After Stockton, economist sees more pain in California and beyond

A California court’s approval last week of the city of Stockton’s bankruptcy protection sets up a battle between Wall Street investors and the state’s pension giant, CalPERS, over whether pensions of municipal workers must share the pain.

Stockton, California’s 13th largest city, has so far not planned on reducing pension contributions, which CalPERS argues is barred by state law.

But bond insurers and investors such as the Franklin California High Yield Municipal Fund, who will be forced to take a haircut, argue that federal bankruptcy laws trump state laws and that CalPERS and city employees must share in the plan to resolve Stockton’s debts.

How much protection the law affords pensioners remains to be seen as the case advances through the court system. But for a broader look at the municipal finance crisis affecting California and the nation, AdvisorOne spoke with Bill Watkins, below right, a veteran economic forecaster specializing in the U.S., California and Oregon economies, and executive director of the Center for Economic Research and Forecasting (CERF). The institution is based at California Lutheran University in Thousand Oaks, Calif.

AdvisorOne: What has caused Stockton’s crisis?

Watkins: The proximate cause was the crash of the housing market and fall-off of revenue. That was preceded by aggressive spending by the city and the pension problems that most cities across California face.

Are pension payouts indeed contractual and unalterable?

It looks like CalPERS won the first round. [Editor’s note: The federal bankruptcy judge ruled a decision on that matter would come at a later phase of the city’s bankruptcy administration.]

I’d expect the other creditors to push for having CalPERS take a share in the loss. You’d have to talk with a bankruptcy lawyer, but it seems there are all sorts of contracts that are annulled in bankruptcy court.

On what have Stockton and cities like it spent aggressively?

You can’t be elected to be a city councilman without the support of police and fire. Police and fire [crews] often have attractive contracts.

What other California municipalities are vulnerable to bankruptcy?

San Bernardino, of course. Fresno is also a possibility. A year ago, even Los Angeles city officials were talking about bankruptcy but stopped doing so before last month’s municipal elections.

Every major city in California has challenges, partly because of pensions, and partly because ever since Prop 13 when the state took over redistributing property tax revenues, the state has managed to shove a large part of that to local governments — cities, counties and special districts.

Local governments have seen the biggest decrease in government employees, and this is where most government services are actually delivered.

Are there any positives for California’s economy?