The Morning Report
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There were a lot of interesting people eating eggs at a breakfast panel Thursday.
The city’s firefighter and police unions had leaders there. Prominent conservatives and business leaders were there along with a few members of the mayor’s secret kitchen cabinet including retired shipbuilder Dick Vortmann and restaurateur Dan Shea. The city attorney, Jan Goldsmith, was there. Progressive activist Norma Damashek listened as did libertarian activist Richard Rider, who chatted afterward with someone from the Reason Foundation.
Lawyers were peppered through the audience.
But one team was conspicuously absent: the mayor and his staff. They were probably too busy. But they’ve been avoiding the discussion that was going on Thursday for four years — it would not have been out of character for them to avoid it one more time.
What was everyone there to hear? A frank, informative and very interesting discussion about municipal bankruptcy.
And yet, neither the panelists, nor the moderator — accountant and former chairwoman of the Pension Reform Committee April Boling — said a word about the city of San Diego.
That was a good idea. Every time, since 2004, that the issue of bankruptcy has been discussed at all seriously, it has devolved into a discussion about the San Diego’s particular position. But San Diego is just one city in this county. When you look at places like Chula Vista, where two years ago the city manager said they were on the path toward insolvency, it’s not hard to see how many people will want to know more about this procedure.
The point of the breakfast was to understand what a municipal bankruptcy proceeding would entail and if what we think it is really what it is. And the panelists were perfect: Retired Judge John Ryan, who oversaw Orange County’s 1994 bankruptcy case (and who was the subject of our Saturday Q&A); Margaret Mann, a bankruptcy attorney at Sheppard Mullin; and Ali Mojdehi, another lawyer from Baker McKenzie.
Let’s get into it and review a list of statements — they might be myths, theories or just plain uninformed declarations. But are they true? Let’s test them against what the panelists said.
True or False? Bankruptcy is a choice.
True, it is a choice.
What city officials do is look at their situation and ask themselves whether they will be able to continue paying all the bills the city owes. The city owes money to investors who lend it money and employees who work for it, among other lesser obligations.
If a city is coming close to a position where it won’t be able to pay back lenders or make good on employee contracts, it can ask a court to declare it insolvent.
Ali Mojdehi said there are basically two factors a court considers: Whether a city is unable to pay its debts (or whether it will be unable to pay its debts) and whether it has no reasonable way, outside of bankruptcy, to negotiate with the people it owes money to change those debt obligations.
“That is really the first theater of consternation between those who oppose bankruptcy and those who are siding with it. It’s a fight over whether or not a municipality is insolvent,” Mojdehi said at the breakfast.
True or False? By its very nature, a city can’t be insolvent because it will exist into perpetuity and can either cut services or push its debts out to the infinite future because it will be around in 100, 200 or 300 years. It’s therefore never going to be at a point where it can’t make good on the most immediate of obligations.
This was one of the most interesting themes of the conversation.
Margaret Mann answered it best. Yes, a municipality can push its debt off years, even centuries into the future. But a dollar now is worth far more than a dollar in 350 years. Creditors and employees need money now.
And if a city is in bad enough shape, cutting and cutting until its back in balance will leave you with an untenable situation:
“If you really take the hypothetical out the whole way, you are going to end up with a city with no services,” Mann said.
In other words, the municipal bankruptcy option is codified in law precisely to protect a basic level of services residents might expect their city to deliver. If city management has left it so imbalanced that it will have to eat into core public heath, safety and infrastructure services to make good on its debts, the bankruptcy option is there as a last resort to right the ship.
“The premise is there needs to be at least a modicum of services that a municipality provides its citizens. How much it is, you can debate those kind of issues. But I don’t think you can debate some of the fundamental needs,” Mann said.
True or False? A city would have to prove that it has tried to raise taxes and cut as much as possible before a judge would accept an insolvency claim.
Mojdehi said that there was no technical requirement for the city to have tried to raise taxes before a judge will declare it insolvent. Nor was there a requirement to have negotiated with creditors or labor unions.
And he went on to describe the situation in Vallejo, the Northern California city that started the bankruptcy proceedings last year and won a judgment that it was insolvent.
“In case of Vallejo they did engage with the unions for a considerable period of time. They did, in fact, enter into a Band-Aid solution with their unions that enabled them to meet their obligations for a year. But they finally came to the point where they were going to run out of cash in the matter of a couple months so they made the decision after taking all of those preliminary steps of cost cutting and engaging with their creditors to file for bankruptcy,” Mojdehi said.
True or False? A city in bankruptcy proceedings would be beholden to a judge who could raise taxes, sell land, cut services or even change the city’s laws and structure. The city’s elected representatives would be subservient, therefore, to an appointed judge.
This was a fascinating part of the discussion that came up in various ways a couple of times. It was made very clear how limited the power of the judge is — he can do none of those things. On the other hand, saying he has no power over them is like saying the president has no power over the legislative process. The president, in fact, has a very powerful tool over legislation: He can veto it.
What became clear was this: The judge presiding over a bankruptcy has to make determinations about what is brought to him. So, for instance, a city can simply reject one of its agreements with unions and a judge might have to declare whether to uphold that or not.
But what is most likely to happen, the panelists all agreed, is that neither the city nor its labor groups will want to risk leaving it all up to the judge and they will work to forge an acceptable agreement before that — a plan the judge is likely to approve.
Can the judge force the city to raise taxes, sell land, raise rents on property it owns or restructure the governance?
“Basically the bankruptcy judge serves as the referee for the game which is played by the participants before the court. What the judge can do is … rule on the contested matters that are brought before the court and those include, most importantly, the plan which is ‘What are you going to do with these troubled affairs of the city.’”
Judge Ryan basically agreed but Mojdehi said he was being modest.
“The reality is that the court plays an extraordinarily important role as the director of the symphony. The symphony director doesn’t play any instruments but he or she does manage the process to achieve an equitable resolution,” Mojdehi said.
True or False? A bankruptcy proceeding means millions of dollars to the lawyers who shepherd it through.
Without question, this is true. Mojdehi said that Vallejo has shelled out $5 million to lawyers so far and the process is far from over.
What’s more, the lawyers have a priority claim on their fees. In other words, under a bankruptcy proceeding, everyone to whom the city owes money basically hires lawyers and get in line to jostle for their fair share of whatever pie is left.
Mann said that the actual administrative costs of the bankruptcy proceeding along with the basic costs of keeping the city operating are the top priority in that line.
“The process has to carry itself,” she said.
The question is whether this major expenditure is worth it.
The city of San Diego is pretty well acquainted with handing out massive fees to consultants and lawyers it thought were helping to bring it financial stability and credibility. Taxpayers gave Kroll Inc. more than $20 million to research and write a report about how bad things were here.
Unsurprisingly, the lawyers on the breakfast panel were supportive of that kind of expenditure to help a city restore itself.
“Restoring financial health is something that is, needless to say, expensive. But the question I think that is better asked is: ‘If you don’t restore financial health, what is the cost of that?’” Mojhedi said.
Mann and Ryan agreed.
“How are you going to resolve a billion dollars of claims inexpensively? The key is to have good attorneys and it’s important. In the Orange County case, we had wonderful attorneys and the county was smart enough to listen to those attorneys,” Ryan said.
Can you avoid the cost of these attorneys? A sort of do-it-yourself bankruptcy? That brings us to our final theory, of which I’m a prime purveyor.
True or False?The city of San Diego and others have the opportunity now to avoid the cost and combativeness of a bankruptcy by convening stakeholders to negotiate across-the-board sacrifices that will put us on a healthy and sustainable trajectory.
This is, of course, my basic theory: the city’s stone soup. Nobody individually can solve the city’s problems but if we each put something in the pot, we can make a good soup.
We can’t deal with this problem by looking at individual issues: raising parking meter costs here, cutting an employee benefit there, etc. We have to look at the city as a whole, convene everyone and agree to reasonable revenue increases in exchange for reasonable and significant employee benefit reforms.
So the question came up at the panel: Can’t we just do this on our own without bankruptcy?
Mojhedi said yes and no. There are really two things bankruptcy provides that normal negotiations don’t: One, you can tear up agreements with employees no matter what anyone says about them being vested benefits or not. And two, you can negotiate lower rates with lenders, a process that is difficult if not impossible outside a structured bankruptcy. Sure, in normal times, you can refinance loans, but if you want to negotiate with a particular lender without refinancing and those associated costs, you are out of luck.
“The bankruptcy process enables you to achieve a collective solution hopefully by consensus but it’s very difficult outside of bankruptcy — particularly if you have a complicated balance sheet to deal with multiple constituencies,” he said.
So is bankruptcy the right answer for local cities that are underwater?
I don’t know, but the discussion made it clear that there’s nothing to be ashamed of in having these kinds of talks at an ever-more sophisticated level. The mayor himself, years ago, saw the merits in keeping bankruptcy in mind as an option.
There seem to be two camps among this city’s leaders and thinkers. The first sees the city as just another ship floating precariously in rough sees. They seem to be working furiously to keep the ship afloat — whether it is with gum, duct tape or something else, the goal is to survive. And either they believe 1) that if they just keep things going long enough, the seas will calm and the city will prosper again or, 2) that if they just keep things going long enough, they’ll be able to hand over the helm to someone else.
The second camp believes that something needs to change and change fast. The city is deteriorating and services will be on the chopping block like nothing we’ve seen. It’s one thing to try to solve a deficit knowing that next year might bring prosperity. It’s another thing to know that solving this year’s deficit and know that it’s only going to be worse next year.
As evidenced by the sophisticated forum last week, those in the second camp are now thinking about bankruptcy very seriously.
Update: I tweaked the formatting on this post and added “True or False?” to make it clear those bolded statements were the ones we were putting to the test in this post. Just to be clear. Some readers were confused.