Stockton, California tries to avoid bankruptcy via mediation

Stockton, California could become the largest city to declare bankruptcy in the US. On Tuesday the city council voted to skip $2 million in payments on $320 million in bonds. The bond insurer has promised to pay creditors in the event that the city cannot.

Now Stockton is in mediation. A new process, mediation is the result of AB 506, the intent of which is to slow bankruptcy proceedings by requiring all affected parties (debtors, creditors, unions) to meet and hammer out deals with a neutral party.

According to The Los Angeles Times, the city council is working on a restructuring plan. Since 2010 the city has twice declared a fiscal emergency. Pressure on city finances from rising health care benefits and debt associated with development projects have coincided with a period of depressed revenues and weak economic activity. Stockton has the second-highest foreclosure rate and eighth highest unemployment rate in the nation, reports Bloomberg News.

How the city reorganizes its finances is surely to be driven by the politics of unions and pension reform. The city faces a $417 million unfunded liability for employee health care benefits. How could that be allowed to happen? As a local city official tells The San Francisco Gate: “The problem is, nobody asked the question: ‘How do you fund it?’ And consequently there was no money set aside to fund those commitments,” Deis said. “It was an unsound decision and it has similarities to a Ponzi scheme.” Unfortunately, Stockton is not unique in this regard. Nearly all public sector health care benefits in state and local governments are unfunded.

In addition to its retiree health care costs, Stockton is paying 94 retired police pensions of $100,000 per year. As already accrued benefits, it’s not clear that the city has much room to modify this portion of the budget. And in fact, the police union is suing the city for reducing benefits. Another lesson in the importance of clear-eyed budgeting comes from Stockton’s troubles. Officials were caught off guard by the city’s sudden shortfall in part due to accounting gimmickry which included double-counting parking ticket revenues and overstating the city’s balance by $2.8 million.