Stockton, Calif., Could Become Nation’s Biggest Municipal Bankruptcy

Published March 30, 2012

Stockton, California is quite at home on lists of dubious distinctions.

This Northern California city has been variously listed as the city with the second-highest home-foreclosure rate of any major U.S. metropolis, the second-highest violent crime rate in California, and was two times the frontrunner of Forbes magazine’s “America’s Most Miserable Cities.”

Now Stockton is hoping to avoid its next bleak title, that of biggest municipality in U.S. history to enter bankruptcy.

After Heyday, Payday

Eighty miles east of San Francisco and home to nearly 300,000 people, Stockton has cycled through decades of city-planning booms and crime-ridden busts.

These days many residents are just doing what they can to stay safe and survive. Unemployment in the city tops 16 percent. Foreclosures are at an all-time high. Homeless shelters are out of beds. The police force has shrunk 25 percent, and this year’s homicide total may surpass last year’s record high of 58.

In the early 2000s, after years of decline, Stockton began pouring money into revitalization projects. Developers built residential subdivisions, a theater complex, sports arena, waterfront walkway, and marina.

City coffers bulged on the resulting property tax increases, and city employee contracts ballooned. One month of city employment meant eligibility for full retiree health care. Today, the city’s long-term health care liability totals more than $400 million. There are 94 pensions each worth at least $100,000 annually.

“Stockton overcommitted to long-term obligations that even under the best of times the city could not afford. So if there was not a recession, the city would have been having the conversation we’re having in four or five years,” said City Manager Bob Deis in a recent Time magazine interview.

Some Debt in Default

Stockton now faces up to a $38 million gap in its $165 million operating budget and has already defaulted on about $2 million in debt payments through June.

On March 27 Moody’s Investors Service downgraded Stockton’s pension obligation bonds from B1 to B3 and the 2006 lease revenue refunding bonds from B2 to Caa1, considered highly speculative and with substantial risk. All of Stockton’s long-term ratings remain under review for further downgrades.

In short, the city is losing ground in the fight to pay back what it owes.

City leaders on March 27 announced Ralph R. Mabey, the federal mediator in the Lehman Bros. bankruptcy, the largest in U.S. history, will lead mediation with creditors in an attempt to restructure Stockton’s debt.

Spreading Worry

There is fear that if Stockton defaults, other cities may follow suit. Yet the worry may be misplaced.

With the exception of Jefferson County in Alabama, most of the 11 municipal defaults in 2010 and 2011 (18 total since the recession started in 2008) were small cities struggling to maintain general services. Those isolated instances—out of about 9,700 rated cities and a $3.7 trillion market—are too small a sample for any sweeping lessons, said Bhu Srinivasan, principal at Munigo, a municipal bond distributor. 

“Defaults capture headlines, but it is man bites dog,” he said. “You could go the other way and say in even the deep recession, municipalities are strong and bonds aren’t defaulting.”

Moody’s Vice President-Senior Analyst Merxe Tudela agrees.

“Municipal debt defaults will remain infrequent and isolated events, rather than systemic traumas, despite unprecedented credit pressure,” he said in a March 7 statement.

Residents’ Income Crucial

Still, Stockton’s boom-time expenditures do represent a mentality among city leaders that some say goes a long way toward damaging a city’s long-term economy.

“Every dollar is sacred, and a dollar you put into urban development is a dollar not in the pockets of people who live in the city,” said Wendell Cox, a Heartland Institute policy adviser and urban specialist and demographer. “Cities are not about warming the hearts of architects. It doesn’t do anyone any good to make a pretty city.”

Cox said true success is based on the incomes of people who live and work in a city. Stability requires long-term problem-solving in areas such as education and business, and creating a tax structure that doesn’t over-promise or rely on volatile income.

Whitney Stewart ([email protected]) writes from Minnesota.