CalPERS: It Came from Sacramento

“Heads I win; tails you lose.” That essentially sums up the relationship the California Public Employee Retirement System (CalPERS) has long enjoyed vis-à-vis the Golden State’s elected officials. Now it is finally facing a serious challenge.

Last week, a federal bankruptcy judge ruled that cities must treat bondholders and pensions in like fashion. Judge Christopher Klein of the Eastern District of California said he would decide by the end of October how to apply the ruling to the bankruptcy of the City of Stockton, but it seems unlikely that pensions will escape cuts altogether, while bondholders are forced to take haircuts. 

As The New York Times reported on the case:

Calpers is a powerful arm of the state, with statutory powers that include liens allowing it to foreclose on the assets of a city that fails to pay its pension bills.

Calpers had argued that if Stockton stopped making payments and dropped out of the state pension system, the lien would let it claim $1.6 billion of its assets. But Judge Klein said those statutory powers were suspended once a California city received federal bankruptcy protection.

“Why should I take that lien seriously?” he asked a lawyer for Calpers, Michael Gearin. “I may avoid it as a black-letter matter of bankruptcy law,” he said, referring to well-established legal principles.

He did not dispute that Stockton would be billed $1.6 billion to leave Calpers and said such a termination fee “can be seen as a golden handcuff.” But in bankruptcy, he said, Stockton could legally refuse to pay the bill because it arose from the city’s contract with Calpers, and contracts are broken routinely in bankruptcy.

“The bankruptcy code provides that the lien can be avoided and be treated as an unsecured claim,” Judge Klein said.

Judge Klein also said that Stockton had many options other than Calpers for retirement benefits: a private provider, like an insurance company; a multiemployer pension plan affiliated with a union; one of California’s county-run pension plans; or it could even offer no pensions at all.

As many fiscally troubled California cities have struggled to get control over their finances in recent years, government employee pensions have proven an obstacle because of their overly protected legal status. The difference this time was a lawsuit by a creditor, Franklin Templeton Investments.

In mediation, the city had initially proposed to settle the entire debt for less than a penny on the dollar, but Franklin managed to improve its position somewhat by showing that about $4 million of the debt was secured and had to be paid. That helped, but the city was still offering less than a penny on the dollar for the unsecured portion.

That left Franklin to argue that Stockton’s exit strategy could not be approved by the court because it unfairly discriminated among creditors because Calpers was not going to lose a penny and Franklin would receive so little. 

As noted, how Judge Klein applies his ruling remains to be seen, but it should send a clear signal, as The Fresno Bee’s editorial board aptly summarized:

To the Legislature: It can’t rewrite federal bankruptcy law. To the city of Stockton, Franklin Templeton Investments and CalPERS: They need to make a deal. And to local officials across California: They need to get serious about pension reform.

That message should extend to state officials as well. The CalPERS albatross that’s weighed down cities like Stockton and Vallejo was created in Sacramento. Yes, pension reform is a huge challenge that requires upsetting some a politically powerful constituency, government employee unions. But as the example of Rhode Island state treasurer Gina Raimondo shows, it can be successful—and even yield political benefit, if pursued boldly.