Pension Crisis

California Public Pensions Put on Notice

Federal judge gives hope to busted cities.


Credit: 401(K) 2013 / photo on flickr

SACRAMENTO — Public-employee pensions are not protected when a city goes belly-up, according to a ruling Wednesday by the judge overseeing Stockton's much-watched federal bankruptcy case. Judge Christopher Klein's few words have re-energized the state's disheartened pension-reform movement – and left the nation's most-powerful pension fund reeling.

One can't go a day in Sacramento without hearing about a "historic" piece of legislation or a "groundbreaking" decision, but the Stockton case – held in a downtown Sacramento courthouse – could change everything on the pension front. Klein said in the verbal ruling that pensions are just another contract: "Impairing contractual obligations – that's what bankruptcy is all about."

Until now, there has been no way for California cities to get out from underneath the overly generous pension promises they have made to public employees over the past 15 years, the result in part of a pension-increasing bonanza spurred by 1999 legislation championed by the California Public Employees' Retirement System.

CalPERS has argued successfully in many courts that municipalities cannot reduce pensions for public employees, even on a go-forward basis. That has reduced fiscally sound cities' ability to shave costs. But CalPERS has taken that argument further by claiming cities must make their full pension payments – even when they no longer can pay their bills.

Stockton, a San Joaquin Valley city stung by an economic downturn and crashing housing market, two years ago filed for federal bankruptcy protection. The city had paid its employees 125 percent of the state average and even offered a lifetime medical benefit that one councilwoman referred to in court as a "Lamborghini-style" plan.

As officials there struggled to come up with a sustainable blueprint to exit bankruptcy, they were able to trim back salary and benefits, which are not "vested," or guaranteed, rights. But city officials refused to tackle vested pensions – arguing that cutting them back would make it too hard to retain public employees in the hard-pressed, crime-ridden city.

The city passed a sales tax. It came to terms with most Wall Street creditors. But Franklin Templeton Investments – steamed that it would be offered only $4 million out of $36 million owed, while CalPERS wouldn't lose a dime – challenged the bankruptcy by arguing that there was no reason pensions should be off the table.

In the Detroit bankruptcy case, a federal judge also ruled that pensions are not sacrosanct. But CalPERS has argued that California law is much different. As an arm of the state government sanctioned by the state Constitution, CalPERS says it is not subject to the "supremacy clause" that allows federal law to trump state law.

"The drafters of the bankruptcy code acknowledged that certain powers have been reserved to the states under the United States Constitution and therefore limit the power of the bankruptcy court to interfere with the state's control over municipalities and state agencies in a bankruptcy case," according to the CalPERS legal position.

Judge Klein, however, disagreed in what The Sacramento Bee referred to as CalPERS' "dreaded decision."

In response to the ruling, CalPERS retorted, "We disagree with the judge's opinion on the issue of pension impairment. This ruling is not legally binding on any of the parties in the Stockton case or as precedent in any other bankruptcy proceeding and is unnecessary to the decision on the confirmation of the city of Stockton's plan of adjustment."

Klein still needs to rule on whether to accept the city's workout plan. The judge has delayed that part of the decision and set the next hearing for Oct. 30, according to a report in the Stockton Record. The city is likely to stick to its "protect CalPERS at all costs" plan, regardless of Klein's words saying that it could give CalPERS the heave-ho.

Former Stockton Assemblyman Dean Andal said the judge first had to decide whether CalPERS can be impaired in the bankruptcy. Now he has to decide whether the city's plan will produce long-term solvency. I reported last October on an official bankruptcy document showing the city is likely to return to insolvency in four years under its current workout plan.

But even if Klein says the plan works, he must decide if it's fair to give Franklin Templeton a tiny percentage of what it is owed while giving CalPERS 100 percent of what it is owed, Andal said. The latter two points matter to Stockton residents, but the decision Wednesday – provided it holds up and is viewed as precedential – matters elsewhere.

Consider that San Bernardino, another bankrupt California city, had tried to treat CalPERS as any other creditor, but couldn't afford to fight the pension fund's insistence that it pay the full pension amounts. Keep an eye on that city going forward.

"It has never made any sense that government workers' pensions should be in a unique protected category," said Jack Dean, vice president of California Pension Reform and publisher of the Pension Tsunami web site. "In the private sector when a corporation goes bankrupt, pensioners take a cut along with all the other creditors."

With CalPERS untouched, it means everything else has to be cut. I go to Stockton frequently, and the city has become unkempt as city officials lack the funds to pave roads and trim trees, even as they pay $29 million annually to CalPERS.

Echoing the views of Stockton officials, Dave Low, chairman of the union-backed Californians for Retirement Security, warned that such a decision "will result in a mass exodus of police, firefighters and other public employees who will have no incentive to rebuild bankrupt cities."

But Dave Renison, president of the city's taxpayers' association, sees no evidence current employees will flee relatively high-paid city jobs if retirees have to trim some benefits. Modest reductions – reducing cost-of-living adjustments, rolling back unearned retroactive benefits, trimming benefits for future employees – could fix the budget problem without "dire circumstances," he argued in a letter to the judge.

"We can't balance budgets on the back of everything that remains," he said, portraying the judge's ruling as a win for all struggling California cities and not just Stockton. If the decision stands, it's a whole new pension-reform battleground. For the first time in years, the mighty CalPERS will be on defense – and will have some incentive to negotiate with cities.