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Thursday, March 24, 2005 | John Moorlach screamed and pleaded, warning that Orange County’s finances were in grave danger. Those in power denied the problems; he was rebuked, ostracized and accused of playing political games.

Then the bottom fell out on the county’s risky investment schemes. The county declared bankruptcy. That day, the private accountant wept longer and louder than he ever had before.

His day of vindication was a dramatic and painful one, but now he’s serving his third term as the county’s treasurer-tax collector. And from that role, the whistleblower-turned-officeholder has held one of the most intimate views of municipal bankruptcy and its aftershocks as anyone.

The county still feels the tangible, painful impacts of that December day in 1994 when it made national news. Bankruptcy could have been avoided, he said, but a lack of leadership eventually left little choice.

“I didn’t want to do it, but it was probably the only remedy,” he said.

The prospect of using municipal bankruptcy as a tool to resolve San Diego’s fiscal crisis was first pushed off as the wild idea of reformers and political opponents of sitting City Hall leadership. But the concept now is slowly easing its way from the fringe to the mainstream, as powerful downtown groups such as the San Diego Regional Chamber of Commerce contemplate its utility.

Only months ago, the chamber’s political point man, Mitch Mitchell, dismissed the idea out of hand. But worries about the same sort of leadership vacuum experienced in the Orange County case shifted his views.

He said a lack of a comprehensive plan, or even an understanding of the enormity of the financial problem, coming from City Hall has led his board of directors to examine the merits of Chapter 9, or municipal bankruptcy, to cure the city’s financial ills.

“Is it possible to get it done in the current circumstances? There is some serious doubt,” Mitchell said. The chamber’s board will vote in May.

Problem bigger than pension

Mayor Dick Murphy has laid out his plan for managing the $1.37 billion pension deficit and putting the city on the road to financial recovery. It includes a bundle of salary and benefit cuts and freezes currently being negotiated with labor unions, the appointment of seven new pension board members made last week and the sale of pension obligation bonds once the city regains its credit rating. He said the plan will knock $600 million off of the pension deficit in just two years.

Murphy said bankruptcy is not an option for the city, that it would ruin the city’s credibility on Wall Street and cost the taxpayers millions of dollars in unnecessary legal fees.

But many observers see the pension deficit as simply the symptom of a larger ill – a structurally unsound and dishonest budget. This year’s proposed budget still digs the pension deficit deeper, they say, while future unfunded needs in the hundreds of millions of dollars for such things as retiree health care and basic municipal upkeep can’t be addressed.

Orange County’s house literally collapsed overnight, forcing a bankruptcy filing to stave off anxious creditors. San Diego scoots along.

But Mitchell figures that the true size of 2006’s budget hole is more to the tune of $100 million than the announced $50 million because of discrepancies in items like the pension payment and police and fire overtime. He worries that the city could be one big financial hit away from being forced into bankruptcy – such as losing the pending appeal on the $100 million owed to developer Roque de la Fuente.

“Are we going to have this flashpoint where we are going to say, ‘Man, I wish we would have taken care of that before?’” Mitchell said.

Debates at dinner tables around town and the corridors of power downtown center on the pros and cons of Chapter 9, and three prevailing questions: How does a municipality end up in Chapter 9? Does the city qualify? What would bankruptcy do to existing pension benefits?

Weighing the pros and cons

Moorlach, who has been watching San Diego very closely, looks 10 years later at the positives and negatives of the Orange County bankruptcy and sees many of the same arguments that highlight today’s discussions to his south.

The positives: Bankruptcy creates a forum to get all sides at the negotiating table, strong snap decisions can be made by a CEO-type in the person of the assigned judge and creditors can be kept at bay.

The negatives: Orange County paid out more than $100 million in fees to its lawyers, consultants and accountants, as well as those hired by all the other parties involved; bankruptcy carries with it a national stigma; and the county pays $90 million a year to finance bonds taken out to cover the debt.

After all, before a hit television show sprung up two years ago, the OC was probably best known nationally for its bankruptcy. Today, $90 million leaves its bank account every year to cover the costs of its previous financial problems.

“Bankruptcy is the municipal equivalent of the Roach Motel. Once you’re in it, you can’t get out of it too easily,” said Harvey Leiderman, a San Francisco bankruptcy attorney who represented Orange County’s retirement fund during its proceedings and recently took a Northern California water district through Chapter 9.

The city, labor unions, all the creditors and all the bond holders will hire lawyers, accountants and other professionals, all at the expense of the city, he said.

“The only people who made out well in the bankruptcy of Orange County were the professionals. Everyone else lost in my opinion. The county lost, the county citizenry lost, the county lost its credit rating” for a long time, Leiderman said. (Orange County regained access to capital markets in 1997 and received an A-plus rating in 2000.)

Both Moorlach and Leiderman felt the city of San Diego could structure a recovery package before having to go to bankruptcy. Moorlach said a strong personality is needed to call all sides into the room, explain the dire situation and hammer out deals, forcing all parties to understand that the alternative is Chapter 9. Leiderman said municipal officials in these situations sit down at the counting house, figure out everything they have and then seek to maximize their assets.

“I think the big issue is leadership,” Moorlach said.

However, others believe that San Diego has already reached the point of no return and bankruptcy is the best tool for negotiating debts, reworking the labor contracts that have contributed heavily to the pension debt, and structuring an entirely new budgetary foundation.

“I think the big advantage is you can negotiate with labor unions and get some adjustments made. This puts the city in a very strong position. Someone needs to play hardball here, and it gives them the equipment to do that,” said Scott Ehrlich, a professor of bankruptcy law at California Western School of Law.

If San Diego only had one specific fiscal problem such as the retirement deficit, bankruptcy wouldn’t be a worthwhile option, supporters believe. But because it has a host of problems, bankruptcy serves as the vehicle to deal with all the issues at the same time, with jurisdiction over all the involved parties.

“There literally are times when going into a Chapter 9 proceeding is seen as a positive sign,” said attorney Pat Shea, who worked on the Orange County bankruptcy, is married to pension whistleblower Diann Shipione, and serves as an advisor to his friend, City Attorney Mike Aguirre. He said Wall Street and agencies such as the Securities and Exchange Commission, currently investigating City Hall for financial disclosure practices, would see the filing as a sign that the city is serious about dealing with its problems.

Supporters also say entering proceedings now would speed up the pace toward recovery. They say that the city is already bleeding financially while not completely paying its bills, and money will have to be spent on professional experts to cure the problem either through bankruptcy or otherwise.

“This isn’t an easy discussion,” Mitchell said. “It isn’t about a hammer over labor’s head, it’s about: Does the city have an opportunity to fix this structural problem for the future? Because right now we’re just treading water.”

Questions surrounding the logistics

The City Council would have to vote to send the city to bankruptcy court. Once there, the city would have to prove it is insolvent. Whether or not the city would pass the insolvency test is of contention among some attorneys and politicians in town.

However, Leiderman said it would only even be an issue in court if an outside party were to challenge.

Shea put it bluntly: “You might as well throw Chapter 9 out if San Diego doesn’t qualify.”

To date, much of the discussion surrounding bankruptcy has occurred within the context of politics. It has been raised for political motives by people such as Aguirre; it was dismissed out of hand for political motives by people such as Murphy, said City Councilman Michael Zucchet, District 2.

To that end, Zucchet said, he welcomes the chamber’s analysis.

“What I’ve said is, ‘Show me the numbers on paper that the city is insolvent or nearly insolvent or has no plan on the table to address the issues,’” said Zucchet, who admitted the mayor and council have done a poor job of communicating the benefits of their plan to the public. “I would encourage the chamber or anyone else to weigh in on it.”

Shea also encourages the open debate as well, saying an open dialogue has been lacking for too long. “We shouldn’t have to do it in dark corners with masks on. Should we do it or not? If not, we should do it because we decided it’s a bad decision, not because it’s a politically tough move.”

Lack of case law

Because municipal bankruptcies are few and far between, not too many people have hands-on experience with them, and some angles unique to the San Diego experience have no prior case law. That leaves many open questions – and interpretations – regarding the security of vested pension benefits in a Chapter 9 proceeding.

“That’s where San Diego gets a little more dicey,” Moorlach said.

In Orange County, no attempt was made to go after benefits. So that leaves as many different interpretations as lawyers. Some believe that benefits for the already-retired would be off-limits. Others believe that any existing contract is open to alteration under Chapter 9, leaving the benefits of retirees and current employees susceptible to a challenge.

“I will tell you that it’s a real horse race. There’s no good case law,” Leiderman said.

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