Friday, October 18, 2013

What happens if Measure A fails?

Measure A and the bankruptcy exit plan are directly linked and have some flaws (my discussion of those flaws has been highlighted by opponents on a flyer).  The question to voters is will the alternatives that emerge if Measure A fails be better or worse for the City?  

There are several clear short-term impacts if Measure A fails:  1) the hiring of cops for the Marshall Plan on crime will be delayed, 2) Stockton taxpayers will save about $27 million (about $90 annually on per capita basis, although sales tax is paid by residents and non-residents).

Other impacts are less clear and direct.  Here is my take on some key questions.
1)   Will a tax proposal on the ballot next year be better or worse than the current proposal?  Will it be an unrestricted or restricted tax? Will there be competing tax proposals on the 2014 ballot?

As I listen to the debate around Measure A, a lot of the opposition is that it isn't a restricted tax, and if it fails - there will probably be a big push for a restricted tax.  It is possible there could be competing tax proposals (restricted and unrestricted) on the ballot, a situation that was avoided this November when the Safe Streets initiative faded and the Mayor compromised and supported Measure A.

A restricted tax is a bad idea for a City in bankruptcy, as well as one that has recently emerged from bankruptcy and has a really thin budget.  While in bankruptcy negotiations with creditors, a restricted tax is simply bad faith, and the City clearly needs some additional funds to finance a plan of adjustment and taxes legally restricted to police would make the path out of bankruptcy very difficult.

If the Plan that replaces Measure A looks like the Safe Streets restricted tax initiative, the City is worse off.

It is also possible that an unrestricted tax could be significantly worse than Measure A.  Some alarming recent evidence of this is in the Stockton Police Union's statement of neutrality on Measure A.  The Union wanted a salary floor, based on a salary surveys of other cities, placed into the fine print of the ordinance.  That is really poor fiscal practice reminiscent of what drove Stockton into bankruptcy in the first place.

I fear that some of the alternatives to Measure A could lock some negative budget choices into the tax measure itself - as evidenced by both the former Safe Streets proposal and the salary floors the Police Union tried to negotiate into Measure A. 

It looks like future tax alternatives are likely to be worse, not better than Measure A as I had hoped.  Thus, this is a reason to vote for Measure A.

2)  How will passing Measure A and B affect the bankruptcy case?

Until recently, I didn't think that Measure A and B would have a major impact on how a judge would rule on the bankruptcy plan of adjustment.  In fact, one of my concerns about Measure A/B has been that they would pass and then the judge would subsequently rule against the City's plan of adjustment.  This outcome would have put the City in a very tough political and financial bind.  I thought it was a strong argument for delaying a tax vote until next year when more bankruptcy issues would have been sorted out.

In a big surprise to me, the City and Assured Guaranty, the City's largest and most antagonistic bond creditor reached a settlement deal that depends on the passage of Measure A.  This settlement and others recently announced by the City means that we know a lot more about the bankruptcy exit plan if Measure A passes, and that there is an extremely high probability that the plan will be approved by the court if Measure A passes.

I have reviewed the settlement with Assured Guaranty, and I think it is reasonable.  The City was never going to get a creditor loss as large as their original ask, and I think this deal will result in a 30%-50% loss for the creditor that is comparable to the loss by City retirees and is thus pretty close to what would have eventually been approved by the court. 

Contrary to my original expectations, it appears that passing Measure A will directly lead to a bankruptcy exit plan approved by the court, and the City would formally exit bankruptcy some time next year.  This will directly save the City millions in additional legal costs, and I doubt it could have done much better with creditors if it pushed for a "cram down" in court.  Less directly, getting rid of the bankruptcy stigma will be good for the City's image, and I think it will be good timing that makes it more likely that the City will  benefit from the improving economy.   Thus, this is a reason to vote for Measure A.

3) Can the City be trusted to keep all the promises in Measures A/B: including hiring 120 cops, sunset the tax measure in 10 years, and finance a plan out of bankruptcy that is acceptable to creditors and employees? 

It is exceptionally hard for the City to keep all these promises, and that has been my concern about Measure A/B from the beginning (but restricted taxes are not the answer).  Something has to give.  As discussed in previous posts, that something appears to be sunset measure in Measure A.

It is bothersome to me that the City puts the sunset clause prominently in the ballot measure, and then hides the City Council's option to extend it in the fine print.  And as I have pointed out, their bankruptcy exit plan and even their settlement with their largest bond creditor assumes Measure A is permanent.

Although it is not reflected in their current plan, even if Measure A passes, the City Council can take actions to hold down cost increases (primarily through the negotiation of new employee costs) and put the City on track so that Measure A can sunset, and if it is extended in a decade, the City should be financing additional service recoveries, not just maintaining bankruptcy levels.  In my earlier blog post when I said the City Council should reject the plan of adjustment, I was saying that they should revise their financial plan filed with the court to show greater cost control so that Measure A can expire.  Even though many of those future costs are uncertain, revising the plan would set more reasonable expectations for employee unions and other stakeholders. 

While the City Council did not reject/revise the financial plan, it is clear to me that they heard the message and the projected increase in costs are not obligations.  It is up to them and the citizens of the City to stay engaged in the long-range financial projections and demand that the City keeps a tight lid on its costs.  This is true whether or not Measure A or any future tax measure passes or fails.

The City's bankruptcy exit plan is financially tenuous, does not account for a Measure A sunset, and by assuming employee compensation (not counting increasing pension costs) grow faster than projected revenue, the plan seems to prioritize employee compensation over restoring City services.  This is a reason to vote against Measure A.

4) Will the City have to shut down libraries and fire stations if Measure A does not pass?

Only if the City Council chooses these options to balance the budget, and if they do, they should be voted out.  I don't think this will be necessary for two reasons 1) the real estate rebound will boost property tax revenue in the short-run, and 2) the City has other less unpleasant options to reduce costs, and has used them in the past when facing deficits.

How much will property taxes rebound?  Earlier this week, the state Board of Equalization released an estimate of a 5% increase in valuations for San Joaquin County as a whole as of 1/1/13.  The City budget assumed less than a 1% increase this year, and assumes a 2.5% increase next year.  Assuming City property taxes actually increase 5% this year and next year, the City could expect about $5 million more over this year and next than its current projections.  That would address about half of the anticipated deficit, and that would be enough to balance the budget at current levels if the City were not incurring bankruptcy legal costs or if CalPers were not increasing its rates.  The budget would be very bad, but I am not convinced it would require closing libraries and fire stations below the current low level of services.  

However, there will be a significant impact on City Services if Measure A fails, the hiring of additional police for the Marshall Plan will most definitely be delayed.

Getting more police on the streets now is a reason to vote for Measure A.  Concern that the City might have to close its libraries is not a reason to vote for Measure A.

5) If Measure A fails, does that mean the City will take on CalPers and cut pensions?  Will it walk away from the Arena and give it to creditors?

No, the City has clearly indicated it will not go down either of these paths.  There are good financial reasons not to even though I think it is clear that building the arena and approving more generous pensions were past financial mistakes.

Politically, it isn't going to happen either.  Did you see the Stockton mayor or any members of the City Council with Chuck Reed when he turned in his pension reform initiative?  It is possible that blocking the City's negotiated settlements with a No vote, could result in the CalPers issue being raised by creditors in court as a reason to reject any "cram down" the City may try to impose on them.  But the court can't impose a CalPers cut on the City and I would guess the City would sweeten its offers to creditors even more before going after CalPers.  As I discussed in an earlier post, even Stockton's anti-pension crowd is just proposing a cap, and even if it is successful, it is unlikely to yield budget savings worth the cost.

If you are a pension reform advocate in Stockton, you should support Chuck Reed's statewide pension reform initiative and try to get Stockton to take advantage of it if it passes. 

Voting against Measure A will not lead to meaningful pension reform or savings.   

6) If Measure A fails, are there better options for Stockton to exit bankruptcy other than a sales tax increase?

Sales taxes are regressive, encourage poor land use and policy choices by city (subsidize retail!), and are an overall lousy way to finance local governments.  But in California, that is just about the only tax that cities can adjust.  The only other real option would be to raise the utility users tax, which is arguably even worse, and Stockton's utility users tax is already much higher than other comparable cities, while there are nearby cities that have sales taxes higher than Stockton. 

The City needs a tax increase to exit bankruptcy and improve public safety.  There are not any better options than an unrestricted sales tax.

My bottom line:

When the City released its bankruptcy plan of adjustment, I moved from leaning slightly in favor of Measure A to a neutral position with consideration of not supporting it.  This was primarily due to reason #3 above, and my concerns were discussed in detail in this September 30 blog post that has become a favorite of Measure A opponents. 

Since September 30th, three developments have changed my thinking a little and I am now leaning in favor of Measure A.

1.  Assured Guaranty made a reasonable settlement with the City a few days later, contingent on Measure A passing.  The deal is beneficial to both parties and was the key to paving the way out of bankruptcy.  The deal seems to eliminate most of the risks to Stockton of passing a tax increase before the bankruptcy case is resolved.

2.  I have done some more thinking about what kind of tax we might see to replace Measure A, see the discussion under #1 above.  Listening to Measure A opponents push a restricted tax and seeing this letter where the Police Union tried to negotiate a salary floor into the Measure A fine print convinced me that economics professors would not be writing a future tax measure, and that there is likely to be something worse than Measure A on a future ballot if it fails.

3.  Concerns about escalating costs and the projections in the financial plan of adjustment have been heard, if not acted upon yet.  I am concerned that the City's financial plan sets unrealistic expectations about the ability of the City to provide COLAs and raises for its employees going forward.  But these projections are just planning assumptions, they don't reflect contracts.  I have been assured that City leaders understand the long-run budget reality and will hold the line on costs.  It is up to the citizens of the city to remain engaged and ensure that they do.


  1. Professor,

    You said: "I have reviewed the settlement with Assured Guaranty, and I think it is reasonable.”

    Were you able to read something other than the disclosure documents, if so, is it available for others to review? If so, do you have a link we can follow?

    If Measure A does not pass, why would the demand of Assured Guarantee increase?

    Did Vallejo require a sales tax increase to exit bankruptcy?

    Looking at the Water Fund Audit report (issued by management without the knowledge, review or approval of the City Council, the Audit Committee or the Mayor), it seems that the Water Fund and by analogy all the enterprise assets may be considered assets of the city subject to bankruptcy protection and perhaps akin to assets of a bankruptcy estate. Those are very valuable assets. Should we consider the realizable value of these assets to repay creditors and fund city services?

    You said: "I have been assured that City leaders understand the long-run budget reality and will hold the line on costs."

    Financial statements and audits are very delinquent. Moss Adams, the City's own "internal auditor" recently issued a very damming report on internal controls, consistent with the reports by the Grand Jury, State Controller's Office and prior external auditors. Would not your acceptance of "assurance" be much stronger, if these problems were corrected before a vote on the sales tax measure?



  2. The term sheets for the creditor settlements are appendices at the end of this document,
    You can compare them to the information in the AB 506 documents to see how this differs from the original loans, and the initial ask by the City.

    If Measure A does not pass, I don't think Assured Guaranty's demand for repayment will increase. There is a "contingent" payment sweetener in this deal and that depends on Measure A passing. It is possible the City could have gotten this creditor to receive a larger loss through a bankruptcy "cram down", but there would be risk, cost, and delay in pursuing this route.

    Vallejo did pass a sales tax increase by a few votes, but I believe it was after the court approved its exit from bankruptcy. I always thought that was the plan in Stockton too, but I think the Mayor's Safe Streets campaign may have forced the City Manager and legal team to support a tax now to head off a restricted tax.

    As for the water fund, it is helping the City's General Fund somewhat. The debt from the Howard Jarvis case will no longer be paid from the general fund, thus increases to water bills will have to replace these payments from the General Fund. Also, the pension bond repayment has been extended 15 years to 2052, including payments allocable to the water funds which have never been missed. Thus, the water funds will end up paying more than they originally were supposed to pay on the pension bonds. I am not sure if there is any legal way that the City could use the value of its water fund assets to help with bankruptcy.

    It is a good point about the audits, and I am not convinced that the City Council is fully committed to long-term cost control and who knows about the next City Manager.

    The vote is a close call. However it comes out, there is still a lot that needs to be done to improve the City's finances.


  3. Jeff,

    Thank you for the information.

    I believe the Vallejo sales tax was after bankruptcy and not part of the plan of adjustment. So after bankruptcy a sales tax was enacted, and today even after the "cram down" and negotiated revisions in various contracts and debt agreements as part of the bankruptcy plan, there are substantial concerns about the fiscal health of Vallejo.

    That is what we want to avoid in Stockton. And that is why we should have greater confidence that comprehensive, effective fiscal discipline is in place in Stockton before we exit bankruptcy and before we vote for a sales tax hike.

    Thank you again.