The Wages of Bankruptcy: Stockton’s Cautionary Tale for Detroit

More than a year after filing for Chapter 9 protection, the California city is struggling with protracted court battles and stripped city services — and that's exactly what the Motor City might be in for

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A pedestrian walks by a Stockton Record newspaper rack displaying the headline "Bankrupt!" on June 27, 2012 in Stockton.

At night, Stockton, Calif., becomes a ghost town. Streets lined with boarded-up buildings and rubbish-strewn parks are mostly empty except for drug dealers and their customers, says Dave Macedo, president of the local firefighters’ union. Even in daylight, shootings break out with regularity, and the city of 300,000 was ranked the 10th most dangerous in the country in 2012. “It’s the wild, wild West out there,” says Macedo. Or rather, the wild, bankrupt West.

When Detroit filed for Chapter 9 protection on July 18, it became the largest American city to ever declare bankruptcy. The progress of the city it replaced in the record books offers some clues about what Detroit will be facing in the coming months and years. Just over a year after seeking bankruptcy, Stockton is struggling with protracted court battles and stripped city services with little relief in sight.

After its June 2012 filing, Stockton’s first hurdle was proving itself eligible for the process: in order to be declared legally bankrupt, the city had to demonstrate to Judge Christopher Klein that it was insolvent and had attempted to negotiate its debts in good faith. City bankruptcy attorney Marc Levinson described the court battle as an unfortunate precursor to the real show. “We spent an awful lot of time, and an awful lot of money, just trying to stay in bankruptcy,” Levinson says. Finally, after nine months of eligibility battles and against creditors’ vehement objections, Judge Klein determined on April 1 that Stockton was insolvent. Winning the eligibility battle only set the stage for a larger war. The biggest chunk of Stockton’s debt is the $900 million owed to CalPERS, the California Public Employees’ Retirement System, a statewide pension service.

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But Wall Street creditors and unsecured private creditors also expect Stockton to fulfill its obligations to them, and they say it’s unfair for pensioners to get preferential treatment. Also at play is a conflict between federal and state law: while California requires Stockton to pay CalPERS, federal law allows it to renege on that obligation. Municipal bankruptcies are so rare — or at least used to be — that there’s no legal precedent for the jurisdictional fights, experts say. Any court decision released as Stockton and Detroit wind through the courts could play an important role in future proceedings.

Even while Stockton negotiates with its creditors, it continues to pay into the pension fund. But that doesn’t mean it hasn’t cut other services. So far, the city has trimmed pensioners’ health care and negotiated new contracts with city employees, such as police and firefighters, who had already faced a series of cuts before the filing. Senior centers, library programs and recreational services have all been axed.

The pension problem is not unique to Stockton — Vallejo, Calif., which exited bankruptcy in 2011 paying some creditors as little as 5¢ on the dollar, didn’t even try to challenge its obligation to CalPERS, likely because of the sky-high legal fees that would have come from lengthy court battles, says bankruptcy attorney Karol Denniston, who is representing a group of taxpayers in the Stockton bankruptcy. It’s not yet clear if Stockton will challenge its obligations to CalPERS when it files its final plan of adjustment this fall. But Stockton has defended its obligation to CalPERS by citing the importance of providing a pension plan to employees. Without a stable pension plan, Stockton might risk losing its dwindling police officers and firefighters, says Macedo.

(MORE: Motor City Meltdown: Long Road Ahead for Detroit’s Record Bankruptcy)

Now, as it continues to make its CalPERS payments, Vallejo remains in severe financial straits and unable to provide many public services. “Stockton doesn’t want to be another Vallejo,” Denniston says. Neither does Detroit.

Like California, Michigan’s constitution prohibits changes to pension benefits, which creates complex legal conflicts. On Thursday, just 20 minutes after Detroit filed for bankruptcy, Ingham County Circuit Court Judge Rosemarie Aquilina found the Chapter 9 filing to be unconstitutional on the grounds that it violated pension protections included in a state-constitution amendment. That ruling, along with other lawsuits seeking to stop the bankruptcy, was halted by a Michigan Court of Appeals on Tuesday in response to a motion filed by Attorney General Bill Schuette. And on Wednesday, the federal judge overseeing the bankruptcy also froze all state-court lawsuits against the city. But the battle of state constitution vs. federal law still looms.

The bankruptcy won’t just affect pensioners. In Stockton, staffing and budget cuts mean police and firefighters are leaving the city in search of jobs where the pay is higher and the town safer, says Macedo. Stockton’s 58 homicides in 2011 jumped to 71 in 2012 as police officers left the city in droves. And with city services on a shoestring budget, the fire stations occasionally experience truck shortages, and he says injuries among firefighters are on the rise.

In violence-ridden Detroit, police departments and fire stations have already endured reductions in staffing and equipment. Compared with the national average of an 11-minute wait time after calling the police, Detroiters wait an average of 58 minutes, according to a letter written by Governor Rick Snyder that authorized the bankruptcy filing. If Stockton’s bankruptcy is a guide, Detroit’s crime rate and derelict city services might only get worse.

Detroit has more than twice the population of Stockton, and its pension and health care liabilities comprise a hefty $9.2 billion of the city’s almost $20 billion debt. But one point in Detroit’s favor is the official steering the process: emergency manager Kevyn Orr, a restructuring expert who is not subject to the same political wheedling as Stockton’s city council. “Bankruptcy people live in this perverse world where we see everything happily, like, ‘Hey, great news, we only had to amputate two limbs and this person’s still alive,'” says University of Michigan law professor John Pottow. “Kevyn Orr will probably be more sanguine about making those decisions.”

No matter Orr’s skills, there’s no guarantee these fiscal amputations will be fast or safe for the people of Detroit. The city’s future is uncertain as the bankruptcy filing inches forward. And if Detroit’s anything like Stockton, it will be a very long time before this bankruptcy and its effects are in the Motor City’s rearview mirror.

MORE: Is Stockton the Start of a Rash of Municipal Bankruptcies?