Wall Street lenders say they're getting a raw deal in Stockton's bankruptcy, losing millions while the city continues to fund pricey employee pensions.

The city says too bad.

A blistering statement issued this week by Assured Guaranty, a bond insurance company based in Bermuda, suggests that Stockton is the new battleground in the fight over retirement promises made to government workers.

Assured Guaranty complained that Stockton, after filing for bankruptcy protection, is stiffing bondholders to give preferential treatment to employees and CalPERS. The company called that "a contortion of the bankruptcy process" and said today it will press its argument in court.

Assured's broadside raises new questions about a topic once thought to be out of bounds: whether governments can tamper with retirement plans.

While some corporations have used bankruptcy to cut their obligations to retirees, public-sector pensions generally have been considered sacred: Once workers go on the payroll, their retirement can't be touched.

Responding to Assured's claim, CalPERS said pension obligations take precedence over lenders under California law.

"The obligations owed to the public workers of the city have priority over those of general unsecured creditors, including bondholders," said CalPERS general counsel Peter Mixon in an email to reporters.

But the sanctity of pension promises is increasingly being called into question. Voters in San Jose and San Diego recently approved ballot initiatives to trim pension benefits for current employees. Unions are challenging both initiatives in court.

Similar issues have popped up in other states. Colorado, Minnesota and South Dakota pared back scheduled cost-of-living increases for their retirees in 2010, said Keith Brainard, research director at the National Association of State Retirement Administrators.

"We're watching public pension benefit law unfold before our eyes," Brainard said.

In one striking case, retired police and firefighters in Central Falls, R.I., agreed to cut their pensions by 25 percent last fall after the city filed for bankruptcy protection. The city was threatening to reduce the pensions to nothing.

"We had that sword hanging over our head," said Matthew McGowan, the workers' attorney.

The issue continues to simmer in California. San Bernardino filed for bankruptcy protection late Wednesday, saying pension costs contributed to the city's woes. Gov. Jerry Brown is trying to push pension reform through the Legislature.

Stockton's problems are many. During the housing boom, the city blew millions on waterfront redevelopment and an arena.

Pensions, too, figure into the city's troubles. Besides the $29 million a year Stockton pays into CalPERS, the city got in a jam when it borrowed $125 million in the bond market in 2007 to pay for enhanced pension benefits. The money was plowed into the city's CalPERS account.

That strategy blew up in Stockton's face when the market crashed a year later. Not only did the city's investment lose about one-third of its value, but Stockton still owes $124 million on those bonds.

As part of its bankruptcy, it plans to withhold most of its debt payments. That would leave Assured Guaranty on the hook for $103 million.

The city noted that employees are taking cuts, too. Retiree health care is being slashed.

But Assured said it's an outrage for the city not to pay its bond debt while honoring its obligations to CalPERS. The company isn't particularly sympathetic to the city's investment losses, either.

"If Stockton is disappointed with CalPERS' investment performance, it should be taking that up with CalPERS rather than reneging on the city's obligation to holders of the pension bonds," Assured said.

Assured added that bankruptcy shouldn't be used "as a sword to prefer one class of similarly situated creditor over another."

Translation: Bondholders are getting hammered by Stockton but CalPERS is getting kid-glove treatment.

CalPERS, though, said Assured has itself to blame.

"Unlike insurance companies, policemen, firefighters and other public employees are not in a position to evaluate credit risk of their employers," he said. "Assured Guaranty is in the business of evaluating these risks."

City Manager Bob Deis told the Stockton Record that Assured was guilty of "bad faith and whining."

In a followup statement today, Assured said it will fight it out in court. "Stockton is advocating a plan that unfairly discriminates against bondholders' rights to be treated equally and fairly among Stockton's creditors," company spokeswoman Ashweeta Durani said by email. "Assured Guaranty opposes this plan and intends to vigorously defend our rights in court."

One municipal bankruptcy expert, Chicago lawyer Jim Spiotto, said it will make for a significant battle. "CalPERS is asserting their position and … it sounds like it will be tested," he said.

One sure thing: CalPERS will respond.

When Vallejo went bankrupt in 2008, the city toyed with the idea of scaling back its pension obligations. Officials backed down after CalPERS "threatened a costly and debilitating court battle," according to an account in the New York Times.

CalPERS spokesman Brad Pacheco said there were no such threats. But he said, "I think it would be fair to say that CalPERS outlined its views on vested rights of pensions."

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