Monday, October 10, 2011 | Although Santa Ana city officials and union leaders are saying they can work together to pare down the city’s $30-million budget deficit, the word bankruptcy is being whispered more often these days in the corridors of City Hall.

And it is clear, as the city and unions enter the early stages of negotiations, that if the two sides don’t agree to drastic cost-saving measures, the prospect of bankruptcy will go from a persistent rumor to a distinct possibility.

Yet because there are so few cases of municipal bankruptcy, there is no clear understanding of what bankruptcy would ultimately mean for the city. Labor contracts may or may not be scrapped. The city’s credit rating could be left scarred, or it could easily bounce back. Long-term pension obligations have never been tested in bankruptcy court.

“These are experiences we don’t have a lot of history on because Chapter 9 [municipal bankruptcy] hasn’t been exercised very frequently,” said Larry Rosenthal, an assistant adjunct professor at UC Berkeley’s Goldman School of Public Policy.

Municipal bankruptcy is unique in that a city can’t simply dissolve, sell off its assets and pay back its creditors like a company that files for bankruptcy. Instead, bankruptcy forces cities and their creditors back to the negotiating table. Cities present a budget-balancing plan to a bankruptcy judge, who then decides whether the plan will work.

If Santa Ana does file for bankruptcy, the city would join a small, inglorious fraternity of public-sector bankruptcies that are already overrepresented by California governments. Orange County’s bankruptcy in 1994 remains one of the great cautionary tales of how a government can go broke betting on Wall Street.

Former county Treasurer Robert Citron gambled away more than $1.6 billion in taxpayer money on investments that soured. Interest earnings at one point were expected to fund 35 percent of the county’s general fund budget. But Citron’s bets failed, and the county continues to pay about $90 million annually to retire debt from the bad investments.

Then in 2008, the Bay Area city of Vallejo began what ended being a painful, years-long bankruptcy process after the city failed to close a $9-million deficit in its $83-million general fund budget.

The similarities between pre-bankruptcy Vallejo and Santa Ana are undeniable. Both had general fund budgets that were redlining public safety costs to well over 70 percent of the general fund, with the lion’s share for salaries and benefits.

Public safety unions argued that Vallejo could cut in other places to balance the budget, but a judge ruled that the city could ignore its fire and electrical union contracts.

The city took an ax to its public safety budget by eliminating dozens of police positions and closing fire stations.

“All bankruptcy did was lend assistance to the city in renegotiating the contracts with its workers,” Rosenthal said.

But Rosenthal cautioned that Vallejo was just one case and not necessarily a predictor of how a bankruptcy would go in Santa Ana. Once a municipality declares Chapter 9, it puts its fate entirely in the hands of a judge, and a judge could rule in favor of maintaining union contracts, Rosenthal said.

“It changes the bounds of power between the parties. That doesn’t mean that any given bankruptcy judge will [invalidate the union contracts], but that’s what happened in Vallejo,” Rosenthal said.

More Bankruptcies To Come?

Even with the uncertainties inherent in the process, Rosenthal expects that municipal bankruptcy will become an increasingly attractive option to municipalities. As more cities take the leap, bankruptcy lawyers will have an easier time processing such cases, driving the legal costs down, Rosenthal said.

One of the biggest long-term consequences with municipal bankruptcy is the political stigma, something Orange County Supervisor John Moorlach can describe from experience.

“It gave us a scarlet letter, we [Orange County] will always be known as the county that went bankrupt,” Moorlach said. “If they [Santa Ana] go into Chapter 9 the way Vallejo did, they will become famous.”

Nonetheless, Moorlach said he hopes that cities will use bankruptcy to tackle their ballooning pension obligations, specifically the plan that allows employees to retire at age 50 with 90 percent of their salaries, known as the “3% @ 50” formula. Vallejo’s city leaders didn’t wade into those waters during its bankruptcy, fearing that they would lose the pension battle.

Vallejo’s agreements with the unions after bankruptcy included slashing retiree health benefits from $1,500 to $300 per month. Payout on accrued leave time was eliminated. Eventually, the city’s firefighters union agreed to reduce its pension formula for new hires to retiring at age 50 with 2 percent of final pay for each year served.

Because of Vallejo’s reluctance to confront what some call a looming pension tsunami, Moorlach questioned the city’s decision to go into bankruptcy, which ultimately cost the city more than $9 million in legal fees.

“Why would you go into bankruptcy court where you spend a few million bucks when you can do that outside for free,” Moorlach said.

Santa Ana also lets public safety employees retire under the “3% @ 50” formula. The annual cost for employee retirement is expected to rise to $20.4 million by next fiscal year, consuming 11.3 percent of the budget, according to a consultant’s report.

“Some city has to go into Chapter 9 and deal with the bargaining agreements,” Moorlach said. “We need some kind of unfunded liability messiah to come along.”

Jonathan Weber, former editor-in-chief of the Bay Citizen, a nonprofit online news organization, had a front row seat for the Vallejo bankruptcy. He said the city is still suffering mightily in the aftermath. He points to an increase in crime and attributes it to the deep cuts to public safety.

Crime has a domino effect, Weber argues, driving down property values and drying up business investment. Ultimately, such deep cuts in services injure the city’s ability to bring in revenue, Weber said.

“I think from the city’s [Vallejo’s] point of view it was really kind of a grim scenario,” said Weber. “They might argue that they had no choice, but it’s certainly not something that’s a good thing — even from the perspective of a city manger.”

The Thinking in Santa Ana

The Vallejo case was widely seen as a cautionary tale for labor unions engaging in bare-knuckle negotiation tactics. In the run up to bankruptcy, city leaders sought steep concessions from the unions that they simply wouldn’t accept.

“It’s plain in hindsight that they [unions] would have been better off cutting a deal,” Weber said. “Whether they would admit that, I don’t know.”

Santa Ana’s public safety unions, at least in the early going, seem to be taking a more conciliatory stance. John Franks, president of the Santa Ana Police Officers Association, has been particularly clear in his intentions.

“What I can say is that we will make the necessary concessions,” Franks has previously said.

Franks didn’t return a phone call seeking an interview for this story, but he has said that talk of bankruptcy is an unnecessary distraction. He wants to be able to negotiate in good faith with the city without bankruptcy or outsourcing of police services brought into the conversation.

The cordial relationship between public safety unions and city leaders so far is encouraging, said Councilman Sal Tinajero. The willingness to work together is what makes Santa Ana different from Vallejo, he said.

“I’m not even thinking about bankruptcy right now, because bankruptcy right now is not an option.”

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