Stockton Goes Bankrupt; Los Angeles and CA Next?

The city of Stockton, California, America’s 65^th largest city, has filed for bankruptcy. While the media presents Stockton as a sad case of a city economy damaged by the real estate market and frivolous spending on various public works projects, the truth is far different: Stockton has been bankrupted by its government worker unions. And Stockton is important because it’s just the first – or rather second, after Vallejo – domino to fall. Next in line: Los Angeles, then California, then the United States.

Just take a look at the statistics surrounding Stockton. The city faced an annual deficit of $26 million; last year, it faced a $37 million deficit; the year before, it faced a $23 million deficit. By fiscal year 2014, it was supposed to grow to $48 million. 

Now, how did Stockton pay for these deficits? By selling bonds. And at a certain point, bondholders stopped buying more bonds, because they realized they’d never see their money again. One good indicator that bondholders were going to lose their cash came this year, when Stockton defaulted on $2 million worth of bonds, instead turning over City Hall and several parking garages to Wells Fargo.

So, where was all this money being spent? On the unions. The city had over $800 million in unfunded pension liability and health benefits to union members; a full 81% of the city’s general fund budget was employee (read: unionized) services. Retirement costs constitute a full 17.5% of the budget.

In desperation, Stockton made cuts — $90 million from the general fund over three years, including reducing the police department by a quarter and the fire department by 30%. No dice. And they couldn’t get a better deal thanks to mandatory mediation rules between unions and the city.

All of this was fun and games while the economy was good, and Stockton could keep raising taxes and selling bonds. But when the real estate economy tanked, Stockton quickly hit the skids.

Here’s the real problem: Los Angeles is next to go.

Los Angeles is currently facing a $238 million shortfall in 2012-2013; the city also faces $27 billion in unfunded pension liabilities. The annual budget is approximately $7 billion. So we have a problem.

And check out these percentages: for fiscal year 2011-2012, pensions will constitute some 15.4% of city expenditures. That’s not much lower than Stockton’s.

And the state of California has the same problem. The state reportedly has nearly $1 trillion in unfunded pension liabilities. Every year, California runs a massive deficit. According to certain calculations, well above 80% of California’s budget goes to state employee compensation. And the cuts Jerry Brown has suggested are Stockton-like – they don’t amount to a drop in the bucket.

Stockton is just the beginning. At a certain point, you run out of other people’s money – or they stop buying your bonds. When that happens, look for true fiscal ruin to set in.