California cities looking for economic recovery

• Cities%27 financial woes called %27ubiquitous and massive%27
• Collapse of housing market%2C high unemployment blamed
• Cities also face soaring pension and health care costs

LOS ANGELES — How bad and widespread are California cities' fiscal problems?

"Virtually ubiquitous and massive,'' says Rod Kiewiet, professor of political science at California Institute of Technology.

In April, Stockton became the fourth California city — and the nation's largest — to go into bankruptcy protection since the recession began five years ago. The move by the Central Valley city to reorganize its wrecked finances under court protection has triggered a guessing game over which hard-pressed cities might be next.

Despite signs of economic recovery, many parts of the nation's most populous state are feeling a hangover from the collapse of housing prices, prolonged high unemployment and resulting declines in revenue. They are confronting soaring demands for spending on public workers' pensions and retiree health care while slashing services, rolling back pay and laying off cops, firefighters and other workers.

"There's a huge amount of California that's in extreme distress,'' says Joel Kotkin, a professor of urban development at Chapman University in Orange, Calif., a frequent critic of California fiscal policies.

"You're going to have bankruptcies," he says. "It's almost inevitable."

While California cities' struggles to stay solvent are in some ways particular to the state, California represents one-tenth of the nation and is the place where the rest of the country looks for emerging trends. If Stockton, San Bernardino or other California cities are able to alter or avoid debts or escape pension obligations through bankruptcy, cities across the country could be tempted to follow a similar route.

Short of that, the mere prospect of bankruptcies could reshape a municipal bond market that cities all over the country rely on for capital projects.

"If bankruptcies lead to financial relief to those cities by reducing their obligations to debt service or pension costs, other fiscally stressed cities may consider bankruptcy filings,'' Moody's Investors Service said in a report this week.

After years of budget deficits, California's state government has begun to rebound with the help of lower unemployment and recovering home prices in some areas, and voter approval of tax increases sought by Democratic Gov. Jerry Brown.

But apart from Silicon Valley and wealthy coastal areas, inland California still suffers depressed housing, foreclosures and double-digit unemployment — 14.1% in Stockton, 17.2% in Merced and a staggering 23.7% in El Centro. The Los Angeles metro area has unemployment of 9.9%; statewide unemployment is 9.4%.

Stockton, the small resort city of Mammoth Lakes and San Bernardino all sought bankruptcy protection from their obligations during a two-week period last summer. They followed the path Vallejo, in Northern California, took in 2008. Mammoth Lakes has since withdrawn its bankruptcy petition.

The bankruptcy filing by Stockton, which has more than 290,000 residents, has been closely watched. Bond insurers who guaranteed the city's debt opposed it, arguing that the city had not reduced payments into the CalPERS state pension fund for participating public workers. A bankruptcy judge approved the city's filing while avoiding the legal question it posed: whether pension obligations can continue to be paid in full, as the city intends, while other creditors, including bondholders, are not.

Few city officials want to plunge into bankruptcy, but in some cases there has been no alternative, says Chris McKenzie, executive director of the League of California Cities. Retiree health care, financed by most California cities on a pay-as-you-go basis, and pension payments based on agreements with workers, are the prime drivers in many cases, he says.

"It depends on decisions they've made over the last 10, 15 years, whether to give richer benefits,'' McKenzie says. "Some cities did. Some did not.''

Hundreds of California cities have won concessions from public workers unions, McKenzie said, to stay solvent.

No city wants to be seen as a likely candidate for bankruptcy, and state officials say they do not know which cities, if any, may be next.

State Treasurer Bill Lockyer has commissioned a study to develop ways to measure the probability any city is headed to insolvency.

"We don't see a tidal wave of municipal bankruptcies hitting California,'' says Tom Dresslar, spokesman for the treasurer. "But we're concerned about the San Bernardinos and Stocktons of the world and what the state can do to try and prevent bankruptcy and defaults in the future.''

Credit-rating agencies such as Moody's and Standard & Poor's have taken a closer look at California cities since the spate of bankruptcies last year, resulting in downgrades for some.

"Most cities are adjusting,'' says Eric Hoffmann, Moody's lead analyst for California cities. "At the same time, we do expect that there's a good possibility other distressed cities could face severe fiscal pressure going forward.''

Matt Fabian, managing director of Municipal Market Advisors, which monitors cities that issue bonds, says more than a dozen California cities have notified the bond market of significant fiscal stress since the bankruptcy filings last summer. "The pressures that were around in 2012 are still around in 2013,'' he says.

Even big coastal cities with large tax bases, including Los Angeles, San Diego, Oakland and San Jose, have had to manage deficits and cut jobs, pay and services.

Los Angeles has seen TV ads warning of bankruptcy by groups trying to sway the race to succeed Mayor Antonio Villaraigosa. City voters rejected a sales-tax increase in March, and officials are looking for ways to close a $200 million shortfall next year, even after concessions from public workers unions.

San Diego is struggling to emerge from a decade of fiscal austerity but still faces deficits. Voters last June approved a plan to put new city workers in less-costly 401(k)-type plans rather than defined benefit pensions, but that faces a legal challenge and has saddled the city with more than $20 million in upfront costs.

Local governments in California are constrained in efforts to raise revenue through taxes by the Proposition 13 property tax limitation of 1978 and later ballot measures.

San Francisco lawyer Karol Denniston, who is monitoring the legal battle over Stockton's bankruptcy, says some California cities are already close to or in "service insolvency" — that is, no longer delivering acceptable levels of public safety, health and other services.

"The cities are going to have their backs up against the wall in terms of needing to do real meaningful restructuring,'' she says. "That's why Stockton is being watched so closely.''