State Net Capitol Journal: Will pension reform save California cities from themselves?

California Gov. Jerry Brown (D) made public employee pension reform a benchmark of his 2012 agenda. For most of this year, however, his Democratic colleagues met his call with a pronounced lack of enthusiasm. But with the session winding down to its final minutes, lawmakers last week endorsed a plan to bring what Brown called "radical change" to the state's retirement system but which his critics said was insufficient. 
 
Brown started his effort last October by issuing a 12-point pension reform plan he said would save the Golden State up to $11 billion over the next three decades. The Legislature's Democratic majority, however, was hesitant to embrace the cause, ostensibly in fear of alienating their employee union base. Practically the only support Brown received came from legislative Republicans, who adopted the proposal as their own. But with polls showing that without pension reform voters were not inclined to support Brown's other pet project for the year - a multi-billion dollar tax hike that Democrats also favor - lawmakers finally caved in and gave Brown a moderate portion of what he wanted. 
 
The plan lawmakers agreed to last week (AB 340) includes requiring all new government workers to pay at least half of their retirement costs, places an annual cap on the state's highest pension earners, ends the practice of "pension spiking" and enacts a higher retirement age. 
 
Those changes drew an angry response from Dave Low, chairman of Californians for Retirement Security, which represents 1.5 million public employees and retirees. In a statement, Low said that while the group supports "common sense reforms," the plan lawmakers endorsed went too far. 
 
"This is far more than 'low hanging fruit.' This is the fruit, the branch, the tree trunk, and the roots," he said. 
 
But other critics contend the measure does not go far enough, pointing out that none of the most impactful changes - and only a handful overall - apply to current workers. The new plan also does not include what Brown considered the heart of his original proposal: moving new employees into a hybrid system featuring a 401(k)-style defined contribution plan. It also fails to address the state's soaring retiree health care costs. 
 
These are not insignificant omissions. State retirement officials have indicated California faces a pension funding shortfall of around $165 billion. The Wall Street rating agency Moody's thinks it could be almost twice that figure. 
 
Even so, Brown lauded the agreement, saying it will save state and local governments even more than his original proposal, pegging the figure at between $18 billion and $30 billion over the next 30 years. The California Public Employee Retirement System (CalPERS) was even more optimistic, saying the savings would be between $40 billion and $60 billion during that time, although the agency's actuaries have not yet done a thorough analysis. 
 
"These reforms make fundamental changes that rein in costs and help to ensure that our public retirement system is sustainable for the long term," Brown said in a statement last Tuesday. 
 
Whether or not he is right won't be known for some time. But change can't come soon enough for people like Stockton, California city manager Bob Deis, for whom reforming the state's public employee pension system is literally a matter of life and death. Deis recently sent Brown and all four of the state's legislative leaders a letter practically begging them to enact pension reform. If not, Deis wrote, his city could "slip into municipal chaos." 
 
Deis' fear revolves around Stockton's status as the largest U.S. city to ever declare bankruptcy. Four of the city's creditors - bond insurers Assured Guaranty and National Public Finance Guarantee Corporation, global investing firm Franklin Advisers Inc. and Wells Fargo bank - have challenged the city's right to file for Chapter 9 bankruptcy protection, saying it should have first tried to negotiate down its annual $37 million payment to CalPERS. Federal law requires municipalities seeking Chapter 9 protection to first participate in a 60-day negotiation with their major creditors, something Stockton did with the four financial companies but not with CalPERS. As such, the company's say, Stockton should not be eligible to claim protection under Chapter 9. The final decision will be made by U.S. Bankruptcy Judge Christopher Klein, likely early next year. 
 
Although Deis says the city will "vigorously" fight the claims, he made it clear the ramifications of a verdict against the city would be dire, saying it would then "have no choice" but to reduce its payments for both current and future employee pensions. Doing that, he says, would potentially spark "a mass exodus of experienced police officers in one of the state's most violence-prone cities." 
 
Deis acknowledged that Stockton's fiscal woes are mostly self-created, the product of a series of poor fiscal decisions made by previous city leaders. Those choices include handing out generous benefit hikes to workers during the tech and real estate booms, often to keep pace with those being given to state government workers. The city also took out $125 million in pension obligation bonds in 2006 to pay for a pension increase, but revenues from that sale evaporated with the bursting of the housing bubble. Even so, he argues, it would be completely unfair to the city's residents to force Stockton to choose now between paying pensions or paying cops and firefighters. 
 
Stuart Drown, executive director of the Little Hoover Commission, an independent state oversight agency, says it is too early to tell how much relief AB 340 will give to cities like Stockton. But he noted one element that could help them a lot. 
 
"Under this deal, local governments can not only ask employees to pay half of their normal costs, but also to help pay down the cities' unfunded pension liabilities from previous years," he said. "The question is how much of that will be done at the bargaining table." 
 
Even so, Drown says, it is far from an immediate fix for cities with problems facing bankruptcy now. 
 
"It will help, but it's a tool that will take some time to really work," he says. 
 
Stockton has already scratched out a key victory on the benefits front. In July, the city implemented unilateral cuts to retiree health benefits, a move that was immediately challenged by retirees who claimed those benefits were vested and not legally subject to reductions. Judge Klein rejected the request, saying "the shield of the Contracts Clause crumbles in the bankruptcy arena." 
 
Ben Feder, a special counsel who focuses on bankruptcy for the New York City office of Kelley, Drye & Warren LLP, says that with so much at stake, other cities in similar pension-fueled deficits are undoubtedly watching the Stockton case play out. He says that while every situation is different, it's "very likely" that other cities will be inclined to use Chapter 9 bankruptcy if the court rules against Stockton. 
 
"If that happens, you will see more and more of that," he says. 
 
But Sacramento City Manager John Shirey, who has endured his own protracted duel with some of his city's unionized workforce, most notably its largest police union, disagrees. 
 
"I don't buy that at all," he says. "Regardless of how the court rules, cities will still do all they can to avoid bankruptcy." 
 
Stockton is not alone in facing a legal challenge over its pension changes. Last June, voters in San Diego and San Jose overwhelmingly endorsed ballot measures requiring current city government workers to pay substantially more toward their pensions. Unions have challenged each of those measures in court. 
 
Shirey says he fully expects AB 340 to also be challenged in court. 
 
"Isn't everything litigated these days?" he says. 
 
If it passes legal muster, he says the law should help all local governments whether they are facing bankruptcy or not. But he says there is one thing the state could do that would help even more. 
 
"The state government would be most helpful to local governments if it would just get its own house in order," he says. 
 
That, Brown says, is what he is trying to do. At a press conference last week, he indicated he is also closely watching the Stockton, San Diego and San Jose cases, telling reporters at a news conference - without offering details - that he would consider pushing legislative changes that impact current employees. 
 
"We have lived beyond our means," he said. "The chickens are coming home to roost and this is just one in a series of countermeasures that will be required over the next decade."

- By RICH EHISEN 

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