Update on Stockton's Likely Bankruptcy Filing

City in California Nears Bankruptcy updates the disastrous financial situation now facing the citizens of Stockton, California. The city is broke, heavily indebted, unable to fund its operations properly and therefore in need of "wholesale" change. The means they're likely to now enter the formal bankruptcy process:

"Stockton, Calif., is set to declare bankruptcy as early as this week, according to local officials, a move that would make it one of the largest U.S. cities ever to file for reorganization.

On Monday, a state-required mediation with creditors to find a fiscal solution is scheduled to expire. Stockton's City Council is then slated to meet Tuesday to decide whether to adopt a budget for operating in bankruptcy, a move widely considered the last step before the city formally submits a Chapter 9 petition to federal bankruptcy court.

Stockton is required to file a budget before its new fiscal year begins July 1.

"The budget I'm sending to the council assumes we will file for bankruptcy," Stockton City Manager Bob Deis said in an interview. "We've been working very hard in trying to negotiate a major financial-restructuring package, but the timeline is close to ending."

Stockton, a Northern California city of roughly 300,000 people in the agriculture-heavy San Joaquin Valley, would be one of the largest cities ever to file for Chapter 9 bankruptcy, according to municipal-finance experts and bankruptcy officials.

Vallejo, Calif., a city of 120,000 just north of San Francisco, owed $50 million to creditors when it sought bankruptcy protection in 2008, while Stockton has a debt load of $700 million. (Vallejo emerged from insolvency last year.)

Chapter 9 of the U.S. Bankruptcy Code provides a financially distressed municipality protection from creditors while it develops a plan for adjusting its debts. The filing bars creditors from demanding a liquidation of assets to repay the municipality's debts.

Stockton spiraled into a morass of debt because of high retiree costs for municipal workers and big spending on a downtown-revitalization effort, coupled with falling property-tax revenue due to the real-estate downturn, among other factors.

The city has slashed more than $90 million from its budget since 2009—including reducing its police department by 25%, cutting its fire department by 30% and slashing pay by as much as 22% for some workers.

Still, Stockton faces a $26 million deficit in the $150 million provisional budget for the fiscal year beginning July 1. The deficit is expected to grow to $40 million annually by 2016, according to city records.

City officials have concluded that more service cuts and layoffs won't close the shortfall. In February, Stockton began negotiating with 19 parties, including retirees and city workers, under a California law that requires municipalities to try mediation before filing for bankruptcy. The process expires Monday.

Greg Lipitz, an analyst with credit-ratings firm Moody's Investors Service Inc., said "bankruptcy is a very high probability" given that large payments for retirees and leasing agreements are due in coming weeks.

Stockton already has defaulted on three sets of bonds, which resulted in the city losing control of three parking garages and an eight-story office building that was supposed to be its new city hall."

My Take

Stockton is clearly insolvent and unable to get out of its deep financial hole all by itself.

The city has a debt load of $700 million and has cut operating expenses substantially, but it still expects to incur an operating deficit of $26 million out of a total $150 million budget in the fiscal year beginning July 1.

The straightforward math clearly demonstrates that there is no way they can repay that debt, and that even getting to a balanced short term operating budget is probably beyond the city's current capability as well. The situation resembles that of Greece, Spain, Italy and others.

Thus, the claims of its creditors, employees, services and other costs will have to be adjusted even more radically going forward. And that draconian adjustment process will likely need to take place under the supervision of the bankruptcy court.

It's a very simple but profound problem they've created for themselves.

Too much operating expense and infrastructure building costs, resulting in deficits and debts that can't be serviced as agreed upon, for the amount of revenue generated by the government in taxes and fees, will result in onerous and untenable city financial obligations. That in turn translates to insolvency.

Lots of other places are in the same boat. That's a simple but sad fact, too.

Thanks. Bob.