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San Bernardino bankruptcy: How hard will CalPERS fight for its money?

A sign stands in front of California Public Employees' Retirement System building. CalPERS is trying to prevent bankrupt cities from evading pension obligations.
A sign stands in front of California Public Employees' Retirement System building. CalPERS is trying to prevent bankrupt cities from evading pension obligations.
Max Whittaker/Getty Images

Last week, Moody's, the rating agency, released a note about the ongoing San Bernardino bankruptcy and the city's pension obligations to CalPERS. According to Moody's, San Bernardino's total unfunded pension liability far outstrips it other municipal debt. 

San Bernardino declared bankruptcy in July, after the city council revealed that it barely had enough money to keep the lights on. A big question in the bankruptcy has been whether the city will attempt to reduce or discharge its CalPERS liabilities. As Moody's pointed out, neither Vallejo, which went into Chapter 9 in 2008 and emerged in 2011, nor Stockton, which declared bankruptcy earlier this year, sought concessions from CalPERS. In Vallejo's case, other creditors took a substantial haircut. 

CalPERS maintains that pension obligations can't legally be reduced in bankruptcy. That hasn't stopped San Bernardino from ceasing payments, to the tune of $6 million. CalPERS is now disputing San Bernardino's Chapter 9 eligibility, according to Moody's, and is threatening to do away with the city's pension plan. This would expose San Bernardino to a bigger pension payment, due immediately. 

The City of Compton is a similar situation, although it hasn't yet declared bankruptcy. CalPERS has sued Compton for not making timley payments, and in response Compton has announced that it will soon issue $10 million in new debt to to cover its liability.

From Moody's perspective, CalPERS is concerned that the previously sacrosanct nature of pension obligations will be legally undermined by the recent spate of bankruptcies in California. Stockton, for example, was allowed by the bankruptcy court to suspend health benefit payments to retirees. It might not be that big a leap for financially stressed cities to make the leap to terminating CalPERS payments.

This is from Moody's note:

[T]his line of thinking forms the basis for San Bernardino’s discontinued payment to CalPERS, although the city is also motivated by the need to preserve cash from wherever it can. Cash preservation is also Compton’s main motivation for discontinuing payments. Compton has faced consecutive yearly operating deficits and depleted cash reserves, conditions that have forced it to borrow from restricted funds.

If either San Bernardino or Compton succeed in redefining its pension obligations, it would set a precedent that CalPERS (and potentially CalSTRS, the California State Teachers’ Retirement System) can be brought to the negotiating table. CalPERS, however, has every incentive to pursue all of its legal rights to their fullest extent to make these cities pay under California law, and so discourage other fiscally-stressed California municipalities from withholding their required pension payments.

Of course, you can look at all this legal wrangling over who gets paid and see a benefit to San Bernardino's debtholders if CalPERS ends up fighting it out in court with everyone else. 

“It's definitely a positive for other San Bernardino creditors, if only because it preserves cash with which they can be paid," said Eric Hoffmann, a Moody's senior vice-president. "It's potentially positive for other municipal creditors generally, depending on how this dispute is decided in the courts."

He added, “If CalPERS is deemed an unsecured creditor, other San Bernardino creditors and creditors of other municipalities in bankruptcy could be better off."

It is safe to assume that CalPERS isn't going to let any of this happen without a fight, as it actions toward San Bernardino and Compton demonstrate. But the willingness of San Bernardino to challenge CalPERS proves that the way the municipal bankruptcy game is played has changed significantly since Vallejo. 

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