Originally posted on the Milken Institute Currency of Ideas blog

The decision of Stockton, Calif. to consider bankruptcy has had ramifications throughout the state. The city’s relative size of nearly 300,000 people and significant deficit that could reach as much as $38 million by next year raise significant concerns about the financial health of cities affected by the economic downturn, especially in California.

For investors and people living in California, the news is clearly a cause for concern. The question is not simply, “Will Stockton actually declare bankruptcy?” but, “Are there other Stocktons out there considering the same steps?” Although many of the factors that have pushed Stockton to this stage are much more severe in Stockton’s case, the key elements of pension obligations, declining local revenues, and fiscal uncertainties at the state level are mirrored throughout California by many other cities, both large and small.

In many ways, Stockton mirrors the rest of California. Commitments made during boom times, such as higher pensions, are combining with the consequences of the recession and the burst housing bubble to severely dent the city’s fiscal situation. Further exacerbating the difficulties are the massive deficits at the state level, which has led to significant cuts to funds for local programs such as education and the elimination of redevelopment agencies.

Pension obligations are the biggest concern, as cities that agreed to join CalPERS — such as Stockton and Vallejo — must match any contribution rules made by the state legislature. The result is that many cities, as was Stockton’s case, lose control over significant portions of their budgets. And in poor economic times, they cannot raise the revenue needed to cover their obligations.

In other ways, the situation in Stockton involves many factors that are if not unique to the city in their type, are clearly unique in their intensity. Stockton in particular is a city that saw an extremely dramatic shift in its economic fortunes. In 2005, despite its position in the fairly remove San Joaquin Valley, Stockton saw itself developing as a satellite suburb for San Francisco and Oakland, and the city ranked 31st in the country in the Milken Institute’s Best Performing Cities index for that year, buoyed by a strong economy and booming housing market. By 2009, Stockton had slipped all the way down to 166th place, reaching a state low 187th in this year’s index.

This rapid decline in the city’s job situation combined with rapidly falling land values was seen as early as 2007, when Stockton issued a large $125 million bond to pay off CalPERS obligations right before the stock market dropped. Stockton’s economy has also failed to rebound when other Northern California metros, such as San Jose and Merced, did. No other California metro has seen such a consistently weak job situation over the past five years. The City Council’s decision to delay bond payments also raises concerns over long term fiscal issues such as those facing Jefferson County, Ala.

There is hope on the horizon, however. Negotiations to reduce future pension and benefit obligations are bearing fruit and will clearly show long-term improvements for cities such as Stockton. Construction of intermodal port facilities in the city are creating jobs both in the near and long term. The concern is that neither of these developments helps Stockton and cities like it right now.