Public pensions may be at risk in bankruptcies

The public pension-reform legislation that the California Legislature and Gov. Jerry Brown adopted very carefully avoided any changes to current pensioners’ benefits and those of future recipients now on state and local payrolls.

Not only would that have been politically impossible, but it’s widely assumed that pensions are protected by the California Constitution’s ban on “impairing the obligation of contracts.”

Therefore, all of the pension  changes apply only to future employees.

But is the legal barrier to changing current pension promises absolute?

Or could Stockton’s municipal bankruptcy filing punch a hole through it?

Under bankruptcy protection, Stockton wants those who hold millions of dollars in city-issued bonds — or their insurers — to take a cut, but it doesn’t reduce the $29 million it pays each year to the California Public Employees’ Retirement System. That doesn’t sit well with the bond insurers.

Assured Guaranty Ltd., which insured many of those bonds and could lose more than $100 million, complained in a bankruptcy court filing that Stockton “targeted its bondholders and left CalPERS and serious labor concessions off the negotiating table.”

Another insurer, National Public Finance, added: “Rather than face the hard realities imposed by its unbearable liability to CalPERS, the city takes a pass.”

The insurers, in essence, are asking bankruptcy Judge Christopher Klein to declare that the city’s bankruptcy plan is inadequate because it ignores pension debt, thereby presumably requiring it to reduce pension costs. In reaction, CalPERS has told Klein that pensions should have more status than bonds.

During Vallejo’s bankruptcy reorganization a few years earlier, CalPERS warned the city not to attempt to cut pensions and it didn’t. Nevertheless, Vallejo generated union-backed, albeit unsuccessful, legislation to force cities to get permission from a union-friendly state board before filing for bankruptcy protection.

But what about the California Constitution’s protections of pensions as contracts? Wouldn’t that shield them in bankruptcy court?

Not necessarily, as Klein’s ruling in a related matter implies. Stockton cut health care for its retirees, and they asked Klein to restore coverage, claiming “vested contractual rights.” But last month, he declared that federal bankruptcy law trumps the state constitution’s contract impairment provision.

“In other words,” he wrote in a 40-page ruling, “while a state cannot make a law impairing the obligation of contract, Congress can do so. The goal of the Bankruptcy Code is adjusting the debtor-creditor relationship. Every discharge impairs contracts.”

Could bond insurers force Stockton to reduce its retirees’ pensions?

It’s certainly possible. If it happens, long-held assumptions about the sanctity of California’s public pensions will change.

Dan Walters covers state politics for the Sacramento Bee.

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