Vallejo, Mired in Pension Debt Again; Lesson for Stockton and Detroit - Shed Those Pension Obligations Now!

When Vallejo entered bankruptcy, it had a golden opportunity to shed pension obligations. When the city failed to do so, I made an easy prediction: Within years, Vallejo would be back in bankruptcy court.

And here we go again: Two years after bankruptcy, California city again mired in pension debt.

Less than two years after exiting bankruptcy, the city of Vallejo, California, is again facing a budget crisis as soaring pension costs, which were left untouched in the bankruptcy reorganization, eat up an ever-growing share of tax revenues.

Vallejo's plight, so soon after bankruptcy, is an object lesson for three U.S. cities going through that process today - Detroit, Stockton and San Bernardino, California - because it shows the importance of dealing with pension obligations as part of a financial restructuring, experts say.

The Vallejo experience may be particularly relevant to Stockton, which is further along in its bankruptcy case than Detroit and San Bernardino and has signaled its intention to leave pension payments intact.

"Any municipal bankruptcy that doesn't restructure pension obligations is going to be a failure because pension obligations are the largest debt a city has," said Karol Denniston, a municipal bankruptcy attorney in San Francisco.

"A city like Vallejo can be reasonably managed but it is still going to be flooded out because it cannot be expected to keep up with its pension obligations."

Vallejo, a port city of 115,000 near San Francisco that was staggered by the closure of a local naval base and the housing market meltdown, filed for Chapter 9 bankruptcy protection in 2008 with an $18 million deficit.

During its three-and-half year bankruptcy, the city slashed costs, including police and firefighter numbers, retiree health benefits, payments to bondholders and other city services.

The only major expense the city did not touch was its payments to the $260 billion California Public Employees Retirement System.

"We realized we did not have the time or the money to take on a giant behemoth like Calpers," said Stephanie Gomes, Vallejo's vice mayor.

When it exited bankruptcy at the beginning of 2011, the payments to Calpers were just over $11 million, or 14 percent of the fund. The latest budget pegs those payments at $15 million, or 18 percent of the general fund.

The increase comes largely from the recent decision by Calpers to lower its projected investment return rate, from 7.75 percent to 7.5 percent, and to change the way it calculates long-term pension maturity dates.

Those changes mean cities, state agencies and counties must pay rate increases of up to 50 percent over the next decade. Vallejo expects an increase in pension contribution rates of 33 to 42 percent over the next five years.

Marc Levinson, of the law firm Orrick, Herrington & Sutcliffe, was the lead attorney for Vallejo in its bankruptcy and has the same role for Stockton. He says his clients would welcome pension reform in California, and he is the first to say that contributions to Calpers are a big problem for cities.

But, Levinson said, dealing with the issue is no simple matter.

"How does a city start a new pension plan when it can't pay its bills?", Levinson said. "How can a city break away from Calpers and still retain employees when other jurisdictions have a pension plan?"

Incompetence or Something else?

Allegedly the city did not want to take on CalPERSs then. Instead, it is going to face another drawn out bankruptcy drama.

Was there really much of anything to take on? I doubt it. The city had free rein in bankruptcy court to do what needed to be done: slash pensions.

As for Levinson's ridiculous question "How does a city start a new pension plan when it can't pay its bills?" ... The city cannot pay its bills precisely because of preposterous pension payments!

The simple solution would be to make sure the plan is fundable at a reasonable discount rate. The yield on 30-year US treasuries seems about right.

Yes, that would be quite a haircut, but so be it. I also propose that the higher the current mandated pension payout, the bigger the cut. That way, some lowly clerk with a small pension would be more protected than city officials, police, and fire workers with high pensions.

Retaining employees would be easy enough. I suggest the city seek a bankruptcy court agreement such that any city employees who quit now would forfeit their pensions (or whatever portion is necessary to make the system solvent).

Ongoing, Vallejo should kill their defined benefit pension plan completely. With millions of people unemployed, I assure Vallejo would be loaded with qualified applications for whatever hires it needed to make (if indeed any).

In retrospect, the vice mayor's statement "we did not have the time or the money to take on a giant behemoth like Calpers" sounds like a bald-faced lie. I suggest the real reason Vallejo did not go after pensions is the city bureaucrats would have cut their own pensions, and they did not want to!

Regardless, Stockton and Detroit have a choice. They can cut pensions now, or cut them later in a second bankruptcy, just like Vallejo will.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com