Econintersect: Stockton, California has become the largest U.S. city to gain court permission to file for bankruptcy. A U.S. Bankruptcy court ruling permits Stockton to proceed with it’s Chapter 9 filing from last June (see GEI News) after creditors had filed protests.
The case may prove to be a decisive test for the extent and limits of U.S. bankruptcy laws. The city of about 296,000 will have their bankruptcy case see a face-off between the state pension system and other creditors. Some of the other creditors argued that a bankruptcy filing was not needed; that the city could make payments without such a step.
A major legal issue involved in this case is whether the U.S. Bankruptcy Code, which forces pension funds to share in settlement losses with other creditors outranks California state law that states pension fund obligations must be paid.
Generally federal law takes precedence over state law in case of direct conflict. However, the 10th Amendment will be the crux of the case here. That states that powers not expressly granted to the federal government by the constitution are reserved to the states or to the people. Pensions are not mentioned in the U.S. Constitution so legal arguments will focus on whether the commerce clause or some other constitutional provision applies. Since the commerce clause clearly excludes intrastate commerce and CalPERS is a pension plan operating solely within the state of California, the superior position of federal bankruptcy law may be challenged.
U.S. Bankruptcy Judge Christopher Klein said ( from AP):
“I don’t know whether spiked pensions can be reeled back in. There are very complex and difficult questions of law that I can see out there on the horizon. It’s apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety as well as other basic government services without the ability to have the muscle of the contract-impairing power of federal bankruptcy law.”
Stockton has pared public services and number of employees drastically in an effort to make up for a huge loss in property tax revenue that accompanied the collapse of the housing bubble. According to the AP the city is now experiencing one of the highest crime rates in the country.
The city’s biggest individual debts are $165 million to bond holders that funded 2007 CalPers (California Public Employees Retirement System) payments and $900 million the city still owes to CalPERS today. The city has many smaller claimants because the city has foregone payments for goods and services in order to maximize payments to CalPERS to the extent possible with available revenues.
The question then arises: Could a bankruptcy settlement require a claw-back from CalPERS to reduce their payments received to an equitable position with other creditors? This may be part of the situation(s) Judge Klein referred to when he talked of pensions being “reeled back“.
A late breaking story from Bloomberg says that Stockton may seek to increase sales taxes in order to hire 100 more policemen to combat the soaring crime rate. The tax would increase by 0.5% to 8.75% and raise about $18 million per year. The added tax revenue would be outside of the bankruptcy deliberations if implemented using a restricted account approved by 2/3 of the voters.
Sources:
- Judge rules Stockton, Calif., to enter bankruptcy (Tracie Cone, Associated Press, Yahoo, 01 April 2013)
- Stockton California: Belly Up (GEI News, 28 June 2012)
- Municipality Bankruptcy (Chapter 9, U.S. Bankruptcy Code, United States Courts website)
- Bankrupt Stockton May Seek Higher Taxes to Combat Crime (Alison Vekshin, Bloomberg, 01 April 2013)
