One Canary, Two Canary …

Will Stockton Be the Biggest Municipal Bankruptcy Ever?

I mentioned yesterday, that Stockton is the biggest municipal bankruptcy in US history. I had my cart slightly ahead of my horse. They haven’t filed bankruptcy. Yet.

In recent years this inland port city of nearly 300,000 people has earned several distinctions, none of them good. Twice atop Forbes‘ list of America’s Most Miserable Cities … Second highest violent-crime rate in California … Second highest home-foreclosure rate of all major U.S. metro areas. Now, Stockton is on the verge of another dubious benchmark: bankruptcy. In its third straight year of fiscal emergency, the city faces a deficit of as high as $38 million on its $165 million general fund budget. As required by state law, the city council is in mediation with creditors and unions. If a deal is not reached in the coming weeks — and prospects are bleak — Stockton will become the largest municipality in U.S. history to go bust.

While Stockton has been down on its luck for a long time, many residents insist its fiscal crisis is a function of bad management during the flush years of the housing boom. Long an agricultural hub for Central Valley farms and situated about 80 miles (130 km) east of San Francisco, it went through a steady financial decline that saw its once thriving downtown hollowed out by poverty and crime. Scores of people decamped for the north of the city, or left altogether. Street gangs multiplied. Then, in the early 2000s, the housing boom drew developers back to the region in droves. Plush subdivisions went up overnight to attract families with easy credit who could not afford the Bay Area.

Prior to the housing boom, reckless spending on public-employee contracts put the city’s long-term health at risk, according to active city officials. As coffers started to fill up from the swelling tax base, the sweetheart deals got sweeter. If an employee worked for one month, for instance, they and their spouses were eligible for retiree health care for life, a policy that had the predictable effect of motivating people to quit working early. Today Stockton has 94 retirees with pensions of at least $100,000 a year, Reuters reported, amounting to twice the number of California towns its size. The city’s long-term health liabilities alone amount to more than $400 million.

Meanwhile, Stockton’s urban core was given a face-lift to seduce homeowners. Tens of millions of dollars were poured into building a marquee waterfront area comparable to San Antonio’s river walk, complete with a gleaming sports arena, theater complex, marina and walkway. A celebrity chef was invited to run a restaurant, rent free, on the first floor of the historic Stockton Hotel. When it came time to open, the city paid singer Neil Diamond $1 million to headline a kickoff concert. “Then,” says longtime resident Robert Weaver, 76, “the whole thing ground to a standstill.”

The housing bubble burst, followed by the Great Recession. City revenue streams dried up (plunging more than $50 million compared with prerecession years), slashing municipal services across the board, from public parking to bike police. The downtown quickly reverted to a no-man’s-land: waterfront entertainments were shuttered, the grand hotels given over to low-income and student housing. A fancy high-rise municipal complex that officials had paid $35 million for is now being rented out, leaving the city council to debate its woes in their old building, where a red, white and blue banner out front reads with fitting irony: “Stockton: An All America City.”

“Stockton did something very similar to what many American families did: the city overcommitted to long-term obligations that even under the best of times the city could not afford,” says Bob Deis, the city manager since mid-2010. “So if there was not a recession, the city would have been having the conversation we’re having in four or five years. But then the perfect storm happened.”

Nobody Asked.

“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.”

In the 2000s, as housing prices soared in San Francisco and Silicon Valley, buyers from San Jose to Oakland seeking affordable alternatives flocked to Stockton, where starter homes cost around $400,000. Single-family home construction, which had averaged 2,500 units a year from 1991 to 1997, tripled to 7,500 annually from 2003 to 2005, according to Robert Denk, senior economist at the Washington-based National Association of Home Builders.

The city’s population grew 20 percent in a decade, to 291,707 in 2010 from 243,771 in 2000, driven by a surge in Hispanics who identify themselves as Mexican, according to U.S. Census Bureau data. That ethnic group jumped 56 percent in the period, to 104,172 from 66,900, while the black population grew 30 percent and the Asian population rose 29 percent, Census figures show.

Boom Time.

“Money was just pouring into the city coffers for development fees and permits,” Miller said. “Property taxes were going through the roof. It was boom-time.”

“There was an unspoken policy that to keep the unions from complaining about the amount of money being spent on projects, the easiest way to do that was to continue sweetening their compensation packages,” Miller said.

Among those measures were automatic salary increases regardless of whether the city had the revenue to support them. The contract with the fire union required the city to compare its pay with that of 16 cities including Huntington Beach, Anaheim and Torrance. Stockton firefighters’ salaries were required to rank fifth-highest, according to the city’s May 2011 emergency declaration document.

$100,000 Pensions.

Stockton retirees also fared well. The 94 with pensions of more than $100,000 compares with 38 in Bakersfield, which has 347,000 residents, and 35 in Chula Vista, with a population of 244,000, according to data compiled from state pension records by the California Foundation for Fiscal Responsibility, a Citrus Heights-based group that advocates pension reform.

An epidemic of foreclosures reached Stockton in 2007, as the recession left thousands of homeowners unable to afford their mortgages. Home construction collapsed and housing prices plummeted.

Revenue dwindled to an estimated $161.8 million in fiscal 2012 from $203.1 million in fiscal 2009. The city fired 25 percent of its workforce.

In Stockton’s San Joaquin County, assessed property values tumbled almost 11 percent in fiscal 2010, followed by 3.9 percent in 2011 and 4 percent in the current year, according to the county’s website.

Drastic Decisions.

“In the beginning, when this whole economic bubble burst, everyone had the attitude, ‘We’ll just avoid making drastic decisions and in a year or two things will be back to normal,’” Miller said.

The base pay for a Stockton police officer can be as much as $76,860, while a sergeant’s can reach $90,836, according to data provided by the city. In 2010, 87 percent of police officers got additional pay that added 8.7 percent for a canine handler, 4.3 percent for SWAT and 5 percent in “longevity pay” at six years of service. All are included in the calculation of retirement benefits.

“We are now the fifth-lowest paid police organization in the county where we handle the majority of the calls,” said Kathryn Nance, a Stockton Police Officers’ Association board member.

By 2009, city officials began considering bankruptcy.

Bankruptcy Protection.

Fritchen, the council member, asked the city attorney’s office to lay out the pros and cons of bankruptcy protection at a budget committee meeting.

A year later, in May 2010, the city declared a fiscal emergency to deal with a $23 million deficit. The declaration allowed the city to make changes to existing labor contracts.

Crime escalated as the police force was reduced by about 27 percent to 324 sworn officers from 441, according to Pete Smith, a police spokesman. There were a record 58 homicides last year, most involving gang violence, Smith said.

“We’re losing our grip on some of the more troubled neighborhoods and don’t have the ability to police the city as proactively as we did,” Smith said.

In the spring of 2011, Deis met with about 15 police employees and budget officials to seek concessions from the union.

Breaking Our Contract.

“He said if we continue to fight on them breaking our contract, then he is going to push the reset button and go bankrupt and we will all lose,” said Steve Leonesio, president of the police union. The union is suing the city, challenging its authority to reduce benefits under the emergency declaration.

Last year, city officials uncovered bookkeeping errors requiring $15 million in budget cuts that “will have the effect of stripping Stockton’s cupboards bare,” Deis said.

The mistakes included double-counting of $500,000 in parking-ticket revenues and overstating the city’s available balance by an estimated $2.8 million.

On Feb. 24, Deis walked into a news conference at City Hall and announced that the errors and the recession represent “the knockout blow” for the city’s finances. He recommended the city invoke the state bankruptcy law.

“We see no viable alternative,” he said.

Given the city’s huge obligations and shrinking capacity to generate revenue, Deis says it’s critical for Stockton to “break itself from the boom-and-bust cycle.” With guidance from a team of urban-development experts from around the country, city leaders are pursuing a new plan to revitalize the downtown — this time with private money. “We’re investing a huge amount of resources to make this process work”, says Deis, praising the tenacity of the current city council in going after bloated labor contracts to find some fiscal breathing space. “But we’re not in control of it,” he adds.

Stockton is not an anomaly. I am certain that I will uncover countless stories similar to this one, if I were to search every day for the next city about to fail. It is almost as if City governance across this country woke up one day in 2012, four years after the fact and said, “Gosh, there seems to be a recession here. Did something happen while we weren’t paying attention?” Yes, something did. I remember having lunch with Robert Bobb, one of the best City Administrators I have ever met. Bobb said, “Oakland has a chance to become one of the premier cities in America, but I wouldn’t bet on it.” He cited the growing pension problems that has Oakland in its grasp today, and that lunch was in 2003. Jerry Brown’s biggest mistake as Mayor was firing Robert Bobb.

The only way out of this mess is for City Administrators to get out in front of this never-ending problem with ballot measures for tax increases to cover the pension costs, and with contract re-negotiations to try and lower the trajectory of growth in pension debt burden. The city employee’s unions must come to the table with more reasonable proposals to re-cast those agreements in the light of the realities of 2012, and be willing to accept the fact that the money to pay for them is simply not there. We can’t party like it’s 1999 anymore.

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About Steve King

iPeopleFINANCE™ Chief Operating Officer. Former CEO of Endymion Systems, Inc. a $36m Information Systems Services company. Co-founder of the Cambridge Systems Group, the creator of ACF2, the leading IBM Mainframe Data Center Security product; acquired by Computer Associates. IBM, seeCommerce, marchFIRST, Connectandsell alumni. UC Berkeley alumni. View all posts by Steve King

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