For the last week, state, county, and local officials across California have kept a curious and watchful eye on Stockton. By the admission of the city manager, the city is teetering on insolvency. Before succumbing to “uncontrolled default,” the city is entering into a mediation process that could take as long as 90 days.
It’s an uncharted process, created under last year’s AB 506, and everyone wants to know what will happen next. But before the next chapter is written, PublicCEO will offer the “Reader’s Digest” version of how Stockton went from a robust and growing city to the first city to under go the neutral mediation prescribed by AB 506.
Previous Year Shortfalls
“The city has leveraged itself with debt that puts the General Fund at risk.”
Every year, Stockton is required to operate on a balanced budget. Despite the efforts of staff and city councils, and perhaps because desperation can lead to desperate measures, mistakes were made. Many of them are just now coming to light.
For instance, the city’s payroll liability wasn’t balanced against actual expenditures between 2005 and 2011. During that time, the city maintained a $315,305 unbalance account due to an inadvertent posted nearly 7 years ago. With that discovery came an adjustment to the current year budget.
Similarly, the city discovered previous variances in its expenses – $186,236 in cash and $96,286 in deposit liabilities.
Those amounts, combined with $500,000 in double counted parking ticket revenues and nearly $2.8 million in aged accounts receivables, created an unexpected reduction to the General Fund’s available balance by nearly $3.8 million.
When the 2010 shortfall was factored into FY2011 spending, the problems began. However, despite some revenues coming in above estimates, expenses eclipsed the budgeted amounts.
The Supreme Court’s Decision upholding AB1 X 26 left the city liable for its redevelopment agency’s debt. That new debt service created a $3.9 million drain on the General Fund. The Development Services fund received a half a million-dollar subsidy from the city and the $650,000 payroll tax liability also contributed to an overall increase of expenses by approximately $5.2 million.
Current Year Shortfalls
“The combined 2010-11 deficit of $6.6 million and projected 2011-12 deficit of $8.7 million have created a $15.2 million shortfall in the General Fund at June 30, 2012.”
With all of the previous year deficits and discrepancies enumerated on the current year General Fund balance, the 2011-12 budget began with an unexpected deficit of $6.5 million.
- The city owes an extra $876,000 to CalPERS.
- The city expects to pay $3.1 million in Redevelopment costs for 2012.
- Revenues will be $825,799 lower than estimated – even after some surpluses are accounted for.
Part of the new costs being added onto the balance sheet is the cost of bankruptcy proceedings, AB 506 mediation, and negotiation with creditors. The city is budgeting $3.5 million for the fiscal year.
Stockton is $15,205,924 in the red.
“We feel we need to take these actions to avoid an uncontrolled insolvency or default.”
City Manager Bob Deis recommended the city balance its budget for the current year by borrowing $15 million from a variety of internal funds.
In many cases, the downside of borrowing is that the General Fund will become the future contingency fund for programs. According to the staff report, the steps were necessary to “avoid an uncontrolled insolvency or default. We still have four months left in the fiscal year and have no reserves.”
On the chopping block are:
- Library $720,995 for infrastructure improvements,
- Measure W Sales Tax – $1.232 million,
- 400 E. Main City Hall – $2.51 million for not moving city hall location,
- Entertainment Venues – $570,000,
- General Capital Fund – $798,309 in cancelled or postponed projects,
- Fleet Fund – $2.3 million in reduced capital for fleet replacement,
- Retirement – $3.7 million in reduced liquidity,
- Arts Endowment – $1.3 million endowment would be taken back by the city, leaving the general fund directly contributing $50,000 per year for grant appropriations, and
- Debt Service – $2 million in cancelled debt service payments.
Should the city decide to cancel its $2 million internal debt service, credit rating companies would downgrade the city’s credit rating. In fact, on Friday of last week, after announcing the potential bankruptcy and cancellation of debt services, Moody’s degraded the city’s rating into junk status – Ba2. It would “constitute an Event of Default on the part of the City,” according to the City Manager’s report on the potential bankruptcy.
Pensions and Employee Costs
“We now have the tail end of a legal but mismanaged program that feels similar to a “Ponzi Scheme.”
Stockton faces increasing pension and healthcare costs for retirees. After the City made unsustainable promises to employees in the 1990s, City Manager Deis says that the city has been operating the legal manifestation of a “Ponzi scheme.” The employee-to-retiree ratio is upside down, with 1,424 employees providing funding for 2,400 retirees and their health and pension benefits. The system is underfunded by $34.8 million, a number that would have been $120 million higher if it weren’t for decisions made by the Council last year.
Compounding the problem, the cost of the city’s pension system is increasing. Public Safety employees’ PERS rate increased to 31.79 percent while the rate paid for non-safety employees decreased slightly. However, a recent recommendation that CalPERS lower its assumed rate of return on investments by a quarter percent would increase the cost for both employees – Public Safety to 40% and miscellaneous to 22%.
Potential Solutions to Long Term Issues
“Whatever services we do continue to provide, we must provide them in a quality way.”
In the last several years, Stockton has laid much of the heavy burden of balancing its budget on its employees. Many have already seen their compensation reduced 12 to 23 percent. The total number of employees has been slashed due to a combination of layoffs and reductions. Should the City try to balance its budget via additional cuts to compensation, the city’s wages would fall below market value – leading to an exodus of talent or a compromise in the quality of services provided.
Cutting services would deeply affect the size and strength of the city’s Public Safety services, which account for 77 percent of all general fund expenditures. However, cutting enough from their budgets would mean reducing police and fire services by 15 percent. Such cuts would save $20 million, but would reduce the number of sworn police officers by 64 and would eliminate the entire community service staff. The fire department would lose 1 fire engine, reduce firefighter staffing on every truck, and layoff 41 sworn fire positions.
The city could seek new revenues, but in the opinion of Deis, it is unlikely that voters in a city with 20 percent unemployment and a mismanaged financial house would approve of new sales or parcel taxes. Even if they did approve of a quarter percent sales tax, it would only raise $9 million per year – not nearly enough to balance out-year deficits, which are estimated to reach as high as $38 million per year.
Other Potential Pitfalls
“The City cannot continue to balance budgets without dealing with other issues driving our unsustainable fiscal environment.”
Not all of the savings in recent years have come voluntarily. The Stockton Police Officers’ Association and the Stockton Public Employee Association both had contracts and cuts imposed on them during a declared fiscal emergency. Those savings, which have been in place for the past year, are being challenged in court. Should they succeed in overturning the imposed contracts, the city will be liable for $11 million in back wages, as well as legal fees. Those savings were not only necessary for balancing the budget in the previous year, but will be required again in the current year.