California Muni Bankruptcies a Growing ‘Disease,’ Kotok Says

Municipal bankruptcies in California, where three cities have filed for protection from creditors since June, are a spreading “disease” in the state, said David Kotok, chief investment officer at Cumberland Advisors.

In Atwater, a city of 28,000 southeast of San Francisco, the council is set to vote today on declaring a fiscal emergency, which would allow it to follow California municipalities Stockton, San Bernardino and Mammoth Lakes into bankruptcy.

Cities in the most-populous U.S. state can make such declarations to bypass mediation with creditors before a Chapter 9 filing. Across California, the recession that ended in 2009 and the foreclosure crisis have depleted property-tax revenue even as municipalities are burdened with rising costs.

“In California, we have a disease, and the disease is spreading,” Kotok said today at the State & Municipal Finance Conference hosted by Bloomberg Link in New York. “I suspect we’re going to see wholesale warnings and downgrades” among issuers in the state, he said.

Kotok helps manage about $2.1 billion as chief investment officer of Sarasota, Florida-based Cumberland.

Rating Revisions

Moody’s Investors Service said in August that California cities may face “across-the-board rating revisions” because of the state’s volatile real-estate economy and “hands-off” policy on local finances.

Atwater, situated among Merced County’s dairies and almond groves about 100 miles (about 160 kilometers) from San Francisco, has a $3.3 million deficit that may leave it insolvent by year-end, according to budget documents.

Under a new state law, cities seeking bankruptcy protection must first declare a fiscal emergency or hold talks with creditors through a mediator. They can file for court protection if mediation doesn’t bring a resolution in 60 days or if the city runs out of money.

State officials have been successful “in taking as much revenue as possible from local governments,” including eliminating redevelopment agencies, said Miguel Santana, chief administrative officer for Los Angeles, California’s largest city.

‘No Cushion’

“For most cities in the state, we’ve been forced to fend for ourselves,” Santana said. “And unlike the state, we really have no cushion.”

California cities can’t rely on the state government for help, “we’re just hoping to be left alone,” Santana said.

Cities have been forced to shrink the size of their governments, cut services, and handle pension and health-care costs on their own, Santana said.

“Ultimately, bankruptcy becomes the option when you’ve run out of options,” Santana said.

Municipal bankruptcies are “largely a self-inflicted wound,” said David Crane, a public policy lecturer at Stanford University near Palo Alto and a former special adviser for former Governor Arnold Schwarzenegger.

“Nobody forced legislators and councilmembers to make promises -- unfunded promises amounting to hundreds of billions of dollars -- to their benefit, to their political benefit,” Crane said.

Curbing Pensions

Ballot measures to curb public-employee pension costs approved by about a two-thirds vote in San Diego and San Jose in June should serve as “a wake-up call” to state lawmakers, Howard Cure, director of municipal research at Evercore Wealth Management LLC, which oversees $3.7 billion, said at the conference.

Voters in San Diego and San Jose, California’s second- and third-largest cities, supported changes that would require city employees to contribute more toward their retirement and raise the retirement age.

Unfunded pension liabilities stemming from promises made during better economic times are straining municipal budgets, forcing city officials to cut jobs and services to stay solvent.

“People are very upset and it’s sort of almost an us-against-them mentality,” Cure said. “Legislators in Sacramento have to start thinking about who their constituency is. Is it the union members and state workers or is it the taxpayers?”

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