Public Administrators See Financial Crisis Ahead for California Municipalities

David Kersten
Kersten Institute for Governance and Public Policy

A relatively small but growing number of public finance experts and administrators are projecting an impending financial crisis for California municipalities—which will become particularly acute when the next recession hits.

The Los Angeles Times, East Bay Times and Sacramento Bee and many other California newspapers have recently run a series of stories documenting concerns voiced by an increasing number of elected officials, public administrators and other experts regarding the impending fiscal crisis that California municipalities face as a result of skyrocketing public pension costs.

Acting Modesto City Manager Joe Lopez recently delivered a sobering assessment about the City of Modesto’s rising pension costs, telling the Modesto City Council that the California Public Employees’ Retirement System (Calpers) is not sustainable in its current form, according to a Modesto Bee report.

“Ultimately there is going to have to be a substantial change made to the way the pension system is run…There is going to have to be substantial changes to the actual benefit packages if these are ever going to be sustainable…Calpers can’t continue to rely on revenue (from cities and its other public sector members to meet its pension obligations),” Lopez told the City Council’s Effective Government Committee, which held budget hearings in mid-May, according to the Bee report.

Lopez is a member of the League of California Cities pension task force and as a member of that task force he is hearing that many cities are facing bankruptcy over rising pension costs, according to the Modesto Bee report.

The City of Modesto projects that within eight years it will pay nearly 72 cents in pension costs for every $1 in salary.  “For every one police office,” Lopez said, “three-quarters of the next police officer is a pension payment.  That is a very scary place to be,” Lopez said, according to the Modesto Bee report.

“I’m pretty sure we can stave that off,” Lopez said referring to a possible bankruptcy in the City of Modesto’s future, due to recent changes enacted but cautioned that many other cities may not be so lucky.

“I think your presentation sucked the life out of everyone here,” Councilman Bill Zoslocki told Lopez, who responded by saying that he wanted to “make sure we painted a realistic picture of the challenge ahead of us.”

According to a recent East Bay Times Report, “Lodi City Manager Steve Schwabauer says he worries about his town’s fiscal solvency—and estimates roughly a third of California’s municipalities are in the same position because of rising pension costs.”

Nancy Kerry, city manager of South Lake Tahoe, says her community will avoid bankruptcy but will have to make severe cuts in services to do so, according to the East Bay Times Report.

“Schwabauer and Kerry are among a small number of top administrators now publicly talking about the financial crisis ahead.  They both say the only way to stave it off begins with reducing pension benefits for existing employees,” states the East Bay Times report.

“If we had taken this on 15 years ago and said we had a real problem, I think there might have been another way out…We waited too long to deal with it because nobody wanted to pay the bill,” Schwabauer told the Times.

But as it turns out many experts, myself included, believe that a significant number of California localities will be unlikely to avoid financial collapse short of filing for municipal bankruptcy.

“I don’t think there’s any chance we can avoid it,” says former Richmond City Councilman Vinay Pimple, referring to bankruptcy, according to a report by CalMatters.org that appeared in the Los Angeles Times.

“A major cause of Richmond’s problems: relentless growth in pension costs,” concludes the CalMatters.org report.

In 2012, Moody’s Investor Services issued a report warning that it expected more municipal bankruptcies and bond defaults in California, according to the Associated Press.

The warning came in the wake of three municipal bankruptcy filings in 2012 alone—the cities of Stockton, San Bernardino and Mammoth Lakes.

But in 2012 the California economy started to turn around from the financial collapse that hit in 2008.

In 2012, the City of San Francisco became the first city in California to achieve revenue levels that equal or exceeded the pre-2008 economic collapse, according to city budget documents.

Most California cities did not see their revenues fully recover until 2013 and 2014, and even 2015, based on my broad review of public agency financial reports.

This turnaround in the economy and public revenues saved many California cities from the brink of bankruptcy, such as the cities of Oakland and Atwater, who were widely believe to be extremely close to bankruptcy in 2012 and 2013.

But now in 2017, Governor Jerry Brown and the California Department of Finance have projected that an economic recession is overdue and caution both the state, as well as local governments, that a significant downturn in the economy and therefore substantial decline in public revenues is imminent.

In December 2016, the board for the California State Public Employees Retirement System (Calpers), bowing to political pressure from the Governor, lowered its investment return assumptions from 7.5% to 7%, which is estimated to result in a 40% increase in required pension contributions for cities and other public agencies.

This increase comes on top of recent 50% plus increases projected for 2015 to 2020, due to the Calpers decision from a few years ago to “smooth” unfunded pension liabilities over a 20-year period.

The December 2016 Calpers changes will be phased in over three years and most likely take effect as public agencies are least able to pay for the increases due to softening revenue growth.

If the aforementioned public administrators and others that I have talked to are correct, many California localities are likely approaching a tipping point in the not so distant future where many public localities will not be able to afford to make the public pension payments and be faced with a few undesirable options.

First, these localities could be forced to suspend their required payments to Calpers as some well-publicized localities have chosen to do, which results in Calpers making drastic reductions to the public pensions of the retirees who retired from these public agencies.

Second, if the revenue declines are significant enough, many of these localities will likely have no other option than to enter municipal bankruptcy.

The only question is when will the next recession hit, and how many California public agencies will be forced to consider municipal bankruptcy as their only option to avoid financial collapse?

David Kersten is the president of the Kersten Institute for Governance and Public Policy—a Bay Area-based public policy think tank and consulting organization. Kersten is also an adjunct professor of public budgeting at the University of San Francisco. 

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