Why the Stockton California Bankruptcy Ruling Can't Stop Public Sector Pension Reform

A federal judge approved Stockton's bankruptcy exit plan which punts on pension debt. But other cities are free to tackle the problem, and they must.

SACRAMENTO — When it comes to pension reform, I've long been a pessimist given the realities in the Capitol and courts. A federal judge's decision in part two of the Stockton bankruptcy case last Thursday, approving an exit plan that doesn't chip away at the city's looming pension debt, at first seems to warrant even more negativism.

But it's probably not as bad as it seems for those who want these municipal debts tamed so that public services can be restored and residents aren't stuck with escalating tax burdens. Sure, Stockton officials chose not to reduce pensions, but other cities are free to address them in the future, thanks to the first part of the decision the judge issued early this month.

The fundamental problem hasn't changed. Even as liabilities have soared, state politicians have supported only superficial reforms. Courts have upheld the "California Rule," which means pensions cannot be reduced for current employees even on a go-forward basis. That leaves few options for hard-pressed cities.

Reformers had pinned their hopes on municipal bankruptcy – not because they want cities to go belly up, but because it would provide a day of reckoning. If pensions aren't safe in bankruptcy, that would give public-sector unions an incentive to support reforms to help keep their localities out of bankruptcy court.

On October 1, optimists were cheering. In a verbal ruling, Judge Christopher Klein ruled pensions could are fair game in a bankruptcy, despite the California Public Employees' Retirement Systems' insistence to the contrary. "Impairing contractual obligations – that's what bankruptcy is all about," the judge said.

But this week, in a decision cheered by California Public Employees' Retirement System (CalPERS) and public-sector unions, Klein accepted the city's plan, which leaves pensions intact and balances the city's debts on the back of creditors. The real loser was Franklin Templeton, which will only be repaid 1 percent on the $36 million unsecured portion of its loan.

The judge was satisfied the city's plan would restore it to fiscal health, despite reports showing Stockton could face budget problems again in four years given the trajectory of pension debt. He thought it was the best the city could do, especially after a recent tax increase. Indeed, cities increasingly are turning to taxes to deal with their pension-related problems.

"There is absolutely no doubt in my mind the pension obligations are driving the volume and amounts of tax-increase proposals and even many of the bond proposals," said Jon Coupal, president of the anti-tax-increasing Howard Jarvis Taxpayers Association in Sacramento. More local tax increases may be a side effect of Klein's ruling.

But the public-employee union officials and others who viewed Thursday's decision as a sign that pensions always are sacrosanct are kidding themselves. "Government pensions in California remain untouchable, at least for now …," concluded the Sacramento Bee.

In reality, the October 1 decision still is in force – and could still change the state's pension landscape. Even CalPERS officials recognized that fact after the verdict. Based on his earlier ruling, it's clear pensions are touchable. That has statewide importance even if Stockton chose not to take advantage of the opportunity offered to it.

"If you have a city that's not as dumb as the Stockton City Council and actually is looking out for its taxpayers, they can take advantage of the judge's willingness to impair PERS," said former Stockton Assemblyman Dean Andal.

Reacting to the city's "yee-haw reaction" to the verdict, San Joaquin County Taxpayers Association President Dave Renison wondered what the city got out of a process that cost $41 million: "It's a shame to waste a perfectly good bankruptcy." Californians in other troubled cities may have gotten something out of the process, though.

"It's a race to see which city will be the first to take a federal bankruptcy judge seriously," said Jack Dean, vice president of California Pension Reform. In other words, local finances might get bad enough that someday officials in some California city might be willing to challenge CalPERS. That leaves at least some reason to be optimistic.