Californias taxpayers should have been rooting for the bankrupt city of San Bernardino as it wrestled with the California Public Employees Retirement System (CalPERS) over the repayment of $13.5 million in debt, plus interest. Unfortunately, San Bernardino last week surrendered as the two sides announced the outline of a deal. Though the details have yet to be released—theyre subject to a court-imposed gag order—it appears that the city will leave its pension plan untouched. That doesnt bode well for municipal financial solvency in the Golden State.
In 2012, San Bernardino, an inland Southern California city located about 60 miles east of Los Angeles, filed for Chapter 9 bankruptcy protection. It was merely the latest in a string of California municipalities to succumb to insolvency in recent years. The San Francisco Bay Area city of Vallejo filed for bankruptcy in 2008, emerging in 2011. Stockton, in the northern edge of the San Joaquin Valley, remains the largest California city to enter bankruptcy so far, preceding San Bernardino into Chapter 9 by a few months. That citys plan awaits final approval from the court after a contentious legal battle with bondholders.
San Bernardino tried something different. City officials decided to stop payments to CalPERS, arguing in effect that the nations largest pension fund should be treated like any other creditor. Neither Vallejo nor Stockton officials wanted to fight CalPERS, which commands vast legal resources. Both cities devised bankruptcy plans that slashed public services, raised taxes, and left pensions untouched. CalPERS responded with a lawsuit challenging San Bernardinos bankruptcy filing, claiming the city didnt need to go bankrupt even as CalPERS supported bankruptcy in Vallejo and Stockton. Last year, tired of fighting, San Bernardino agreed to resume payments to CalPERS, but claimed it could not afford to make the back payments from its year-long hiatus.
Now the city has reached a deal to begin making the back payments. As Ed Mendel of the website Calpensions explained, San Bernardino has not publicly proposed a pension cut. A sketchy plan for operating in bankruptcy only proposed a fresh start that would reamortize CalPERS liability over 30 years, perhaps cutting costs $1.3 million in the first year. After a federal judge ruled that Detroit may abrogate its pensions in bankruptcy (because federal bankruptcy law trumps state law), CalPERS argued in an amicus brief that Congress did not envision that Chapter 9 would become a haven for municipalities that seek to ignore and break state laws and constitutional provisions in order to adjust their debts. In other words, nothing—not even bankruptcy—absolves cities or their taxpaying residents of these promises.
Leaving pensions untouched will have consequences both foreseeable and unintended. Recent news reports, for example, suggest that Stockton and Vallejo are already facing new financial problems because their pension debt remains out of control. For nominally solvent cities, state courts have consistently upheld the California Rule, which holds that once a city council grants a pension increase—even one based on absurdly optimistic or dishonest promises—the full pension must be paid. It cannot be altered, even on a go-forward basis. That leaves very few options for San Bernardino and other cities that are sprinting toward service insolvency—when a city can pay its employees but doesnt have much left over to provide services.
Some California cities, such as San Jose, argued that their charters allow for reducing pensions going forward. San Joses voters in 2012 overwhelmingly approved reforms that would have let the city offer employees a lower-benefit plan. But a court voided that part of the initiative. Meantime, CalPERS has been significantly raising its contribution rates on municipalities that participate in its plan—thus leading to further cutbacks and problems. As Mendel notes, CalPERS lowered the earnings forecast for terminated plans from 4.82 percent a year to 2.98 percent, sharply increasing the debt that must be paid if employers leave the system. When taxpayers are on the hook for the pension payments, CalPERS optimistically predicts a 7.5 percent rate of return. When its own money is at stake, the pension fund assumes a much lower rate.
In the wake of last weeks tentative deal with CalPERS, San Bernardino now is trying to tackle outlandish pay contracts with its police and firefighters unions. The firefighters have been particularly stubborn. The city said that to exit bankruptcy it must terminate a union contract that pays an average annual salary of $190,000 to each of its top 40 firefighters, Bloomberg reports. The next tiers of firefighters earn in pay alone an average of $166,000 and $130,000. And people wonder why these union-controlled California cities are going bankrupt? Yet its not clear that San Bernardino can end these contracts. The firefighters union claims that these salary scales are untouchable because the citys charter mandates that public-safety workers compensation align with such compensation in similarly sized cities, even though most of those cities have broader tax bases and higher average incomes than working-class San Bernardino.
So everyone is protected with special legal limitations—except for taxpayers. And no Democrat in the state capitol is talking about ways to keep these cities from acting as a gravy train for public servants who are paid far above market wages. Spunky San Bernardino at least tried to take on its biggest problem. Apparently, it failed. That leaves few options for other California cities facing similar crises in the years ahead.