California's Bankruptcy Cocktail
In the span of just 14 days, three California cities have opted to file for Chapter 9 bankruptcy protection. San Bernardino, population 209,000, part of the Southern California region known as the Inland Empire, is the second largest city in recent history to file for bankruptcy after city leaders there voted Tuesday to seek protection in the face of a $46 million deficit.
That puts San Bernardino in company with Stockton and Mammoth Lakes, the two other California cities to seek protection in recent weeks. San Bernardino and Stockton, as well as 2008 Chapter 9 filer Vallejo, took similar routes to reach fiscal calamity: overly excited spending during the boom years followed quickly by the recession, a high rate of foreclosures, and topped off with employee payment and pension obligations that outpaced plummeting tax revenues. Mammoth Lakes is the outlier here, with its bankruptcy resulting from its inability to pay the judgment of a development-related lawsuit.
But four notable municipal bankruptcies within the last few years is a black eye for the Golden State and raises the question: are California cities entering an era of widespread bankruptcy?
Chris McKenzie, executive director of the League of California Cities, contends that four cities of the state's 482 is a very small minority.
"Is there something in the water in California? No, I don’t think there is," McKenzie says. "But the trouble spots economically in our state are the Central Valley, which Stockton is in the heart of, and the Inland Empire, which San Bernardino is in the heart of."
By trouble, he mainly means foreclosures. In 2011, one of every 18 homes in Stockton received a foreclosure filing. San Bernardino County had more than 100,000 foreclosures between 2008 and 2011. Both of these areas have struggled through the recession, and with their housing markets in shambles, local tax revenue has not been able to cover expenses and employee compensation.
These conditions are compounding in cities across the state, which currently has the fourth highest rate of foreclosure among states during the first half of 2012, according to RealtyTrac. McKenzie says this combination can be devastating. With little power to turn the economy around or undo the wave of foreclosures that's washed over them, cities may have only one option: reduce employee compensation payments.
"A number of cities have been able to convince their employee groups to pick up a larger share of the cost of pensions," says McKenzie. "In some cases employees are even willing to pick up the city's share. In most cases they're simply reinstating the traditional sharing of cost arrangement that existed before the boom years of the early 2000s, when we saw a lot of cities picking up the employees share of the cost of pensions."
Cities are also rethinking the sizes of pensions for new employees, who are typically being offered smaller packages. That's a good idea for avoiding similar problems in the future, but doesn't change the situation facing cities today. McKenzie worries that bankruptcy may be the only solution for more of the state's cities.
"Cities that don’t have the luxury of time to negotiate these changes or those that may not have willing partners in the labor groups have to do something to keep the lights on," he says. "I don't think were talking about a deluge or a tsunami, but we may be talking about additional cities that have to seek the protection of Chapter 9 bankruptcy."
McKenzie can't directly point out which city may be next. But given the persistent tax revenue, foreclosure and compensation issues cities in California are facing, it's likely that other cities will be considering this route.
"Look at the map of where the mortgage foreclosure problem is the worst and you will see a strong correlation between that problem and where the fiscal pressure is the deepest," McKenzie says. "And if it's married with employee compensation packages which are too generous based on what's happened to the economy in that area, then you're going to see more danger signs."
If foreclosures are one of the main indicators for bankruptcy, will other high-foreclosure states be following in California's bankruptcy trend? McKenzie isn't sure. But in looking at California's troubled neighbors Nevada and Arizona – states which during the first half of 2012 had the first and second highest foreclosure rates in the country, respectively – he guesses that they'll likely be able to avoid a similar string of bankruptcies because they aren't saddled with the other main indicator: employee compensation.
"I don’t think their employee benefits are nearly as generous as ours," McKenzie says, "fortunately for them."
Top image: The San Bernardino City Hall building. (Alex Gallardo/Reuters)