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How Stockton Went Bust:A California City’s Decade of Policies and the Financial Crisis that Followed

251 LPS.1 (Own work) [CC0], via Wikimedia Commons

Executive Summary 

In February 2012, Stockton, California voted to enter bankruptcy mediation. Stockton is one of California’s 20 largest cities, and its bankruptcy would be the nation’s largest in history. Its story highlights the pressures on local governments in the aftermath of the 2008 recession and the looming threat of further bankruptcies. This report strives to understand the causes behind Stockton’s present financial crisis and to explain some of the more esoteric financial details in plain language. 

Our study evaluates the main strains on the Stockton’s budget and their origins through an examination of the city’s annual budgets, audit reports, employment agreements and other documents from the past decade. Although a number of accounts in the popular press attribute Stockton’s financial straits to the 2008 recession, the real story is considerably more convoluted. This report largely attributes Stockton’s financial problems to three distinct but related factors: 

  1. The housing and financial collapses. In the aftermath of the market collapses, the city experienced general fund budget deficits every year. These annual deficits quickly depleted the city’s scant reserves and pushed it towards in-solvency.
  2. Excessive optimism and unsustainable compensation promises. The post-2001 economy grew quickly, driv-en largely by the growth of the real estate market. The city’s higher revenue fueled an unbounded optimism about Stockton’s potential growth. This optimism contributed to the city’s willingness to sign several generous employment agreements during the mid-2000’s. These agreements locked in increasing expenditures on salaries, pensions, and other benefits, which together comprise the bulk of the city’s budget. The city now faces more than $800 million in unfunded liabilities for pensions and other retirement benefits.
  3. An ill-timed bond offering. In 2007, to help lower the city’s high pension costs, Stockton undertook a bond offering that would lower its interest payments on roughly $1 25 million of its pension obligation. Due to CalPERS’s investment performance, today that investment is worth less than $1 00 million, but will ultimately cost the city $248 million to pay back. 

We focus on the portion of the General Fund that was most affected by this series of events: Employee Services, which include all benefits and compensation that an employee receives and comprise 80% of Stockton’s General Fund budget. Additionally, healthcare costs are increasing rapidly for current and retired employees. If Stockton intends to remain solvent and continue providing effective services to its citizens, then addressing these costs will be essential.

Finally, we compare Stockton to Vallejo, California, which exited bankruptcy proceedings in 2011 . We conclude the re-port with a summary of arguments for and against proceeding with bankruptcy, a choice the city will need to make in the coming weeks.

Introduction

When the city council of Stockton, California voted to enter pre-bankruptcy mediation with its creditors and large stakeholders in February 2012, it took a step that was historic in more than one sense. Stockton is one of California’s 20 largest cities, and its bankruptcy would be the nation’s largest in history. It would also be the first to test a recent state law that requires a city to enter a 60-day mediation period before seeking bankruptcy protection. Stockton’s story highlights the pressures on local governments in the aftermath of the 2008 recession and the looming threat of further municipal bankruptcies.

Although a number of accounts in the popular press attribute Stockton’s financial straits to the 2008 recession, the real story is considerably more convoluted. Other key factors include more than $800 million in unfunded liabilities for pensions and retiree health benefits, accumulation of redevelopment and other debt, and the relentless growth of employee compensation relative to revenues.

No single decision, act, group, or circumstance is entirely at fault for Stockton’s financial demise. This report attributes Stockton’s problems to the housing and financial collapses, excessive optimism and excessive public employee compensation, and an ill-timed bond offering.

Drawing on Stockton’s budget records and history from the past decade, this report identifies the most important factors that drove Stockton to the brink of bankruptcy. The report finds that no single decision, act, group, or circumstance is entirely at fault. Rather, for nearly a decade, a combination of factors drove a steady increase in long-term costs to the city. But at the core, Stockton’s leadership ignored the possibility that its revenue might not continue to grow at the same pace, which left the city unable to afford the higher costs it was taking on. 

This report largely attributes Stockton’s financial problems to three distinct but related factors: 

  1. The housing and financial collapses. The post-2001 economy grew quickly, fueled largely by the growth of the real estate market. Inflated real estate prices and general economic growth led to increased revenue for many cities, generating unbounded optimism about Stockton’s potential growth. When the housing bubble burst in 2007 and the financial crisis began in 2008, Stockton’s revenues quickly fell. Despite eliminating many employee positions to reduce costs, Stockton still experienced budget deficits in the general fund each year starting in 2007. These annual deficits quickly depleted the city’s scant reserves and pushed it towards insolvency.
  2. Excessive optimism and unsustainable compensation promises. This optimism contributed to the city’s willingness to sign several generous employment agreements during the mid-2000’s, including a 2005 contract with the police union and a 2008 contract with the Stockton City Employees’ Association. These agreements locked in increasing expenditures on salaries, pensions, and other benefits, which together comprise the bulk of the city’s budget. At the time, revenue sustainability was not a concern.
  3. An ill-timed bond offering. In 2007, to help lower the city’s high pension costs, Stockton undertook a bond offering that would lower its interest payments on roughly $1 25 million of its pension obligation. Due to CalPERS’s investment performance, today that investment is worth less than $1 00 million, but will ultimately cost the city $248 million to pay back.

We focus on the portion of the General Fund that was most affected by this series of events: Employee Services, which include all benefits and compensation that an employee receives. Not only is employee compensation the largest portion of Stockton’s budget, but it is also the fastest growing portion. In particular, healthcare costs are increasing rapidly for current and retired employees. We will discuss the impact of these rising costs in greater detail below. If Stockton intends to remain solvent and continue providing effective services to its citizens, then addressing these costs will be essential.

The following section gives a brief history of Stockton before and after the 2007 housing bust, describing the events that led to Stockton’s current situation. The report then describes the role of employee compensation in the city’s budget. It explains why it is critical that Stockton address this portion of its spending if it is to work its way back to a consistently balanced budget. We then proceed with a description of Stockton’s pension contribution record and the bond offering that Stockton issued as an attempt to reduce pension costs. The report concludes with a discussion on bankruptcy and alternative options available to Stockton.

Stockton Prior to 2007 

After the economic downturn ended in 2001 , the US economy experienced a period of rapid growth. As we have learned, much of this expansion was artificial and temporary, especially in the real estate market. The increased availability of credit allowed cities whose prospects were bleak only five years earlier to become growth powerhouses. City governments began planning more aggressively based on the new, higher forecasts for their economic futures.

Stockton took this trend to the extreme. Housing prices rose from a median of just over $11 0,000 to almost $400,000 from 2000 to 2006 (Figure 1 ).1 The number of new residential permits issued by Stockton peaked at 2,984 in 2003, remained at that level through 2005, and plummeted to 680 in 2007. In 2010, Stockton issued only 1 52 such permits.

Figure 1 : Stockton Median Home Prices, 2003-12 92 (how stockton)
Source: Zillow.com, “Stockton Home Prices and Home Values”

But before the housing bust, encouraged by Stockton’s strong economy, the city’s administration decided to invest back into the city by increasing its workforce (mainly in public safety), augmenting employee salaries and benefits as we will discuss below, expanding city services, and undertaking extensive capital investments.2

In 2007, the city expected its General Fund revenue to increase 9.55% over the previous year to nearly $200 million.3 Based on that prognosis, Stockton increased funding for the Redevelopment Agency, which manages city construction projects and has a separate budget from the General Fund. Some of these new proposed major redevelopment projects included the historic Philomathean building’s rehabilitation, the downtown marina and waterfront’s development, and the Hotel Stockton’s renovation.

These projects totaled $129 million4 and the city assumed that its funding was secure given the expected growth in revenue based on the preceding five years.5 It sold bonds based on that assumption. 

Stockton After 2007: Financial Crisis and Real Estate Crash

These employment and redevelopment decisions may have been sound if the economy and housing markets had continued to grow at the rate they did from 2001 to 2006.6 But when the bubble burst in 2007, everyone from individuals and businesses to corporations and governments felt the effects. Stockton’s housing prices declined over 70% from nearly $400,000 in 2006 back to $11 0,000 in 2009, the level seen in 2000.7 Naturally, the housing market decline drove a drop in Stockton’s property tax revenues. But it also had a secondary effect on other revenue sources related to home ownership, including utility user’s taxes and housing permit fees. The negative effects spilled over into sales tax and other revenues, just as the positive effects spilled over when the housing market boomed. In 2010, the General Fund revenues were 10% less than those of the previous year and 1 9% less than what the city originally expected.8 

By the time the city realized the severity of its crisis, it was too late to make any structural changes to its 2007-08 budget. Stockton did respond quickly by initiating a hiring freeze for 90 open positions on May 15, 2008.9 But the city still ran a $5 million budget deficit for that year. The next year saw a $1 million deficit, followed by a $7.5 million deficit in 2010. To compensate for these deficits, Stockton depleted its already scant reserves.

The city finally considered the possibility of “debt-restructuring” in the 2009 budget,10 but it was not until 2010 that the city council voted to declare a fiscal emergency11 and acknowledged that the city’s fiscal health had to be “restored.” 

By the time Stockton was preparing its Fiscal Year 2012 budget, it had already declared a fiscal emergency for two years in a row and made substantial cuts to remain solvent. But even with these cuts, the city would be forced to make drastic changes in 2012. To highlight how large its potential shortfall was, the city created a “Baseline” budget. This document assumed that the city would experience conservative revenue levels and would maintain all wages, pensions, and benefits at the levels previously agreed upon with the city’s employee unions without any discretionary increases. If Stockton were to enact the baseline budget, it would experience a $36 million shortfall in 2012.1 2

The Dominance of Employee Services

What is at the root of this shortfall in the proposed budget? By declaring a fiscal emergency in the previous years, the city avoided the contracted compensation increases – but those increases would eventually take their toll. The magnitude of the resulting effect reflects the preeminent positions that employee compensation and public safety services occupy in city finances. Figure 2 shows that even if Stockton entirely cut its Administration, Public Works, Community Services, Entertainment Venues, and Debt Service programs, it would still have had a budget shortfall. To remain solvent, Stockton would have to address the two largest portions of its budget: Fire and Police.

Because Employee Services account for 85% of the public safety budget (and 76% of the General Fund budget), any effective budget solution will have to address those costs.

Figure 3 further highlights an area that would have to experience cuts sliced in a different way. The largest portion of Stockton’s budget is Employee Services, which consists of employees’ salaries and benefits.13 Because Employee Services account for 85% of the public safety budget (and 76% of the General Fund budget), any effective budget solution will have to address those costs. 

93 (how stockton)

Stockton’s employee services compensation is specified in great detail by a series of agreements (called Memorandums of Understanding, or MOUs) made with the individual employee unions over the past decade (see the box on the following page). 

Employee salaries are scheduled to automatically increase 2.5-7%, depending on General Fund revenue growth. Consequently, employee salaries increase 2.5% even if the General Fund shrinks compared to the previous year.1 4 Other unions, including the police, require a periodic market survey to ensure the city does not pay less than comparable cities. A provision in the MOU further states that if any other union group in Stockton receives a higher wage increase than outlined in the formula, then all employees affected by the General Fund budget must receive the same increase as well.15 To ensure that the city does not stunt these salary increases underhandedly, the union requires any accounting changes to be announced to the union so that it can renegotiate the growth formula with the city.16 Over time, these conditions have ratcheted the fiscal pressure on Stockton. 

251 Mass United, Flickr

Although salaries make up the bulk of employee services expenditures, expenditures on benefits, especially health costs, are rapidly rising. Figure 4 shows the costs of major categories of benefits afforded Stockton employees, demonstrating the rapid surge of health care for current employees.17 Medical costs have grown at an average rate of 9.7% over the past decade and unless the city makes a concerted effort to address this, health costs for current employees alone could consume more than 20% of the budget by 2015.18

Figure 4 : Current Employee Benefit Costs, 2001-11 96 (how stockton)

The Role of Post-Employment Benefits

Pensions and other post-employment benefits (OPEB) currently comprise a small percentage of the budget1 9 (11 .6% and 8% of General Fund respectively Fiscal Year 2010), but their rapid growth means that they will soon consume an even larger portion of the budget. Pensions, while not the fastest growing portion of employee compensation, constitute the largest portion of long-term debt, calculated to be $1.3 billion in 2010. As this section proceeds, we also focus on the fastest growing portion of employee services – retiree healthcare costs. In policy discussions of financial problems, rising OPEB costs have suddenly become more prominent because it was only recently that their long terms costs were calculated and the fiscal impact examined. 

We hope that the reader will come away with the background knowledge necessary to understand the problems associated with pensions and OPEBs, specifically their rising long-term predicted costs, the volatility associated with these costs, and the unsustain-ability of these costs in the long-run.

Stockton’s Pensions

In the past decade, Stockton has fully paid its actuarially determined contribution for pensions (albeit calculated using what many argue is an overly optimistic 7.75% assumed rate of investment return). However, the financial crash has decimated its assets, so that Stockton’s unfunded pension liability stood at $41 3 million in 2010. As a result, while Stockton has experienced moderate growth in normal costs, it has seen the amortized component of its annual contribution sky rocket over the last four years.20

As Figure 5 illustrates, the present value of future benefits grew at an average rate of 7% from 2003 to 2010.21 This means that if CalPERS’s investments meet or exceed its assumed rate of return (7.5%), the funded ratio of pensions (68% in 2010 based on market valuation of assets) should improve over time, as the investments catch up. However, because of the fund’s extensive losses in 2008 and 2009, even the optimistic 7.5% rate of return will not be sufficient to shrink the unfunded liability, and if we project present trends into the future, its pension liabilities will continue to grow, reaching more than $500 million in 201 5. To remedy this, Stockton will have to contribute more to pensions than it has in the past, further straining its budget.

Figure 5: Pension Accrued Liability vs Assets 97 (how stockton)

Other Post-Employment Benefits (OPEBs)

Much of the public discussion regarding the compensation packages offered by cities to their employees has focused on pension obligations. Often overlooked but rising in importance is the ballooning of OPEB obligations. OPEBs include any benefit a retiree receives other than pensions, and health care has recently comprised 63% of all OPEB related costs.22

The growing awareness of OPEB obligations stems from changes in accounting regulations. Until 2006, OPEB benefits had been funded on a pay-as-you-go basis, and the long-term cost of these benefits was not considered. With the implementation of Government Accounting Standards Board rule 45 (GASB 45), cities began calculating the long-term projections of this debt and a frightening truth became apparent: these costs were increasing even faster than pension costs.

Stockton currently has no assets set aside to pay for retiree benefits payments. Rather, the city pays for those benefits from its operational budget. To fully cover current OPEB costs and prefund future costs, Stockton would have to have paid $31 million in FY2012, over twice the city’s $15 million pay-as-you-go OPEB cost. Between 2004 and 2010, these pay-as-you-go payments were rising at a runaway rate of 12% per year on average. Because Stockton restructured the benefits in 2011 , they are projected to increase at a more moderate rate of 7.5%. However, over time even this somewhat optimistic growth rate will still place a heavy burden on the city’s budget.

Table 1 : Monthly Retiree Health Care Costs 98 (how stockton)

The OPEB costs shown in Figure 6 are made up of not only benefits that retired employees receive, but also the benefits allocated to their dependents (Table 1 describes the healthcare benefits portion). The 2011 value of pro-jected post-employment health benefits was $544 million, entirely unfunded.24 This is a reduction of $1 50 million from previous calculations (also reflected in the dip in annual costs around 2012 in Figure 6) which was primarily due to a change in plan conditions, such as increases in annual deductibles and out of pocket maximums. But even with this restructuring, Stockton must reign in these costs further in the long term. The irony is that even while the city is not funding future obligations, meaning that the costs will increase down the line, the annual payments are already bankrupting it.

The Role of the 2007 Pension Obligation Bond

During Stockton’s period of optimism in the mid-2000’s, Stockton’s city council decided to sell bonds to pay down a portion of its $1 58 million in unfunded pension liabilities.26 For cities facing high annual required contribution (ARC) payments to their pension plans, financing these costs through bonds has become a common way to reduce their burden.27 One goal of a pension obligation bond (POB) is to trade the relatively high assigned interest rate of the unfunded pension liability for the lower interest rate of the bond (5.46% in Stockton’s case).28 The assigned interest rate is the rate used by CalPERS to calculate the amortized cost component of the ARC. That rate is equal to the discount rate (7.75% at the time) because it determines the gains the money would have earned if Stockton had paid its full ARC before. In other words, Stockton would borrow at a fixed 5.46% rate to invest at an (expected) 7.75% rate.

Stockton issued $1 25 million in bonds and contributed the proceeds to its pension fund with CalPERS, which then invested it in the market. By doing so, Stockton would owe 5.46% mandatory interest payments on the bond debt to bondholders (resulting in $1 48 million in interest payments), instead of the suggested 7.75% interest payments to CalPERS (which could amount to around $250 million in interest payments).29 The remaining $33 million in unfunded liabilities would continue to be spread out over future ARC payments, effectively carrying CalPERS’s 7.75% interest rate. Historically, issuing pension obligation bonds has been a fairly standard, low-risk option for cities.

Stockton issued the bonds on March 26, 2007. As we know, 2008 would have terrible consequences for the value of the real estate and stock markets. Because CalPERS was highly leveraged in each of these markets, the bond proceeds declined 23.4% in value by 2009, whittling down the $1 25 million bond investment to an estimated value of $93 million as of 2010.30 In short, the city was still on the hook to bondholders to repay the entire $1 25 million of the original bond offering with $1 48 million in interest payments, but its investments were now worth $32 million less. This is indicative of the risks associated with investment in high-return high-risk instruments that CalPERS favored in past decades. Once again, Stockton’s optimism did not pay off.

The impact on Stockton’s budget will be felt directly when the city diverts funds from other programs to make up for the loss in invested funds to meet its pension obligations, or indirectly through higher future borrowing costs if the city defaults on payments. 

Putting it Together: Driving into Bankruptcy 

Until this point, this report has focused on individual components of Stockton’s finances. The following section takes a high level view of the city’s recent history and its future prospects.

Like a person, a city is bound for financial trouble when it consistently spends more than it earns. When expenditures exceed revenues (called negative net annual activity), a city must either borrow from investors or redirect money from other sources, such as reserves or other government funds. Maintaining negative net annual activity for an extended time will eventually deplete a city’s cash reserves. Debt restructuring can help maintain cash reserves for a limited time because it decreases the city’s current payments, typically with a more back-loaded payment schedule. But eventually, the city’s financing options become severely limited.

Figure 7: Stockton General Fund Finances: 100 (how stockton)

As Figure 8 shows, net annual activity decreased sharply in 2007, which served as the first indication of a serious problem with Stockton’s budget. The city’s cash reserves were all but wiped out after 2010 (Figure 9).31 With a 2010 ending balance of just over $1 million, Stockton was on the edge of insolvency.

It may seem that Stockton could just borrow more money until its revenues pick up again. Unfortunately, debt payments are already one of the fastest growing areas of the city’s General Fund. Debt payments jumped from $3 

Figure 8: Stockton’s “Net Annual Activity”: 101 (how stockton)
Figure 9: Stockton Annual Year End Balances 102 (how stockton)

million in FY 2007 to $1 7.5 million in FY 2012, and are projected to increase past $20 million in FY 2018. The short term solution of taking on more debt would only add to Stockton’s burden later, potentially forcing the city to cut more services. Additionally, because of Stockton’s precarious financial situation, any money borrowed, whether through loans or bonds, would carry a very high interest rate.32 Moody’s has recently downgraded the city’s overall rating to junk status.33 

As a result, bankruptcy became an attractive option for Stockton. Before the passage of AB 506 in California last October, a city could simply apply for bankruptcy like any public entity under Chapter 9 of the federal bankruptcy code.34 But AB 506 requires a city to enter into a 60-day mediation process with its major creditors and “interested parties,”35 as defined by Title 11 of the United States Code,36 before being legally permitted to declare bankruptcy. Interested parties include any entity that has at least $5 million (or 5%) of the city’s debt or obligations at stake.37 Most importantly for Stockton, this law brings previously excluded parties to the mediation table. Banks, unions, CalPERS and other interest groups will now have a role in directing the city’s financial future. The meetings occur behind closed doors, and as of the publication of this report, the period has been extended until June 25th.38

Vallejo: A Telling Example

It is too soon to say whether Stockton will enter formal bankruptcy proceedings or, if it does, what the outcomes and implications will be over the next few years. However, some likely scenarios can be gleaned from the short list of recent municipal bankruptcies such as Vallejo’s. 

Vallejo, California announced its bankruptcy in 2008. That city’s situation resembled Stockton’s in some respects, though while Stockton was oblivious to its impending fis-cal problems during the housing boom, Vallejo was aware of its deteriorating situation for a decade leading up to its bankruptcy announcement.39 The causes of Vallejo’s bankruptcy included its weak housing market, overly optimistic budget saving estimates, worse than expected transportation deficits, mandated pension increases and poor commercial revenues. 

In 2008, Vallejo’s employee services made up 85% of the city’s general fund budget,40 on par with Stockton’s 76%. As in Stockton (and in many cities), the largest portion of Vallejo’s employee services figure was also composed of fire and police. From 2006 to 2008, salaries for public safety employees were scheduled to increase at a “>rate of 21 .4%, while all other employees had scheduled salary increases of just over 1 0%. Benefits and pension increases were also scheduled to outpace revenue growth by a wide margin.41 

Vallejo’s bankruptcy took three years, during which time the city was able to settle lawsuits with unions and renegotiate pay and pension plans for union workers.42 The outcomes of the proceedings heavily favored most creditor groups at the expense of city employees and resident services: 

The outcomes impacting the city included43:

  • Number of police officers reduced from a high of 1 55 to 90 in 2011-12 . 
  • Fire Department staff reduced to 32 from a high of 73. 
  • Number of fire companies reduced to 5 in 2010-11, down from 9 in 2007-08. 
  • Infrastructure maintenance reduced, leaving many streets and buildings in disrepair.

The outcomes impacting stakeholders included44:

  •  Creditors are receiving their principal payments, but only a portion of their interest payments.
  • Unions accepted lower wages and benefit packages for their employees.45
  • There is no longer a minimum employee requirement in the fire department.
  • Insurers of Vallejo’s debt are repaying holders of Certificates of Participation.
  •  Bondholders are relatively protected from losses. 

While the structural causes of the two cities’ problems are similar, the passage of AB 506 is likely to change the dynamics of the bankruptcy process for Stockton. It remains to be seen what outcome this legislation encour-ages at the bargaining table, whether certain interest groups will gain more negotiating powers, or whether the negotiations have little impact on the city’s decision-making process. As to whether Stockton will avoid bankruptcy, the following section lays out arguments for both sides in the final section of the report. 

Is Bankruptcy in the Cards for Stockton?

The first potential outcome is that Stockton will declare bankruptcy after it exits the mediation process. Stockton has an excellent claim that it satisfies the five-prong criteria for filing for municipal bankruptcy because following Vallejo’s case, federal courts have declared that definitive cash insolvency is not a requirement. Declaring bankruptcy would be a reasonable course of action for the following reasons:

  1. There are two important benefits that come with filing for bankruptcy: protection from creditors and, by extension, the possibility of voiding previously negotiated agreements, meaning that the city can reduce employee pay as necessary rather than entirely eliminating positions.46 Reducing employee pay would allow Stockton to keep more of its services functional and would allow employees to keep their jobs instead of forcing the city to resort to layoffs and resident services cuts. Should Stockton declare bankruptcy, the creditor groups – particularly the unions – will have a smaller role in determining Stockton’s future. In a Chapter 9 proceeding, while creditors have a voice in approving a restructuring plan, only the municipality can propose it, thereby giving the city the advantage.47 As demonstrated by Orange County’s bankruptcy, creditors have little power during the process to enforce their claims.48 Therefore, it is in Stockton’s self-interest to go this route after the mediation to maintain more control over its finances. While federal bankruptcy law requires a bankruptcy judge to supervise the initialization of the process and affirm its conclusion, the precedents from Vallejo and Orange County suggest that this process will most likely favor Stockton’s management.
  2. The scale of the required changes and the fact that they require modifications of entrenched contracts suggest that federal bankruptcy protection is the most realistic route for Stockton. The  bankruptcy  process  would  likely  have  a  positive outcome for Stockton’s future, as exemplified by Vallejo. It is our view that cuts to fire and police budgets are necessary but are not in themselves sufficient. However, the result of these reductions should allow Stockton to pay down a larger portion of its unfunded OPEB liability. In the longer term, measures must be taken to control the growth of healthcare costs and to prevent a repeat of the ratcheting up of employee compensation.49
 

Despite the aforementioned arguments, there is also a significant chance that the mediation succeeds and bankruptcy could be avoided:

  1. Assuming that Stockton’s creditors do not want to lose their negotiating power, they may yield to some of the administration’s requests to prevent it from filing for bankruptcy. Although Stockton has the advantage in restructuring its operations should it do so, if it can obtain the same results through AB 506 negotiations, successful mediation is the more appealing route. Declaring bankruptcy carries with it a heavy stigma. 
  2.  Similarly, although unions and other contract holders have less sway during bankruptcy than during mediation, the bankruptcy process vests the ultimate decision of approving the outcome in a judge, and city council may be hesitant to surrender this power. 
  3. Stockton made the necessary cuts in the FY 2010 and FY 2011 budgets to remain solvent despite strong budgetary pressure. The autonomy that Stockton gains from declaring a fiscal emergency may allow it to make sufficient cuts to remain solvent in the short term. While this is not a sustainable approach, it may provide sufficient breathing room for the city to pull through.

Given these reasons, whether Stockton chooses to declare bankruptcy is contingent on the cooperation of stakeholders included in AB 506 negotiations. Because many of the unions were willing to negotiate previously and creditors would prefer to take a loss without ceding control, there is good reason to think Stockton will refrain from proceeding with bankruptcy.

Concluding Remarks

As this report shows, the root of Stockton’s situation rests in the perfect storm of a wholesale financial downturn and unwise promises of increasing salaries and generous benefits. Because Stockton will not be able to significantly increase its revenue in the near future — in-deed revenue is projected to stay flat for the next three years — any realistic solution must make significant changes to present and future employee compensation. And because police and fire employees make up the majority of that spending, they will necessarily feel the brunt of the changes whether these are carried out in mediation or bankruptcy court.

 

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Stockton Market Trends.“Retrieved April 2012.

Stockton 2007-08 Annual City Budget”

Bureau of Economic Analysis. National Economic Accounts.” Retrieved May 2012.

“Memorandum of Understanding: Stockton City Employees’ Association Master Agreement.” Stockton, CA, 2008. (See p. 52, Article 1 7.1 Salaries (a)).

Kathleen Vonachen. Comprehensive Annual Financial Report for Stockton California. City of Stockton. 2011 .

CalPERS. “Actuarial Valuation” for Public Safety and Miscellanious employees combined. 2006-2010, p. 5.

Alan Milligan. “Actuarial Valuation for the Safety Plan of the City of Stockton.” CalPERS. 2010 and Alan Milligan. “Actuarial Valuation for the Miscellaneous Plan of the City of Stockton.” CalPERS. 2010.

Teresia Haase.Memo to Stockton Mayor and City Council From Human Resources Director. May 22, 2012, p. 7. Retrieved June 2012.

Segall 2011 , p.4

Mark Moses. Memo to Mayor and City Council of Stockton. March 20, 2007, p.1 98.

Roger L. Davis. “Pension Obligation Bonds and Other Post-Employment Benefits.” Orrick, Herrington & Sutcliffe LLP. 2006. http://www.orrick.com/fileupload/247.pdf;. Retrieved May 2012.

Calculated from “City of Stockton 2007 Taxable Pension Obligation Bonds” official statement. Public Finance Department of Stockton. September 1 , 2007, pp. 4-5.

Estimated from CalPERS 2011 Annual Report total portfolio value.

Note that the net annual activity for 2011 was pulled from a current budget, meaning that the final fiscal year end figure had not yet

Management Partners. “City of Stockton Financial Condition Assessment.” February 2012, pp. 251 .88-89. http://www.stocktongov.com/files/AgendaItem1 5_02_2012_2_28_CouncilAgenda.pdf;. Retrieved April 2012.

Scott Smith.Stockton credit takes another hit.” Recordnet.com.Retrieved May 26th 2012.

Adjustments of Debts of a Municipality. 11 CFR, pt. 9. 2012.Retrieved April 2012.

An act to amend Section 53760 of, and to add Sections 53760.1 , 53760.3, 53760.5, and 53.760.7 to, the Government Code, relating to local government. AB 506, sec. 2. 09 October 2011 . California Government Code. Retrieved April 2012.

“Stockton’s AB 506 Process Clarified.” City of Stockton. March 8, 2012.

Adopted Budget” Fiscal Years 2004-2010, City of Vallejo, California, pp. i.Retrieved April 2012.

http://www.ci.vallejo.ca.us/GovSite/default.asp?serviceID1 =754;. Retrieved April 2012; “Memorandum of Understanding: Stockton City Employees’ Association Master Agreement”. 2008, Pp. 44-51 , 52-56. http://www.stocktongov.com/files/2SCEAMOU%20.pdf;. Retrieved April 2012; “City of Vallejo – Questions & Answers,” City of Vallejo. 2010.

http://www.ci.vallejo.ca.us/GovSite/default.asp?serviceID1 =71 8;. Retrieved April 2012.

The website uscourts.gov offers an explanation of the purpose of municipal bankruptcy . Specifically, see http://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Chapter9.aspx.

When Cities Struggle, Workers Punished — But Bondholders Spared.” Huffington Post. March 3rd, 2011. Retrieved May 2012.

Bobby White. Long Road Out of Bankruptcy.” The Wall Street Journal. May 4th, 2011 .Retrieved May 2012.

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