California city becomes America's largest, latest to enter bankruptcy

A federal judge has ruled that Stockton, California will be allowed to enter bankruptcy. The city, located near San Francisco and home to 300,000, is the largest yet in the US to file for bankruptcy, marking a new low point in a trend sweeping California.

US Bankruptcy Judge Christopher Klein ruled Monday that Stockton would be allowed to begin reorganizing its debt in order to continue carrying out “its obligations to its citizens on fundamental public safety as well as other basic government services.”

Next, city officials must win the judge’s approval for a specific adjustment plan that allows them to adjust financial debts held by Wall Street creditors who have fought Stockton’s bankruptcy claim and, in the opinion of Judge Klein, acted in bad faith.

“The creditors got a big black eye today,” attorney Karol Denniston, who helped draft bankruptcy legislation for city officials, told the Los Angeles Times. “Now the stage is set for the real dogfight.”

Legal experts have kept a close watch on the case, because when it comes to massive pension bills combined with housing market debt, Stockton is far from alone and could set legal precedents. Last year Moody’s Investors Service warned of a domino effect on American cities crippled by poor financial planning.

In the early 2000s Stockton's financial planners forecast city salaries, benefits, pensions and borrowing on long-term developer fees and slowly-rising tax revenue. That plan fell apart in the mid-2000s as tax revenues plummeted amid the national economic recession.

“There’s nothing to celebrate about bankruptcy,” said Stockton city manager Bob Deis. “But it is a vindication of what we’ve been saying for nine months.”

Financial gurus from California Common Sense, a state legislative think tank, pointed the blame squarely on Stockton politicians who, they say, staked the area’s financial future on booming home property values that were unlikely to last. The biggest piece of debt is a $900 million bill to the California Public Employee’s Retirement System (CalPERS) that the city has, so far, been able to continue paying while ignoring other fees.

Since Stockton filed for Chapter 9 in June of 2012, fellow California cities San Bernardino and Mammoth Lakes have followed suit.

“To summarize, we expect…more bankruptcy filings and bond defaults among California cities reflecting the increased risk to bondholders as investors are asked to contribute to plans for closing budget gaps,” read an August 2012 report by California Common Sense.

“In the current environment, as more municipalities approach the economic or political limit to raising taxes or adjusting spending, we expect an increase in defaults and bankruptcies over the next few years.”

While California has carried the heaviest debt, areas including Jefferson County, Alabama and the City of Central Falls, Rhode Island have also filed for bankruptcy.

“Every city in the state is looking on with some concern,” said Dave Vossbrink, a spokesman for the city of San Jose, California in an interview with CBS. “Governments of all kinds borrow money, usually to build infrastructure that lasts a long time. It’s like getting a mortgage to build roads, a sewage plant, whatever it might be. If the investment community perceives greater risk, you may not be able to borrow as much for public purposes.”