A bankruptcy judge handed CalPERS and organized labor a decision they’ve long feared Wednesday, declaring the city of Stockton has the right to reduce pension payments and even sever ties with the powerful pension fund.
The verbal ruling from U.S. Bankruptcy Judge Christopher Klein was groundbreaking. It pierced CalPERS’ aura of invincibility and made clear, for the first time, that public employee pensions in California aren’t sacred. Two years after Stockton filed for bankruptcy protection, buried under more than $200 million in bond debt, a judge has declared that a municipality can walk away from its obligations to the California Public Employees’ Retirement System.
Klein’s ruling was prompted by a legal protest from Franklin Templeton Investments, which is due to be repaid just $4 million on a $36 million loan it made to the city during better economic times. Franklin wants a better deal from Stockton even if it comes at the expense of the pensions.
The practical effect of Klein’s ruling is unclear. It depends in large part on whether Klein will accept Stockton’s financial reorganization plan – a plan under which the city promises to keep making its annual $29 million pension payments in order to retain its relationship with CalPERS.
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If Stockton gets Klein’s approval and can resolve its bankruptcy without slashing pensions, the impact of Klein’s ruling is blunted somewhat. But Klein won’t rule on the city’s plan until Oct. 30.
Wall Street applauded the ruling. Moody’s Investors Service today called the decision “a positive sign for investors that pension obligations will not be given preferential treatment over debt in a municipal bankruptcy.” Moody’s added that it could prompt other stressed municipalities to “consider bankruptcy as a way of trimming unaffordable and growing pension burdens.”
Because of Stockton’s pledge, CalPERS attorney Michael Gearin downplayed the decision and said it doesn’t force the city to cut its pension payments. “It doesn’t establish a precedent. Those were his comments about a hypothetical city” that wants to cut ties with the California Public Employees’ Retirement System, he said.
Nonetheless, CalPERS was disappointed. It creates a ruling that undercuts CalPERS’ contention that public pensions are ironclad and municipalities must make their contributions, no matter what. About 2,000 municipal agencies cover their employees through CalPERS.
Klein compared the Stockton-CalPERS relationship to a retailer using bankruptcy to opt out of a bad shopping-mall lease. “The city’s contract with CalPERS could be rejected,” the judge said to a courtroom packed with lawyers, city officials and retirees.
Until now, public pensions in California were believed to be off-limits, even if the government provider went bankrupt. Lawmakers could scale back benefits, but only for newly hired workers, as the Legislature did last year. A bankruptcy judge did rule in Detroit last year that pensions could be reduced for existing workers and retirees, but CalPERS argued that ruling wasn’t relevant because there are additional protections in California law.
As a result, Klein’s ruling reverberated throughout the legal world and among public employee unions. Dave Low, chairman of a union-backed coalition called Californians for Retirement Security, said “the judge has sided with Wall Street in a decision that has the potential of devastating citizens, employees, and making bad situations worse.”
Stockton retirees called the decision a slap in the face. “Employees operated in good faith,” said Anthony Delgado, a retired Stockton police officer who attended the hearing. “Retirees and active employees could be left holding the bag. It goes against every fiber of my being.”
On the other hand, Dan Pellissier, a pension-reform advocate, welcomed the ruling. But he said Stockton, by sticking with CalPERS, is squandering an opportunity to reduce its pension costs and spend the savings on more police, firefighters and city services.
Franklin Templeton wants Stockton to reduce its CalPERS payments to free up more cash to repay the loan. It said the proposed repayment amounts to just 12 cents on the dollar, while other creditors are due to receive 50 cents to 100 cents on the dollar.
“That’s discrimination, and it’s unfair,” said James Johnston, a lawyer for the San Mateo investment firm. He also said CalPERS was seeking “exalted status under California law.”
City officials have said they have no choice but to stick with CalPERS. If it doesn’t pay the pension fund in full, default would occur, and the city would either have to make a one-time payment of $1.6 billion to keep pensions whole or let CalPERS slash benefits by 60 percent. The result would be a mass exodus of employees, the city said, creating an enormous setback just as the troubled city, saddled with poverty and a high crime rate, is starting to get back on its feet.
Last fall, Stockton voters approved increasing the sales tax to 9 percent – expected to generate $28 million annually – in order to beef up city staffing, particularly police officers.
“The city cannot impair pensions and continue to function as a city,” said Stockton lawyer Marc Levinson in remarks to the judge.
As it is, even with the economy recovering and tax revenue rising, the city is “still operating at a barely … solvent level,” Levinson said.
Coming up with an alternative to CalPERS would be prohibitively expensive and cumbersome, he said.
He noted that the city has already laid off about one-fourth of its work force and rolled back salaries. The approximately 2,400 municipal retirees have had their city-paid health insurance completely eliminated. The city’s budget has been trimmed by $90 million a year.
“The retirees and the city’s employees have already given enough,” said Jason Rios, a lawyer representing retirees in the case.
Noting that other creditors have signed off on the Stockton reorganization plan, he said: “As the holdout creditor, we don’t think Franklin should torpedo the city’s plan.”
The average retiree gets a pension of $24,000 a year, according to Rios.
But some employees, particularly police and firefighters, get considerably higher pensions. A “midlevel sergeant” in the police force can expect a $68,000-a-year pension after putting in 25 years, according to city testimony.
In declining to rule right away on the city’s plan, Klein said “I need to reflect more carefully.” But he also signaled that he expects the city and Franklin to make another stab at settling their differences before he rules.
“It’s still open season,” the judge said.
Levinson said the city could offer Franklin a “contingent note” that would give the investment firm a 22 percent share of any tax revenue above a certain threshold.
CalPERS has always fought any attempt by a city to reduce its pension obligations. When Vallejo went bankrupt in 2008 and hinted it might try to lower its annual payments, CalPERS said it could take the city to court.
San Bernardino, the other California city in bankruptcy, actually suspended its payments to CalPERS for several months, and some city officials suggested they would fight CalPERS in court. But earlier this summer, San Bernardino worked out a settlement plan with the pension fund. The details haven’t yet been disclosed.