So the largest city so far in America has declared bankruptcy this week:
Bloomberg had an interesting analysis of the situation, which blames the bankruptcy on several major factors:
The best overview of Stockton’s troubles comes from California Common Sense, a think tank that identifies the factors that combined to drive the city into bankruptcy:
First, Stockton had a huge property bubble, with median home prices rising 200 percent between 2000 and 2006. This flooded the city’s coffers with property tax revenues. Assuming the trend would continue, officials signed employee contracts that proved unaffordable. The city even agreed to a “heads you win, tails we lose” pay structure tied to the city’s tax receipts: In strong revenue years, workers got 7 percent raises, but even if revenues declined, they got 2.5 percent raises.
Then Stockton had a huge property bust. The median home price in Stockton fell 70 percent from 2006 to 2009 (i.e., back to 2000 levels). In many states, municipalities raise property tax rates when values fall; that’s illegal in California, so plummeting home prices meant plummeting tax receipts. But even as tax receipts were falling, compensation costs per employee continued to rise; in recent years, the city sharply cut headcount, but still could not close its budget deficits.
Making matters worse, says the think tank, in 2007 Stockton issued $125 million in pension obligation bonds. As in other jurisdictions that tried to “fix” their pension problems with bonds in the last decade (see Woonsocket, Rhode Island), this backfired: The assets Stockton bought with the bond proceeds declined in value, and the city is stuck with both a pension liability and a bond liability. And that pension liability has been a major driver of the city’s insolvency.
The part about trying to sell bonds to cover pension costs is particularly important:
California also needs to give municipalities more flexibility to adjust employee benefits, so that places like Stockton do not have to resort to bankruptcy to get compensation costs under control. Public employee unions have excessive political power in the state, which could be curbed by abolishing collective bargaining in the public sector. And the state must reform pensions so that costs are predictable and municipalities do not get into pension bidding wars that leave taxpayers saddled with costs for decades to come.
And a national lesson: Nobody, anywhere, should ever issue pension obligation bonds! Let’s think for a moment about what these really are. They are commonly described as a way of exchanging a pension liability for a bond liability. But really, when a city issues pension obligation bonds, it gets a bond liability and keeps its pension liability -- plus it gains an asset that offsets the bond liability. Typically, the jurisdiction invests the bond proceeds in an equity-heavy portfolio, which may lose value, but the bond liability remains fixed