On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:
Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.
The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.
While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.
After Rhode Island enacted this law, the Wall Street Journal explained:
Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.
“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.
The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors. Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:
“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?
“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.
While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.