San Francisco’s public-sector unions have been gloating following last month’s defeat of Proposition B, which would have required city employees to boost contributions to their generous pension and health-care benefits. The unions’ multimillion-dollar campaign—featuring a TV ad with a mother (presumably a city worker) unable to pay for her son’s medical visit—defeated the initiative by a solid 57 percent to 43 percent margin. But Prop. B’s sponsor, Public Defender Jeff Adachi, is in a stronger position than ever, thanks to another bout of bad news for the city’s economy.

On November 17, Moody’s Investors Service downgraded the city and county of San Francisco’s general obligation bonds, from Aa1 to Aa2. It’s not a dramatic change, but the downgrading will increase the city’s borrowing costs. It reminds us that the benefit-related debt problem isn’t going away just because the city’s political establishment and voters would like it to. Moody’s was clear that the failure of Prop. B was one of the key factors in its decision. Pointing to San Francisco’s remaining FY 2012 budget gap of $394 million, Moody’s wrote: “There are no indications that there is the political will or practical ability to bridge this still very large gap in a structurally sound manner. In fact, in the recent election voters defeated Proposition B which would have required city employees to contribute more towards their pension and health care benefits. While the city did not count on these revenues for the current year budget, it appears clear that there is no political pressure to cut programs and services in order to achieve structural balance.”

Prop. B’s passage would have brought in $120 million per year to the city, which would have gone a long way toward closing the deficit chasm—and sent a message to the investment community that San Francisco and its voters have the will to do what nine other municipalities across California did on Election Day: begin to control benefit costs that are draining municipal budgets. In San Francisco, Adachi warns that unless something is done, fiscal calamity looms, given the city’s massive budget deficit and the expectation that pension and other benefit costs will grow by $130 million in the coming year. Adachi echoes a San Francisco grand jury report from earlier this year warning that pension and health-care costs will soar from $413 million to more than $1 billion in the next five years.

“It will cost the city millions of dollars more to borrow,” Adachi tells me during an interview in his office. “We’re beyond little fixes—the only places to go are mass layoffs and increased fines.” Adachi, a well-known Democrat with possible mayoral ambitions, made the progressive case for pension and health-care reform. Without reform, he warned the city’s mostly left-leaning residents, the government programs they truly care about—such as after-school programs and parks—will be slashed in order to fund often six-figure pensions for retired employees, many of whom stop working in their early fifties.

“It’s not that government shouldn’t honor its promises,” he points out, “but it must be honest with constituents.” Adachi also pointed to the intentionally misleading numbers that government unions have sometimes used to justify pension expansions. It’s unfair, he believes, that pension benefits are considered binding contracts, unreformable even when the actuarial data promoted by supporters to get the contracts approved is faulty or dishonest. Often, unions and sympathetic politicians advance retroactive pension increases while promising that the increases will pay for themselves through increased investment income. The true numbers always come to light, but by then it’s too late to do anything about it. The courts have ruled that new benefit levels can’t be touched.

“We took an issue that’s a complicated one and brought it into the public debate and dialogue,” Adachi says. “110,000 people voted yes. They got it. We have to continue our work.” He was disappointed by the level of opposition to the initiative from the city’s establishment and by the institutional bias against his efforts. City election officials crafted the ballot question in a way that made it seem as if its passage would cost taxpayers more money, he contends. Anti-Proposition B signs were placed throughout San Francisco on city property, even on the City Hall lawn, and calls to remove them went unheeded. As the city’s problems worsen, however, there may be more public will for change.

Adachi was criticized for bundling pension and health-care reform in one package, thus complicating the message. Defending his approach, Adachi notes that health-care costs make up 55 percent of the city’s benefit problem. Unions portrayed the Prop. B initiative, he adds, “as a conservative way to screw working families out of their money, but what about the other 94 percent of working families who are not city employees?” Believing that change can still be best achieved from outside City Hall, he has vowed to launch another similar initiative. Though he offers few details at this point, he promises that this time he’ll focus more intensely on what the lack of reform means to the rest of the city’s residents.

Certainly, it’s hard to make a case for pension reform in a liberal city like San Francisco, even though the progressive case for reform is actually compelling. The unions knew that if pension reform passed in San Francisco, it would become inevitable in less liberal places—that is, just about everywhere else. Regardless, the numbers dictate that something soon must be done. San Francisco Chronicle columnist C. W. Nevius reports that in the wake of the Moody’s downgrade, even Adachi’s most bitter union opponents have expressed a newfound willingness to discuss reform. But it’s easy to be skeptical that union officials will offer anything approaching real change, given their resistance to Prop. B’s modest contribution increases.

“Ultimately, we will be vindicated,” Adachi says. But how bad will things have to get in San Francisco before such vindication comes?

Steven Greenhut is director of the Pacific Research Institute’s www.calwatchdog.com journalism center, author of Plunder! How Public Employee Unions Are Raiding Treasuries, Controlling Our Lives And Bankrupting The Nation, and a columnist for the Orange County Register.