San Bernardino's Fiscal Mess
July 16, 2012 12:46 p.m.
Aaron Burgin, Watchdog reporter, UT San Diego
Pat Shea, bankruptcy attorney in San Diego.
Related Story: A View Of San Bernardino Bankruptcy From San Diego
CAVANAUGH: Last week, we learned that San Diego intends to become the third California city this summer to declare bankruptcy. It's on the path to follow Mammoth Lakes and Stockton into filing chapter nine protection. San Diego seemed to be on a similar path, not long ago, with leaders considering bankruptcies a way out of chronic multimillion dollar deficits. San Diego's mayor says they're now a thing of the past here. But many analysts fear other California cities are also headed off the financial cliff. Joining me are my guest, Aaron Burgin, watchdog reporter at UT San Diego. Welcome to the show.
BURGIN: Thanks, Maureen.
CAVANAUGH: And Pat Shea is a bankruptcy attorney here in San Diego. Thanks for coming in. This vote by the City Council didn't surprise a lot of the people that you spoke with on the city streets of San Bernardino. What did they tell you about the money problems in the city.
SHEA: They say they've got to look at the history of San Bernardino to understand how it got here. Some believe it's been limping along that direction for 20-odd years since Norton airforce base shut its doors in 1994, which took away the city's major source of employment. All of inland Southern California thrived off of that, revenues went up. But a lot of people believe the revenues masked the problem that was going on this which was spending more money than you really had at a point where you were gifted a lot of money. So police and fire were given pretty good deals with their pensions. They still actually don't want pay any portion of their pensions. You had a lot of projects that went on, some were successful, others were prolonged unsuccessful projects. Then you reached that cliff in 2008 when the housing market bust hit, you had property tax revenues just plummet. And here we are today where all of those problems have just come to roost.
CAVANAUGH: Does the city look like it's hurting financially?
SHEA: Well, when you drive in on I217, it just looks like a city that has seen its better days. It was a 1966 boomtown, but it looks like a city that's had a lot of financial hurt.
CAVANAUGH: And what was the rate?
SHEA: 17.7% unemployment, and 43% of the population is on some form of public assistance.
CAVANAUGH: Wow. Okay. So what amount of debt is the city of San Bernardino facing that is provoking this request as it were for bankruptcy?
SHEA: Right now, they're facing about a $45†million structural deficit, which means there's a big gap between the revenues that are coming in and the expenses that they've incurred. And they've gotten to the point over the past few months where they may not make payroll in the next 30 days without taking that bold decision to file for chapter nine bankruptcy.
CAVANAUGH: Pat, what would filing chapter nine bankruptcy allow San Bernardino to do?
TINSKY: A number of things. It allows the process to slow down a bit and allows them to discuss restructuring with all of their different creditor groups, the labor unions, the vendors, operation expenses that are accumulated and not being dressed. You've got bond holders and indentured trustees that require prompt payment. All of these are coming together at one time. And you're short. And because it is a structural deficit, it's not a single acute deficit like you had at mammoth lakes. This is a problem not just for today. It's the same problem next month and next year, and the years after that. The process and what's available to them is the opportunity to negotiate with all of the interest players, all of the stakeholders to restructure their debt package so that they can address it to the future. And to the extent they can't to, get accommodations to reduce it so they can pay the most they can.
CAVANAUGH: One report said this is the kind of filing that allows a city to keep its lights on.
TINSKY: It does. It does that legally, and from a structural standpoint, everybody stops pursuing their own personal interest and waits for the city to announce a structured approach which they would like everyone to consider. You can tell in situations like this the activity level actually comes up as vendors and stakeholders look and notice that you're not going to make it, they work harder and faster to make as much as they can. This calms that process and allows you to deal with them collectively.
CAVANAUGH: What's the downside?
TINSKY: Well, in this situation, there's really none. The downside is you stay where you are right now, which is a mesthat's not going to get any better. You really have to do something.
CAVANAUGH: Does it hurt your credit rating though?
TINSKY: By the time you get to this point, your credit rating -- the great thing about the Internet is we all know everything about everybody, particularly about municipalities. We all know about the Vallejos and the Stocktons and the San Bernardinos. Their credit issues are already at risk. But going to the credit rating issue, the experience that we've seen at least from the Orange County case, which was a collapse of the whole county of Orange under $2.2†billion that was missing. They went from having no credit, going through a restructuring, achieving a plan of adjustment, and being back in the credit market within 18 months. So even though it's unpleasant for the short tem, you don't have a great credit rating, you probably didn't have one anyway, but you can restore it by the fact that you become solvent.
CAVANAUGH: You were talking about the factors that might have precipitated this filing for bankruptcy. Sales taxes basically going down, you talked about pension obligations crushing the city, and that all sounds pretty familiar here in San Diego. But there are a couple things that don't sound familiar. And that is the shutdown of redevelopment money seems to have really precipitated that financial meltdown.
SHEA: Yes. As everybody knows, the state shut down redevelopment this year, and a lot of cities were able to withstand that blow. Not San Bernardino. The city attorney who's an elected city official say that was the straw that broke the camel's back. About about $67†million of that redevelopment money was used to redevelopment and improvement that would have been provided by the general fund. And once that spigot got cut off, you have the rising problems with vendors, creditors, and now $67†million worth of issues that you have to now pay out of the general fund.
CAVANAUGH: Is that because more of San Bernardino was basically designated --
CAVANAUGH: A low -- a problem, risky, low-income kind of an area?
SHEA: Well, most of the city was in a redevelopment.
SHEA: It was considered blighted.
CAVANAUGH: That's the word I was looking for. Thank you.
SHEA: You have a larger redevelopment area than some other cities such as Riverside or Ontario in that community. So you have a much larger area that you needed to use those redevelopment funds for.
CAVANAUGH: Hasn't San Bernardino already negotiated concessions with city unions?
SHEA: They've negotiated some concessions. But some of those -- all of them, actually, were temporary concessions that are set to sunset this year. So some of the structural concessions that you've actually seen San Diego and other cities take, such as paying just a portion of your -- a portion of the share of your pension cost. They haven't even reached that level yet. And a lot of the reason they haven't is because there hasn't been the political will in years to do that. They have a very interesting system, kind of similar to ours, where you're got this duelling city attorney and mayor, and they have had their own political factions. So there's just been this fracture on that council for years, it seems, and they haven't been able to do anything in terms of those hard decisions. One of the things that bankruptcy does, it's going to force the officials to make those hard decisions finally in order to come up with that plan that satisfies -- not necessarily satisfies, but at least it the allow people to get some payment. Everyone is not going to be made whole in this. But they're going to have to make the tough decisions.
CAVANAUGH: Pat, let's take an overview of this. Can you tell us why we're seeing three California cities -- obviously Mammoth Lakes has its own special consideration, but it's a third city heading for bankruptcy this summer. Why?
TINSKY: Well, sure. I think this is a situation that we see -- and we assume, each if we don't know it, we assume that it applies in lots of California cities. They sort of operate in a similar fashion. Nobody is out there by themselves doing stuff that other people aren't doing. So one of the things that has happened is, up, we have during the growth times, and during times of the real estate boom, we got used to having more money. We wanted to buy more things. We did. We borrowed more money. We assumed a greater and greater revenues into the future. So we promised more money to our employees and retirees and we really never built into the equation the downside structure of recognizing that if that turned around or if it changed, the obligations would be fixed, and the revenue would be variable. And as that equation starts to unwind over time, municipalities are good at sort of shifting money from 1†barrel to another to kind of cover, hoping that things will right themselves, if you will. But you can only do that for so long, as long as you have another barrel. Once you get to the point where there's not another barrel, everyone is believing that everything is just fine, they find out that all the barrels are empty and there are no options left. So I think that this is sort of an experience that once you see it once or twice or three times, you can suspect with some rationality that there are more of these, and the process of going from dealing with your problems sequentially, like we were talking about with the labor unions, and instead trying to put together a vehicle to allow you to deal with all of your obligations collectively, so not only do you have the ability to explain that you have limited resources, but among your creditor groups, they can look at each other and understand they're all going to have to be in. That dynamic is so powerful that we're going to see more of these sorts of situations just to have the process available for that dynamic to occur.
CAVANAUGH: San Bernardino is only 100†miles to the north. Any fallout that you can see on either the City of San Diego or the county of San Diego, maybe some of the smaller cities within the county?
TINSKY: I don't see the process this far. We all have this sense that bankruptcy in whatever fashion is sort of an ill wind. Government bankruptcies are different than any others. Governments don't go out of business. All of the downsides don't occur. You don't sell your assets. This is really the opportunity -- people will come to understand, this is the opportunity to restate your financial condition. And the experience you've seen in other municipalities in California elsewhere, this process is relatively short. In Orange County it was 18 months. Vallejo was a couple of years. But that's not a lot of time to restructure a financial situation. And after that is resolved, assuming that the plan really does deal with the structural issues that we're talking about here, your credit rating comes back quickly that you really do sort of reinvigorate not only yourself but those municipalities around you that now take notice of what you've done and try to accomplish it in bankruptcy or outside.
CAVANAUGH: Something of a sidebar issue, there are allegations of some fancy bookkeeping that kept San Bernardino city leaders in the dark about how bad the situation was getting. Tell us about that.
SHEA: It came out -- the Tuesday council meeting last week when they decided to make the decision, are the city attorney said, hey, 13 of the past 16 year, the city administrators, whether the city manager or the finance director, have kept us in the dark. They said that we had profit, and what we really had was debt. We were in the red 13 of 16 years. And then this was an announcement the following day, two days later, that the District Attorney, the sheriff's department, and the city police department have been investigating for self months some financial impropriety that was going on within the city. They don't feel this was necessarily the cause of things. This is kind of like you said, a sidebar. The major issue is they have had all of these problems, are and the officials were doing their best to mask the problems from not only the public but from city leaders. The mayor when he heard this, he hadn't heard this before, he was shocked.
CAVANAUGH: The different barrels that you're talking about?
TINSKY: Exactly. And this happens in municipalities everywhere in California. And I want to address the criminal investigations we're seeing, which may well not have to take place, because one of the things that happens when you go into chapter 9 is the focus and the energy of the entire community goes back into your recovery, your fiscal recovery. That's what happened in Orange County. There were two very minor criminal reviews at the very top, but it never became a criminal investigation because the one thing that chapter 9 does is it focuses everybody's energy, energy's attention on row structuring, and not to pointingly fingers as to who did what to whom and who tricked us. Is this really a deplorable situation when you're in this kind of difficult financial situation to have people start looking backward and decide who's responsible and who are we going to prosecute. That's not going to solve your financial problem. You need all the smart people and all the energy working on financial restructuring, not criminal activity.
CAVANAUGH: As we close, I want to talk about why we can't just come out and say that San Bernardino declared bankruptcy. A new state law is making it more difficult for cities to declare bankruptcy. What steps does San Bernardino have to go through now?
SHEA: The state law says they're required to enter mediation prior to going into bankruptcy, unless they declare a fiscal emergency. Tonight, San Bernardino City Council is taking up who to declare that fiscal emergency.
CAVANAUGH: Why would the state want cities to engage in this kind of mediation?
TINSKY: You know, I'm not a fan of the law. The bankruptcy process is filled with the obligations to negotiate with your creditors. You're required as a precursor to filing for chapter nine to show that you've either negotiated with your creditor classes or it would be impossible or unreasonable to do so. The bankruptcy process requires you to do that. To add an additional state lair -- top of that just delays the process. These people think they're not going to make payroll, and they don't have an unlimited amount of time to go through negotiations with Sacramento which has its own financial problems, by the way. So there is that one out, which is that if you are facing an immediate financial disaster, you can go directly in, and I think they will.
CAVANAUGH: And that's what they vote on tonight. Thank you both.