Dan Walters

Dan Walters: Bankruptcy judge lights fuse with Stockton pension ruling

It should have surprised no one that federal Bankruptcy Court Judge Christopher Klein declared that public employees’ pensions are not sacrosanct when their employers declare bankruptcy.

For months, while presiding over Stockton’s municipal bankruptcy, Klein had dropped broad hints that regardless of state laws protecting pension obligations, federal bankruptcy law superseded them.

One by one, he dismissed arguments by city attorneys and those for the giant California Public Employees’ Retirement System, the final one being that as a state agency, CalPERS enjoys sovereignty from federal interference.

CalPERS had long feared that such a ruling would someday be made and had persuaded the Legislature to enact what it thought were barriers to tapping pension debts, but Klein also declared those state laws to be inoperable.

On Wednesday, Klein made it explicit, declaring flatly that pension obligations are just another form of contractual debt that can be “impaired.”

“California public employee retirement law … is simply invalid in the face of the supremacy clause of the United States Constitution,” Klein said. “I've concluded the pension could be adjusted.”

Whether it will be “adjusted” in Stockton is uncertain, because Klein postponed a decision on whether its plan, which cuts other debts but leaves pensions untouched, is acceptable.

But his verbal declaration, in concert with a similar ruling in Detroit’s bankruptcy, sets up what could be a legal battle reaching all the way to the Supreme Court.

Potentially, it radically changes the balance of power when cities and other local government agencies facing insolvency deal with their creditors.

If Klein’s theory stands, local government unions could no longer refuse to negotiate on pension reduction as a way of avoiding bankruptcy, and CalPERS and other pension systems would have to drop their pay-us-or-else arrogance.

Also, as happened in Stockton, nonpension creditors would gain leverage over distressed governments to demand that they give pensioners the same kind of haircuts that bondholders and other creditors take.

Moody’s Investors Service underscored that effect by declaring that Klein’s ruling is “welcome news for investors” in municipal debt.

So what now? If Stockton makes a deal with its only remaining nonpension creditor, Klein may not force the city – and, by extension, CalPERS – to cut pension debts. But were he to find that without pension cuts Stockton is truly not out of the financial woods, he could reject the plan.

We probably will also see a renewal of efforts by public employee unions to pass legislation forcing local governments to get permission from union-friendly state officials before seeking bankruptcy.

Klein has lit the fuse on what could be a political bomb.