts to public sector workers will be reworked.

    2) The government will find it harder to borrow money in the future.

    3) Which will enforce some degree of efficiency on that government.

    4) And maybe (Gasp!) lead said government to becoming more business and development friendly.

    CA would dramatically benefit from the state government going bankrupt.

  • Ted S.||

    You underestimate Big Government's power to fuck things up.

  • VG Zaytsev||

    I live in OC which went through the largest municipal bankruptcy in the nation's history in the early nineties.

    Life improved after that event and has been better for residents since then than it has been for those in the neighboring counties.

    Hell, I wish all the local governments would go bankrupt on a regular basis. So far it's the only way to limit their growth and stupidity.

  • grey||

    #2 is particularly important.

  • freeAgent||

    You're forgetting another great thing that happens: all the fools who lent money to the government will learn a lesson about lending to uncreditworthy borrowers, and governments all over the country will find it marginally harder to borrow.

  • sarcasmic||

    You wish.

  • Heroic Mulatto||

    You forgot the massive riots that will result when the Obamaphones (et al.) are turned off.

    IT'S ALL FREE ON MY E-B-T!

  • LTC(ret) John||

    Swipe! Swipe!

  • Kendall Rigdon||

    Did you see that they refused to ban the use of EBT cards in strip clubs even?!?!? The rationale is that in some poor neighborhoods, a strip club is the only place that may have an ATM!

    Unbelievable.

  • Fluffy||

    I wish I could believe this.

    Unfortunately, I think ultimately they will kick down doors to seize TV's and silverware, and will knock you down in the street to take the gold fillings in your teeth, before public retirees lose their ludicrous pensions.

  • mr lizard||

    Ya I seriously want to see what happens when a police force loses their pension. Then I want to see what happens when they get IOUs instead of a pay stub.

  • grey||

    I've relied on my son, an avid hunter, to keep guns in the house. He's leaving and I will be buying my own. Already trained, been years, so I'll have to get back out the gun range. I'm not enthusiastic about being a gun owner again, but feel I must. Its not passion, its sadness and resignation.

  • ThatSkepticGuy||

    Wishful thinking. They'll just hike taxes and print mo' money.

  • ||

    bring back debtors' prisons!

  • db||

    Once we release all the drug offenders, the private prison industry will be hungry for tenants. I suggest ramping up public corruption and abuse of office investigations across the board.

  • SumpTump||

    Gotta love those Kangaroo Court Judges lol.

    www.Anon-ISP.tk

  • NateK||

    With respect to the Judge, there is competition in government services in customers because a citizen can relocate, or vote. Similarly, government does provide services of value, in the same way that insurance protects you in case of loss, a private security company protects you in case of theft, and a utility company enables you to have resources to run your business. An accountant doesn't produce anything, but they enable a company to be more efficiently run. And of course, as a regulator, government performs a vital service of making sure businesses play by the rules society has agreed to (e.g. your meat packing plant doesn't have to worry that the other guy's meat packing plant is skimping on sanitation). OF COURSE, all of these function can and have been overreached, but that doesn't mean they are completely wrong or unproductive. They're a necessary part of civilized society. Like most libertarians, I just think they should be done and determined more locally.

  • db||

    Similarly, government does provide services of value, in the same way that insurance protects you in case of loss, a private security company protects you in case of theft, and a utility company enables you to have resources to run your business.

    Of these, the only one the government approximates is the security company. Because it has a monopoly, however, it is inefficient at providing such services.

    I have yet to see a government provide insurance or utilities other than by blocking other competitors out of a market with the threat of violence.

  • JBinMO||

    What about flood insurance?

  • JohnInFlorida||

    Totally off topic, but ...
    How about paying what the actuaries determine is a reasonable premium to a private insurer instead of hooking the taxpayer to subsidize your bad choice of a location?
    Or better still, don't build (rebuild) in a floodplain ... gee, what a novel idea!

  • sarcasmic||

    OF COURSE, all of these function can and have been overreached, but that doesn't mean they are completely wrong or unproductive. They're a necessary part of civilized society.

    If government didn't do it, no one would. There's no possible way that a private entity would do this if society demanded it. No way at all.

  • Ptah-Hotep||

    (e.g. your meat packing plant doesn't have to worry that the other guy's meat packing plant is skimping on sanitation).

    You must have missed all the food recalls in the past. I am sure without the gov to protect us, our food would be maggot filled, half rotted, yellow gruel. I mean, what company wants to make money forever? Oh wait, all of them.

    And of course let's not forget the wonderful job the FDA does at keeping medicines out of the hands of people it might be able to help; and the FCC keeping those nasty movies and tv shows off the air that might offend someone's sensibilities.

    Most of the things you mention are not functions of the government. And they are horribly inefficient at what they do provide.

  • Mr. Soul||

    and the competition/relocation point is only valid to a point. If you buy a home in a town that goes bankrupt, there is no market to sell that home at a good price. The freedom to move on is relative not absolute.

  • johnl||

    So people who vote Democrat will watch their capital evaporate. The invisible hand is not handcuffed.

  • Killazontherun||

    You only demonstrated you don t grasp marginal utility with your accountant analogy.

  • buddhastalin||

    Competition in government services is not quite the same as competition in producing goods. If the price of a brand of bourbon goes up, I can very quickly and easily switch to another brand or else switch to scotch. With government, I have to wait 2, 4 or 6 years to vote for someone new, who might or might not win, and even if they did win, might or might not lead to any noticeable change in government. Also, the "just move" argument is a little too facile. I'd have to take the time to sell my real estate into a relatively illiquid market, and then I'd have to go through the slow, inefficient process of getting a new mortgage. Not just I but also my significant other might have to look for a new job. If I had kids, then I'd have to weigh the disruption in their lives. Then even assuming that everything about moving could fall completely into place, there would need to exist a competing jurisdiction that had a better government. This might be easy if I only had to pick between one locality versus another, but it's much harder when the federal government does something stupid and the choice is between the US and a different country.

    As to your point re government as insurer, when it does so, it distorts the price of risk, causing people to do stupid things knowing that the government will bail them out if anything goes wrong. Worse is that taxpayers who had nothing to do with those other people's stupid choices will end up paying for it.

  • johnl||

    OK but when you have the chance to move, try to move to a neighborhood with a low number of crazy neighbors. Like a marginal free-state project.

  • GregMax||

    My backyard fence does not produce anything (splinters maybe). It contributes to an environment that facilitates my pursuit of happiness. So to say it is valueless is wrong. The thing is, it doesn't keep cats from shitting in my planters, though it does keep dogs from shitting everywhere. The bigger point is - as with government - that the fence does not dictate to me that it has to be made out of stainless steel with gold finishing. Governments regularly these days arrogate the style choices to themselves and then we have to pay the bill or suffer the lien.

  • michaelf||

    The federal government is still paying interest on the $30 billion it borrowed to wage World War I nearly 100 years ago

    Could someone explain this? I understand we still have some pensioners on the books, but thought all the bonds were paid off. I seem to recall the story in the 1970's where the government paid off the last of the WWII bonds.

  • Sevo||

    Bonds are, like money is, fungible. They paid off those bonds with money from new bonds, so the debt remains. The date on the bonds changed.

  • dalewalt||

    "What will it take to keep the government within the confines of the Constitution?"

    Violent and bloody revolution.

  • johnl||

    Investors who wont buy our bonds.

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  • GregMax||

    " . . . no foreseeable end to the flow of cash . . . "

    Isn't this really the core issue? The elected parasites and the fools who perpetually vote them in choose or fail to understand that no perpetual motion exists. Things change - for better sometimes, or for the worse, but pretending there's only upside is foolish.

    And a small quibble with Napolitano's ending is that if you borrow future productivity to spend today ala the Fed - beside having to have far more productivity in the future in inflation adjusted terms - you also inflate and thereby tax the people today who can't easily increase their earning's buying power or the buying power of their savings. So it really isn't just borrowing tomorrow's productivity it's stealing people's buying power today.

    "Economic collapse could NEVER happen in America. We are the greatest economy in the world and can print our own money."

    " . . . no foreseeable end to the flow of . . . " prosperity here!

  • chalmers65||

    just before I looked at the paycheck that said $8143, I did not believe ...that...my brother woz like they say truly bringing home money part-time from there labtop.. there best friend has done this less than 12 months and by now repaid the dept on there place and bourt a new BMW 5-series. this is where I went, http://www.wow92.com

  • ||

    The pensioner would rather see the worlds population Raped, Robbed, and Ravaged before his pension is reduced by one dime. A strangers death is of little concern, but a pet cats life is infinitely more important to an animal lover.

  • chenzhong||

    It took you two minutes to type a line? You must be using the same smartphone as http://www.celinebagsaleuk.com/ I.

  • PatrickHenry||

    You people think that Stockton is still part of the USA? Get a grip. The pendulum swings and has already swung. We lost at the Alamo and LA is now the defensive line. But this is great, guess who gets to defend it? Hahahahahha. Hollyweird millionaires.

  • Audrey||

    I can hardly imagine a state of bankruptcy. So even without reading this post, I can surely assume that you are going to say something negative here. You know, I really like the way you described bankruptcy in America-its goal is to get the creditors something, leave the debtors with something, and let all parties go home in peace and resume their livelihoods.As for me filing for bankruptcy is sort of gate away for some individuals..you have to be responsible for actions. If you, for instance, chose to turn to cash borrowing services, you've gotta be ready to pay everything back.

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