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Since last fall, talk of municipal bankruptcy has wormed its way back into public debate at the city of San Diego.
Mayor Jerry Sanders and City Attorney Jan Goldsmith decided they’d had enough. Last month, both dismissed the idea — and Sanders used particular vigor — by saying it distracted the city from its real financial problems. Besides, they argued, it would cost as much as $300 million and couldn’t affect the city’s most crushing debt: the $2.1 billion it owes for employee pensions.
“You can’t touch the pensions, which is the big nut,” Sanders said in an interview. “Why not use that $300 million to balance the budget in the long term instead of continuing this talk about there’s an easy solution out there? I think people who say that either don’t understand it, or they’re demagoguing.”
The issue is important. If San Diego can’t do anything about pensions in bankruptcy, is it even worth discussing? Especially since Wall Street flips out any time a city mentions the word.
I set out to explore the question: Can a bankrupt city reduce core pension benefits that have been guaranteed in the past?
I started with Goldsmith’s argument, which the mayor used as the foundation for his opinion. Goldsmith says pensions can’t be touched.
The California constitution makes pension benefits permanent. They can’t be changed unless a municipality gives their employees comparable perks. San Diego’s city charter protects pensions, too.
No bankrupt municipality has overturned guaranteed pensions before. To do so in San Diego, a federal bankruptcy judge would have to overrule the city charter, the state constitution and in effect create new law. If it happened, the case would almost certainly go to the U.S. Supreme Court. Goldsmith believes justices would think the ruling impinged on state’s rights and overturn it.
It would be “foolhardy” for San Diego to declare bankruptcy solely to overturn its pension obligations, said Harvey Leiderman, a California lawyer who has lectured on municipal bankruptcy. Leiderman’s San Francisco-based firm is representing the largest bondholder trustee in the current municipal bankruptcy case involving the Bay Area city of Vallejo. Leiderman also used to be fiduciary counsel for San Diego’s retirement system.
“There are some things that it’s not even worth betting on could happen,” Leiderman said. “It’s just like traffic lights turn red after yellow. So it’s possible that a light could turn green after yellow, but I wouldn’t bet on it.”
Recent events support this position. In the initial plan Vallejo is proposing to emerge from bankruptcy, the city is not touching pensions even though they are its single largest debt. The reason? Vallejo says pensions are protected by state law.
Vallejo’s case already saw a major decision when the bankruptcy judge allowed the city to rip up contracts it had with its labor unions. The impact of that decision would be nothing compared to a bankruptcy judge taking on pensions.
“It would make Vallejo look like a small-claims court case,” Goldsmith said.
But both Leiderman and Goldsmith believe such a case will happen someday. A municipality, they said, will attempt to reduce its pension obligations through bankruptcy because it won’t have any other choice.
The law does leave space for a challenge.
Federal bankruptcy code trumps state law, meaning protections offered by the state and cities don’t have to apply, said John Ryan.
He’s a retired federal judge who should know. Ryan presided over the largest municipal bankruptcy in history, Orange County’s 1994 case.
No one has said that a bankruptcy judge couldn’t erase pension obligations. That doesn’t make it likely, though.
“I think probably politically as well as from a general fairness standpoint it would be very difficult to do that,” Ryan said. “I think probably the reason we haven’t seen the issue and haven’t seen it attempted through a plan is that it would be a very tough sell.”
To recap: It appears legally possible for a city to reduce pension benefits through bankruptcy. No one has tried it before, but someone will. That bankruptcy will be a costly war with an uncertain outcome.
Yet the risks in bankruptcy go both ways.
Unions and retirement systems have a lot to lose as well, no matter how strong their legal position. They might not want to imperil the billions of dollars they have at stake in a bankruptcy filing and risk legal precedent that could affect the hundreds of billions in unpaid pension debts nationwide.
It’s an uncertainty that might force unions and retirement systems to take a deal without forcing a judge to rule on the issue.
Such deals are the point of municipal bankruptcy, said Pat Shea, a lead attorney in the Orange County case and a former San Diego mayoral candidate. It encourages consensus and certainty much more than legal battles in state court.
In short, bankruptcy levels the playing field. Everyone owed money must jockey for position. It’s more likely in bankruptcy, Shea said, for a party to settle than to bet on victory particularly when so much money is at stake.
The riskiness of a court ruling for everyone, Ryan said, creates much of the angst over pensions in bankruptcy.
“This is the reason most of these things get resolved consensually,” he said. “People don’t want to have a judge or the Supreme Court say it’s this way.”
A bankruptcy might not wipe pension obligations away, but it could make the debt smaller.
The most prominent San Diego politician to use the “B” word recently is longtime City Councilwoman Donna Frye. Frye told the Union-Tribune last month she believed the city would eventually have to file for bankruptcy.
She told me the same thing this week. She doesn’t know if San Diego could reduce its pension costs in bankruptcy. But that isn’t the point. Her point is nothing more than this: If the city runs out of money, it will have to file for bankruptcy.
“At some point, yes, I believe the city will for all intents and purposes be out of money,” Frye said. “I think if we’re not there yet, we’re darn close.”
Still, Frye said there was plenty the city could do outside of bankruptcy to reduce its costs. She cited pension reforms she’s suggested with colleague Carl DeMaio.
“There are things that can be done to address these problems,” she said. “Until people start taking that seriously, every single year we are going to see ourselves more in debt with more deficits and more cuts and no solutions.”
Her larger point is one Goldsmith and Sanders have both made: The city has long-term budget problems and the city has ways of fixing them.
Sanders said he’s recognized that. He’s promised to unveil his own solution within 18 months.