California cities need a solution to pension mess

Cal Pers building in Sacramento
Cal Pers building in Sacramento Sacramento Bee Staff Photo

The recent announcement of the previously sealed bankruptcy settlement between San Bernardino and CalPERS makes a clean sweep for the pension giant. In their bankruptcy cases, Vallejo, Stockton and San Bernardino all decided to assume their pension obligations in full, rather than reducing those obligations to fulfill others.

This is no doubt a relief not just for workers and retirees, but also for state leaders and CalPERS officials. The reprieve, however, may prove temporary.

Notwithstanding the decisions in favor of CalPERS in these specific cases, Judge Christopher Klein made a landmark ruling as part of the Stockton case stating that, as a legal matter, pensions administered through the California Public Employees’ Retirement System could be reduced in a municipal bankruptcy.

The Stockton case has altered the municipal bankruptcy landscape and the strategic calculus for municipalities evaluating a bankruptcy filing. Stockton and San Bernardino filed nearly two and a half years ago and may have been too far along to change direction in light of Judge Klein’s landmark opinion. A municipality now assessing its options, however, sees a different set of choices, and the next one may not decide to let the pension snowball keep rolling.

There are several large California cities where pensions are forecast to grow significantly in the next several years. According to CalPERS, Santa Ana’s contribution to its public safety pension plan will rise from barely 20 percent of payroll in 2010-11 to more than 60 percent of payroll in 2019-20. For all California cities with populations between 200,000 and 500,000, the median safety plan contribution is projected to increase from 23 percent of payroll in 2010-11 to more than 45 percent in 2019-20.

Some municipalities may turn a critical eye to their pension obligations. They need a way to address pension realities while avoiding bankruptcy.

The municipal pension mess stems from the fact that while management and labor in the private sector have an adversarial relationship, local elected officials and employee unions do not. So there is no political check. Almost as important, there is no financial check. Cities are able to enter into contracts with their unions with no objective analysis of future ability to pay. The lack of financial expertise in municipal leadership often compounds this problem.

State and local elected officials, policymakers and CalPERS should create a task force to forge a solution to help municipalities. Here are two proposals:

▪ Establish a protocol for restructuring municipal pensions out of court.

For troubled municipalities, pensions are typically the single largest expense, the most intractable and the most uncontrollable (because CalPERS determines what the municipality will pay each year). If CalPERS decides to change its investment return or mortality assumptions, or its investment performance suffers, the municipality will have to pay more, regardless of its own activities. If a municipality is in dire straits and cannot meet its obligations, an orderly restructuring would likely be superior to a bankruptcy filing.

This could save tens of millions of dollars for the city in fees on lawyers and other advisers. Additionally, plans could be tailored to minimize the impact on vulnerable groups such as the elderly and long-retired pensioners whose pensions were set in the premillennial sane era, something which might not be possible in a bankruptcy case.

▪ Provide uniform budgeting rules and guidance.

Too many municipalities have made promises that jeopardize their long-term fiscal health. While no one wants another bureaucracy meddling in local affairs, the task force could establish certain basic rules such as requiring municipalities to have long-term budget forecasts that clearly show pension expenses and require additional disclosure when a threshold is crossed.

For example, municipalities whose pension expenses exceed 20 percent of total expenditures (the levels at which voters in the non-CalPERS cities of San Jose and San Diego ratified pension amendments) could be forced to explain why the expenditure levels do not threaten the city’s financial stability.

The costs of municipal bankruptcies are borne not just by the creditors who invested in these cities, but also by residents hit with plummeting property values and deteriorating services. California can do more to protect its citizens from these failures. Let’s put systems in place to ensure this dangerous game isn’t played again.

Matthew D. Covington is a managing director with Conway MacKenzie, a financial advisory firm that has worked on municipal bankruptcy matters in California and across the country.