Wall Street creditors Monday sought to block the largest municipal bankruptcy in U.S. history, arguing in federal court that the city of Stockton improperly claimed insolvency while refusing to cut its massive pension obligations.
As U.S. Bankruptcy Judge Christopher Klein began a four-day trial in Sacramento to determine whether Stockton should be allowed to seek Chapter 9 municipal bankruptcy protection, creditors ripped the city, saying it was wrongly sticking them with the bill for its fiscal ineptitude.
Creditors that insured Stockton's pension bonds and issued bonds for downtown redevelopment projects, including a sports arena, charged that the city should have negotiated concessions in employee pension obligations to the California Public Employees' Retirement System to meet other payments.
While the creditors are seeking to stop bankruptcy for the city of more than 290,000, Stockton officials said the city could face chaos without bankruptcy protection.
Klein said he would approve the Stockton bankruptcy petition if he finds that the city was, in fact, insolvent and negotiated in good faith to resolve its debts. But he said, "The city has the burden of proof."
Stockton slashed its bond payments and made deep cuts in its Police Department and other city staff amid an exploding deficit. The city contended that it was still required to keep up $29 million in annual payments to the state retirement system for employee pensions, a view shared by CalPERS.
But that view was blistered in court by Guy Neal, an attorney for Assured Guarantee Corp., which had insured the city's pension bonds and issued bonds for an ill-fated purchase of an office building for a new city hall.
In his opening statement, Neal argued that Stockton approved generous employee pensions while the city was in a real estate boom but then refused to renegotiate its obligations after the economy tanked and Stockton became ground zero for the mortgage crisis.
"The city declines to address its single liability unfunded pension costs," Neal said in his opening argument. "The city ignores the unfunded gorilla in the room. The city acted to put itself into bankruptcy instead of making the hard decisions to put its fiscal house in order."
Attorney Marc Levinson, representing the city of Stockton, charged that the creditors' challenges to the city's bankruptcy filing last summer including a charge that the city wasn't broke at the time were groundless. He also said the city is bound by its CalPERS obligations and "they know that."
"This is all about leverage," Levinson said of the creditors' claims. "It is about causing the city pain in an attempt to gain bargaining leverage. Nothing else makes sense. What good would dismissal of Chapter 9 (bankruptcy) do for them? What good would it do for anyone?"
Levinson said the city had little choice but to declare bankruptcy after attempting to mediate its debts and slashing $90 million in services over three years, laying off 25 percent of the police force and more than 40 percent of employees in other departments. The city also cut retiree health benefits but not its pension obligations to CalPERS.
Outside of court, Kathryn Nance, president of the Stockton Police Association, a bitter antagonist in city budget-cutting negotiations, said things will get decidedly worse and more police cuts may follow without bankruptcy.
"It's very concerning. We've already had an all-time high in homicides," she said, referring to last year's record 71 killings in the city. "And we're having trouble retaining and hiring officers."
With the city's tax base collapsing amid the foreclosure crisis, Stockton last summer ended up surrendering an office building it bought for $48 million that was supposed to be for a new city hall. The city also gave up downtown parking garages it built.
It claimed a $26 million budget shortfall in a $512 million city budget and annual deficits of $47 million projected within three years.
Meanwhile, the city in 2007 sold $125 million in bonds to cover a gap in its pension obligations. The bonds stand to cost Stockton $248 million in payments, which the city is trying to reduce through bankruptcy.
Matthew Walsh, an attorney for National Public Finance Guarantee Corp., the lead bond issuer on Stockton's $68 million arena and other downtown improvements, said the city filed for bankruptcy without exploring local tax increases and further cuts in city staff and services.
"The city's agenda was clear before the process began," Walsh said. "The city would restructure by targeting the creditors for disproportionate impairment."
But in a pretrial declaration filed with the bankruptcy court, Stockton City Manager Bob Deis said Stockton was in no position to ask local voters to support higher taxes after "paying exorbitant retiree medical benefits" and "creating an unsustainable debt load."
"Asking voters to trust the city with their money was virtually certain to fail," he said in the declaration.
As Deis took the witness stand in open court Monday, he was grilled by Neal over the city's insistence on meeting CalPERS pension obligations.
"The city can't afford to pay CalPERS, can it?" Neal asked.
"The city has to pay CalPERS," answered Deis, who was hired to help the city out of its fiscal crisis. "In order for us to be a viable employer, we're going to have to pay CalPERS."
CalPERS isn't challenging the Stockton bankruptcy. But its attorneys were in court as observers.
Call The Bee's Peter Hecht, (916) 326-5539.