The public-employee pension empire strikes back

January 16, 2013 | Bankruptcy, California, CalPERS, Cities, Litigation, Municipal bankruptcy, San Bernardino, Speculation, US News

By:David A. Smith


As the battle over insolvent cities heats up, Calpers has taken the inevitable step in response to the City of San Bernardino’s filing of bankruptcy and suspension of its payments to its largest creditor – the pension fund manager has sued its customer. 


We’re your pension fund managers and we’re here to sue you


As reported in Bloomberg (November 28, 2012):


Calpers Seeks to Sue San Bernardino Over Pension Payments


The California Public Employees’ Retirement System is seeking to sue bankrupt San Bernardino over missed pension payments, the second potentially precedent-setting fight the fund picked with a California city this year.


This feels to me something of a pre-emptive strike – to sue the City for non-payment before the City can sue Calpers for malfeasance and fraud in the inducement regarding the expected returns from Capers investments.


San Bernardino can’t use U.S. bankruptcy law to justify its failure to make at least $5 million in payments Calpers said in court papers filed Nov. 27.


There’s also a pure tactical element as well:


Calpers also may set a legal precedent in the San Bernardino case if it wins the right to fight the city outside bankruptcy court, Kenneth N. Klee, who helped rewrite Chapter 9 of the U.S. Bankruptcy Code in the 1970s as a lawyer working for Congress, said in an e-mail.


Klee warns against taking it outside … the court


More critically than these legal tactics of venue and forum, if Calpers failed to sue the city, that would give every other city carte blanche to stop making its Calpers payments immediately upon its bankruptcy filing.  So the dog had to bark in the night.


No longer unthinkable, especially in California


The motion relies on arguments the fund is also making in the bankruptcy of Stockton, California, and may be a warning to other cities struggling with high pension costs, said James E. Spiotto, a bankruptcy attorney and partner at Chapman & Cutler LLP in Chicago.


Explicating litigation as intimidation: Spiotto


“You don’t know if they are trying to send a message to others through San Bernardino, which is to be respected,” Spiotto said yesterday in a telephone interview.


Obviously they are.


Calpers is the biggest U.S. public-employee pension fund.


Probably until the money runs out


Though it cloaks itself in the mantle of government, Calpers is nothing more than a private entity – a pension fund investor — and even more fundamentally, it is an instrumentality of public employee unions.  Its suing of San Bernardino was necessary, but doesn’t make the action legally sound or in the public interest.


Other cities and municipal bond investors may fear that Calpers’s strategy will lead to long and costly legal battles that leave less money to pay for essential services such as police and fire protection while driving up borrowing costs, Spiotto said.


Undoubtedly there will be protracted legal battles – that is in the nature of unprecedented bankruptcies, like San Bernardino’s here in California and Jefferson Country’s in Alabama.  But it beats paying the bastards if you do not have to.


You can pay me now or pay them later


Since initiating bankruptcy proceedings, San Bernardino has skipped $6.9 million in payments to Calpers, the pension fund said in an e-mailed statement.


And it will continue to do so, I’m sure.


Earlier this week, San Bernardino passed a provisional spending plan for use in bankruptcy. Under the so-called pendency plan, the city would put off paying $13 million to California’s retirement system and $3.4 million for pension bonds.


Exactly so. This is a David-and-Goliath fight, where the roles are reversed: Calpers is the Goliath.


Kill the head and the body dies


The $241 billion Calpers fund has continued to pay pensions to the city’s retirees, according to the statement.


Yes, Calpers is caught; it’s rich – extremely rich – and if Calpers defaulted on any of its payments, then everybody would sue it, including those cities not yet bankrupt that are still making large payments into the fund.


Bondholders would be penalized if Calpers gets its way, Matt Fabian, managing director of Municipal Market Advisors, a research firm in Concord, Massachusetts, said.


“The issue is, do Calpers obligations supersede unsecured bondholders?” Fabian said in a telephone interview.


Fabian defends bondholder society


The issue in question is enormous, both legally and financially. 


1. Legalities first, as the actress said to the bishop. 


A bond is a debt instrument that represents a pledge by the borrower to make a stream of payments (debt service) over the ensuring months and years.  Normally the bond is also secured by a direct assignment of assets (say, annual tax collections)


An unfunded pension fund liability is the amount estimated by actuaries to represent the net present shortfall between (x) the present value of all the liabilities due to be paid to beneficiaries, and (y) the present value of all assets possessed by the fund.  The liabilities, in turn, are defined benefit, meaning the sums are stipulated regardless of the fund’s earnings performance; the actual amounts paid out depend only on when people retire, when they get sick, and when they die. 


Over-promise, under-deliver – sounds like public financing to me


Of those two, the bond has greater specificity, clearly and more substantial documentation, and better collateral.  All this matters legally, because in bankruptcy creditors have a strict hierarchy, based on what collateral they have secured in their debt obligations.   

In the Stockton and San Bernardino cases, Calpers is arguing that pension contributions must be made ahead of payments to other creditors because they are so-called statutory liens, or debts that state law requires to be paid.  


That’s novel – in effect, Calpers will be claiming that because the legislature authorized certain payments to employees, those payments have the force of law higher than the force of any contract. 


Bondholders and other creditors that oppose Calpers argue that pension debt is a contractual obligation like any other.


Presumably there are state-specific issues of California law, but absent those, or some remarkable documentation to surface in the discovery, there’s no way I can see to claim that unfunded pension liabilities are senior to bonds.


2. Then the finances.  If the unfunded pension liabilities (are in fact debt instruments of equal priority with or superior priority to the bonds, then at a stroke many states will go from theoretically defunct to immediately insolvent. 


Take what your state owes in bonded, and multiply by two


The foregoing table is financially obscene.  Bonds are the instrument states use when they want to build infrastructure – highways, bridges, a subway system, even ill-advised convention centers – and while the indebtedness is a large sum, at least the state’s taxpayers own something for it.  But with pension liabilities, what do we own?  This is money due to be paid to people when they are no longer working for the state – in other words, it’s the deferred compensation payable when people are deadwood. 


 “There’s an awful lot of unsecured bondholders in California. If you put pension obligations to Calpers as secured and senior to unsecured debt, in effect those bonds have been downgraded.”


Exactly so.


San Bernardino City Attorney James Penman and Gwendolyn Waters, a city spokeswoman, didn’t return calls seeking comment on the court filing.


We’ve previously seen the caliber of Mr. Penman’s reasoning.


If A, then B?


“This legal action would allow us to collect the employer contributions from San Bernardino, which are required by state law, to maintain the integrity of the San Bernardino pension plan for its public employees and retirees and to avoid needless procedural disputes and additional legal costs,” Anne Stausboll, Calpers chief executive officer, said in the statement.


Like the Boss, Ms. Stausboll is an Obie, which is to her credit, but she’s also a lawyer, and basically a lifetime state-government employee:


Before coming to CalPERS, Ms. Stausboll was Chief Deputy Treasurer to the California State Treasurer, beginning in July 2000. Prior to serving in the State Treasurer’s Office, Ms. Stausboll worked for six years in the CalPERS Legal Office, including two years as Deputy General Counsel.


It’s our money, you see, and we have to protect it even against bankrupt cities


3. Now the political economics.  There’s a third argument to consider as well.  Are unfunded pension obligations more senior debt than debt represented by a financial instrument, as Calpers is claiming?  If so, if they are valid debt, then they are debts authorized by the taxpayers.  And if they are such debts, that makes a mockery of state balanced-budget laws, such as California’s Proposition 58. 

The city of San Bernardino has $90 million of outstanding debt repaid from the city’s general fund, according to an Aug. 29 council report. Its unfunded pension liability is about $143 million, according to court papers.


Got that?  The unfunded pension liability is 1.7x as large as all the other city borrowing combined.  Truly Calpers is the gorilla of the piece.


Don’t make me mad


To help curb spending, the city has fired school crossing guards, closed three branch libraries and cut 41 non-uniformed police jobs, the city said in budget memos.


More cuts are coming – that is, unless the City of San Bernardino wins a stay of execution in bankruptcy court:


Once a city or private company enters bankruptcy, creditors can’t seize property or sue for payments without permission from the judge overseeing the case.


Calpers claims that it is exempt from that requirement because it is a governmental agency.


Lordly economic imperialism: our actuaries and our executives are more important than your policemen.


The fund may have a hard time winning that argument because it isn’t exercising traditional police powers, Klee and Spiotto said.


For goodness’ sake, it’s a company.  In fact, it’s a company that represents one vested interest – the public employee unions and their members.


We’re just looking out for the state’s interest


Because of this, I think Calpers has to lose in the law.


“If participants in the Calpers system fail to timely make payments, then Calpers will be unable to provide an actuarially sound retirement system,” the pension fund said in a filing in U.S. Bankruptcy Court in Riverside, California.


Probably true, but they already got themselves into that pickle. 


The Stockton fight is further along and may set a precedent for how Calpers payments are treated, Spiotto said. That decision will be made by the federal judge overseeing Stockton’s bankruptcy case in Sacramento.


Senior to bond debt service?  We’ll find out


In a previous post on this subject, I wrote, with characteristic caution:


Write it down now: Calpers will eventually be sued by the California attorney general.


It’s one thing to be sued by individual cities.  It will be quite another when Californai’s Attorney General weighs in, for the health of the whole state.


And Calpers will go bankrupt.


The bigger they come, the harder they may fall.


It could happen