Originally posted at CSAC Bulletin.
Surely you’ve heard the saying “when the state sneezes, local governments catch a cold.” When it comes to municipal bankruptcies, cities and counties across the country may begin to experience flu-like symptoms as federal judges in California and Michigan begin to chart the courses of three high-profile city bankruptcies in Stockton, San Bernardino, and Detroit.
This week, a federal judge declared the long-beleaguered city of Detroit eligible for Chapter 9 federal bankruptcy, making it the largest municipal bankruptcy in the nation with a debt load of $18 billion, of which about $3.5 billion is unfunded pension obligations. Notably, the judge’s ruling included an explicit statement that Michigan’s constitutional protections for public pensions “do not apply to the federal bankruptcy court” and added that pensions are not entitled to “any extraordinary attention” compared with other debts. While the ruling did assert that the court “would not lightly or casually exercise the power to impair pensions,” the potential to do so could profoundly impact local governments and local government employees across the country.
Closer to home, the ongoing legal battles between the city of San Bernardino and the California Public Employees Retirement System (CalPERS) highlight the tensions between an insolvent municipality and its pension commitments. San Bernardino owes CalPERS about $14 million in back payments for its pension costs and is asking for an opportunity to renegotiate its ongoing pension obligations. In response, CalPERS has vigorously fought back, challenging the city’s eligibility for Chapter 9 and pledging to continue its legal fight to ensure that San Bernardino foots the bill for its retirees.
CalPERS asserts that the Detroit ruling does not have the same effect on a statewide entity and believes that employees’ and pensioners’ rights are explicitly protected by the California Constitution. (Stockton has continued its payments to CalPERS and has not asked to restructure its pension obligations during its Chapter 9 proceedings.)
Also this week, the bond rating agency Fitch reported that they expect local governments nationally to continue to experience fiscal pressures into 2014 and noted that pending bankruptcy cases may set precedents that influence what has been a hallmark of the municipal bond market – the willingness to repay debt. Morgan Stanley has predicted negative returns for municipal bonds in 2014, as well. Such a drop would be historic; local agency debt has followed a year of losses with gains every year since Bank of America began keeping data (1989).
It’s clear that, while cities and counties across the country continue to grapple with the erratic economic recovery, we are unlikely to see a return to “business as usual” with regards to the fiscal environment in which government conducts its business. It could be a long flu, as adjusting to this “new normal” will continue over a much longer period and will likely be influenced by judges, lawmakers, voters, and by Wall Street.