Following a burgeoning trend among cities across the country weighed down by hefty pensions and ever-increasing government spending, Stockton, California, has fallen into complete financial disarray, and a federal judge ruled Monday that the insolvent city is eligible for bankruptcy protection. Despite objections from creditors, who tried to block the bankruptcy filing because bankruptcy would mean that bondholders who financed city spending would get back from the city less than the principle that they are owed, U.S. Bankruptcy Judge Christopher Klein affirmed that Stockton may proceed with a plan to reorganize its debt, adding that creditors have acted in bad faith and have failed to subsidize their portion of the costs for negotiations. Klein insisted that the city "will not be able to perform its obligations to its citizens relating to such fundamental matters as public safety, as well as other basic governmental services," without the power of bankruptcy.
The impact Klein’s verdict will have on creditors will be significant, some critics say, as companies have already doled out tens of millions of dollars to the city. “The creditors got a big black eye today,” asserted Karol Denniston, an attorney involved in the legislation that directed the city’s mandated mediation for bankruptcy protection. “Now the stage is set for the real dogfight.” The judge intimated in his decision that the city may also have to reduce its payments to the city employees' pension fund so that the city can afford to pay its bills.
But the issue of whether federal bankruptcy law overrides California’s mandate requiring pension fund debts to be honored could spell trouble for the entire state, not to mention the rest of the country, analysts contend. "The fear is that there is going to be a run on the bank," said bankruptcy lawyer Michael Sweet, who has been following the contentious trial. "'Everyone is going to be cutting CalPERS [California Public Employees' Retirement System]' payments if Stockton is permitted to do it. California's $225 billion Public Employees Retirement System already is underfunded by $87 billion, which means there are more payments due to retirees than there is money in the system."
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