Federal Judge Christopher Klein made the only ruling that he reasonably could have made last week in allowing Stockton, Calif., to enter into bankruptcy protection. The city is clearly broke--as in flat busted, tapped out. After cutting $90 million in staff and services after the last three years--cutting the police department by 25 percent, the fire department by 30 percent and overall city staff by 43 percent--it still faces a current-year deficit of $26 million, deficits over the next 10 years estimated at $100 million, and a billion dollars in long-term debt.
And Stockton is very nearly broken. City Hall is rat-infested, unemployment is 18 percent and a soaring crime rate has made Stockton California's second-most-violent city. The fiscal problems
and the social problems go hand in hand. Cities are integrated systems: You can't fix the finances without addressing the circumstances of the residents, and you can't improve the circumstances of the residents without fixing the finances. As the judge put it, without bankruptcy "it is clear that the city would not be able to perform its obligations to its citizens, such as fundamental matters of public safety."
We're going to be seeing more of these situations, and so we can't keep treating them in isolation. There are going to be strong headwinds pushing against cities for decades to come. A Government Accountability Office study of cities' long-term fiscal trends projected that "the sector's long-term fiscal position will steadily decline through 2060 absent any policy change."
That doesn't mean that every city will find itself in Stockton's situation, of course. Through the economic downturn, most cities have muddled along in the middle, occupying a vast gray area of not great but reasonably OK. Some have even seen their fortunes improving: At a recent Governing event, a representative of one of the rating agencies said that it had issued more bond upgrades of cities than downgrades. We're going to continue to see winners and losers. What's different now is that the losers are going to find themselves in a negative spiral that is extremely difficult to turn around.
Corporations are said by the law to be persons, but we know that cities are far more organic--far more like persons--than General Motors. Like General Motors, cities have to have a rational process to reorganize their debts and obligations when they find themselves unable to pay the bills. Unlike General Motors, cities can't simply be liquidated.
Judge Klein made it pretty clear that Stockton's next fight will be over pensions. When that happens, the California Public Employees' Retirement System should take a serious hit. But everyone--bondholders, residents, city employees and pensioners--has a share of the blame for the condition Stockton finds itself in, and everyone will have to take some of the burden.
When you look at the city's creditors, it's pretty clear that investors have far more resources to protect their interests than do pensioners, city employees, taxpayers and ordinary vendors. Letting bondholders off the hook while extracting concessions from everyone else would violate every principal of fairness, undermine the legitimacy and efficiency of the financial markets, and tilt things against the ordinary folks in favor of the big boys in a way that smells like "too big to fail." We've certainly seen enough of that. If everyone shares Stockton's burden, the result will be salutary in that the various stakeholders will have a much clearer incentive to be more judicious in their demands on the city in the future.
Human beings make mistakes. Sometimes public officials make honest errors, or they allow themselves to be hoodwinked by slick folks from Wall Street. Sometimes voters get hoodwinked by slick politicians who are mostly looking out for themselves. Given the current economic and demographic landscape facing cities, the consequences of mistakes are going to be greater. We need smoother, better ways of dealing with those consequences. In allowing Stockton's bankruptcy to go forward, Judge Klein seems to have begun to point the way.