A federal bankruptcy judge, looking at several options, could rule in the Stockton bankruptcy that pensions can be cut, possibly clarifying whether CalPERS has special protection as an arm of state government.
A judge in the Detroit bankruptcy has already ruled that pensions can be cut like any other contract debt. Ballots mailed to Detroit employees, retirees and bondholders last week would approve negotiated cuts or, if rejected, risk having deeper cuts imposed.
In a filing this month backing a retiree appeal of Detroit’s eligibility for bankruptcy, CalPERS argued that, unlike the city-run Detroit pension system, its an “arm of the state” operating under state laws protected in municipal bankruptcies.
The CalPERS filing said the court ruling in the Detroit bankruptcy nullifies part of the federal bankruptcy law, section 903, that “expressly preserves a state’s laws governing its creatures not withstanding the filing of a chapter 9 (bankruptcy) petition.”
U.S. Bankruptcy Judge Christopher Klein said last week during a four-day trial on the Stockton plan to exit bankruptcy, continued until June 4, that the pension issue is a “festering sore” for California.
“It’s conceivable I could conclude that (Stockton’s) CalPERS contract could be impaired and the (financial reorganization) plan not be confirmed,” Klein said, according to a report in the Stockton Record newspaper.
“Or I might conclude the CalPERS contract can be impaired, but in this case the decision (by the city) not to do so made sense. Or I could decide CalPERS can’t be impaired because of California law. That’s what’s going on in my brain. This is an opportunity to get to the bottom of it.”
Stockton was forced into a rare exit-plan trial when talks under a court-appointed mediator led to debt-cutting agreements with all major creditors except two Franklin bond funds, who say they would only get $350,000 for a bond debt now worth $37 million.
A turnaround consultant hired by Franklin suggested in a report filed in March that Stockton could fall back into insolvency if the city’s largest debt, “unsustainably high” pension costs, are not reduced in bankruptcy.
Klein said before the trial he wanted to be sure that Stockton would not face a second bankruptcy if growing pension costs are not addressed. He mentioned reports that Vallejo has budget problems after emerging from bankruptcy without touching pensions.
A Wall Street credit-rating agency, Moody’s, said in February that without pension relief Vallejo and the two California cities currently in bankruptcy, Stockton and San Bernardino, are at risk of returning to insolvency.
Vallejo officials said they considered trying to cut pension debt, but did not after CalPERS threatened a costly legal battle. The Stockton plan does not cut pensions, saying they are needed to be competitive in the job market, particularly for police.
The employee share of cuts in the exit plan is staff and pay cuts, lower pensions for new hires under a statewide reform and the elimination of retiree health care, a $544 million long-term debt replaced by a one-time payment of $5 million.
Judge Klein upheld Stockton’s immediate cut in retiree health care after filing for bankruptcy in June 2012, noting that the result may be “tragic hardships for individuals” before claims are addressed in an exit plan.
The judge’s retiree health care ruling cited a part of the federal bankruptcy law, section 904, that prevents the court from interfering with the “governmental powers” and “property or revenues” of the debtor.
In his opening remarks last week, the attorney for Franklin, James Johnston, said the evidence will show that Stockton can pay Franklin even “after paying in full its largest unfunded liability,” pensions expected to take 18.5 percent of the budget by 2019.
Johnston said the Stockton plan has a 15 percent budget reserve, a $2 million contingency fund and available public facility fees. He said the Franklin loan collateral, two golf courses and a park, is worth $15 million not the low value assigned by the city.
Not mentioning Vallejo, the Franklin attorney said the turnaround expert, Charles Moore, would show that the Stockton exit plan to pay pension debt in full is not consistent with the minimal payment of the Franklin debt.
“It’s not a feasibility issue but a fundamental issue of consistency,” Johnston told the court.
Late in the second day of the trial, the judge said he had some questions for the California Public Employees Retirement System. “If I just rubber-stamp plans, I might as well just be a potted plant,” Klein said, the Record reported.
David Lamoureux, CalPERS deputy chief actuary, who had given a deposition but was not scheduled to testify, told the court on the third day about basic CalPERS operations, including how pensions can be cut outside of bankruptcy.
If a CalPERS contract with a local government is terminated, CalPERS calculates the debt or “unfunded liability” that must be paid to cover the pensions promised plan members in the future.
After the payment, CalPERS becomes responsible for the pension debt and cannot get more money from the local government employer if funds fall short as pensions are paid during the life spans of the plan members.
So CalPERS uses a low investment earnings forecast to discount the future debt of terminated plans, 2.98 percent rather than the usual 7.5 percent. If the two Stockton plans were terminated now, CalPERS would ask the city to pay about $1.6 billion.
If a city cannot pay all of the debt owed for a terminated plan, the CalPERS board has the power to evenly cut pensions to an amount that would be covered by what the city was able to pay.
But after the payment has been made and responsibility for the plan shifts from the city to CalPERS, if the terminated pool falls short the funds of all of the state and local government plans in the system could be used to cover the shortfall.
The terminated pool is financially healthy as of June 30, 2012, with members from about 90 small plans and $178 million in assets to cover $84 million in future pension obligations.
Lamoureux said there are two ways a CalPERS plan can be terminated: at the request of the government employer, which takes effect a year later, or by action of CalPERS if plans do not make their required contributions, effective 60 days later.
San Bernardino did not make CalPERS payments for a year, owing $17 million before resuming payments last July. Skipped payments by a big plan may be one reason CalPERS lowered its discount rate for terminated plans from 4.82 percent to 2.98 percent.
Last week CalPERS agreed to delay an August hearing on its appeal of San Bernardino’s eligibility for bankruptcy, saying in a joint filing with the city that the delay is “critical to the success of the ongoing mediation,” the San Bernardino Sun reported.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 19 May 14