NYT: For Vallejo, Bankruptcy Isn't Exactly a Fresh Start

By JONATHAN WEBER

Vallejo, which delivered a wake-up call to municipalities around the country when it filed for bankruptcy protection in 2008, outlined in court papers last week how it plans to get back on its feet, financially speaking. For residents, the plan makes for grim reading. And if you’re a public official or taxpayer who’s hoping that bankruptcy might be a way to solve your city’s financial problems, it will surely prompt you to think twice.

People think of bankruptcy as a way to wipe the slate clean of old obligations, but that’s only half true. Yes, it’s sometimes possible for businesses, individuals and governments to eliminate some — even most — debts through bankruptcy. But as Vallejo’s case underscores, the real point of bankruptcy isn’t to let a debtor walk away but rather to force a negotiation between debtors and creditors.

Those negotiations, and the litigation that often goes with them, are now mostly concluded in the Vallejo case, and the city hopes that the formal restructuring plan it just submitted will let it emerge from bankruptcy by summer.

Municipal bankruptcy — and, as The New York Times reported on Friday, a Republican-led effort in Washington to allow states to file some kind of bankruptcy — is increasingly on politicians’ radar as a way to break what are perceived as sweetheart contracts with public employee unions and cancel sometimes-lavish pension deals.

But Chapter 9 of the bankruptcy code, which covers municipal bankruptcy, is rarely used, and it’s not entirely clear what it does and doesn’t allow. (Many states don’t even allow municipalities to file.)

In Vallejo, the four unions representing city employees claimed that California law protected their contracts, but the bankruptcy court ultimately ruled that the city could cancel its collective bargaining agreements. That, in turn, forced the unions to agree to deals that they would not have accepted otherwise.

The city has cut retiree health benefits from $1,500 to $300 a month and stopped making payouts on accrued leave time.

But pension plans for retirees and current city employees, including one that allows police officers to retire at 50 with as much as 90 percent of their pay, remain untouched. The city chose not to test whether messing with pensions would be allowed even in bankruptcy, and so remains on the hook for some $195 million in unfinanced pension liabilities.

Meanwhile, much of the savings in the renegotiated union contracts come from severe work-force reductions: the police department is down to 90 sworn officers from 155 in 2003, and the fire department was slashed from 122 people and 8 firehouses to 70 people and 5 firehouses.

When voters complain about bloated government payrolls, I’d wager that taking an ax to the police and fire departments is not the solution they have in mind.

Now consider the $225 million in debt currently on Vallejo’s books. The bulk is owed by special districts, mainly the water authority, and is unaffected by the bankruptcy case. Only about $50 million in city obligations, mainly lease payments on buildings, will actually be restructured, with a net “present value” savings of around 40 percent.

Meanwhile, even a cursory look at the city’s finances makes it clear that a huge part of the problem has nothing to do with payrolls or pensions or bond debt. Rather, it has to do with revenue: city tax collections plummeted from $83 million in 2007-08 to $65 million in the most recent fiscal year, a result of the recession and the housing bust. Housing values have fallen an astonishing 67 percent.

So Vallejo stumbles forward: with minimal public safety services, a skeleton crew for road repairs, deferred maintenance on everything, and no money for “extras” like parks, libraries and senior centers. That will change only when — if? — revenues begin to climb.

Assuming the bankruptcy plan is approved, the city will have saved some money and shed some long-term obligations. But when you consider the $8 million and counting in legal fees, three years of angry litigation and uncertainty, the millions that contractors, city employees and retirees will lose (they stand to collect only 5 to 20 cents on the dollar for their claims), and the hit to the city’s reputation that will likely impair business growth (and tax collections) for years, it hardly looks like a victory.

Thinking about bankruptcy as a solution to your city’s financial troubles? There has to be a better way.

Jonathan Weber is the editor in chief of The Bay Citizen.
jweber@baycitizen.org

Copyright 2011 The New York Times Company. All rights reserved.

NYT: State Bankruptcy Option Is Sought, Quietly

By MARY WILLIAMS WALSH

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.

Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout. Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.

“All of a sudden, there’s a whole new risk factor,” said Paul S. Maco, a partner at the firm Vinson & Elkins who was head of the Securities and Exchange Commission’s Office of Municipal Securities during the Clinton administration.

For now, the fear of destabilizing the municipal bond market with the words “state bankruptcy” has proponents in Congress going about their work on tiptoe. No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor, although Senator John Cornyn, a Texas Republican, asked the Federal Reserve chairman, Ben S. Bernanke, about the possiblity in a hearing this month.

House Republicans, and Senators from both parties, have taken an interest in the issue, with nudging from bankruptcy lawyers and a former House speaker, Newt Gingrich, who could be a Republican presidential candidate. It would be difficult to get a bill through Congress, not only because of the constitutional questions and the complexities of bankruptcy law, but also because of fears that even talk of such a law could make the states’ problems worse.

Lawmakers might decide to stop short of a full-blown bankruptcy proposal and establish instead some sort of oversight panel for distressed states, akin to the Municipal Assistance Corporation, which helped New York City during its fiscal crisis of 1975.

Still, discussions about something as far-reaching as bankruptcy could give governors and others more leverage in bargaining with unionized public workers.

“They are readying a massive assault on us,” said Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.”

Mr. Loveless said he was meeting with potential allies on Capitol Hill, making the point that certain states might indeed have financial problems, but public employees and their benefits were not the cause. The Center on Budget and Policy Priorities released a report on Thursday warning against a tendency to confuse the states’ immediate budget gaps with their long-term structural deficits.

“States have adequate tools and means to meet their obligations,” the report stated.

No state is known to want to declare bankruptcy, and some question the wisdom of offering them the ability to do so now, given the jitters in the normally staid municipal bond market.

Slightly more than $25 billion has flowed out of mutual funds that invest in muni bonds in the last two months, according to the Investment Company Institute. Many analysts say they consider a bond default by any state extremely unlikely, but they also say that when politicians take an interest in the bond market, surprises are apt to follow.

Mr. Maco said the mere introduction of a state bankruptcy bill could lead to “some kind of market penalty,” even if it never passed. That “penalty” might be higher borrowing costs for a state and downward pressure on the value of its bonds. Individual bondholders would not realize any losses unless they sold.

But institutional investors in municipal bonds, like insurance companies, are required to keep certain levels of capital. And they might retreat from additional investments. A deeply troubled state could eventually be priced out of the capital markets.

“The precipitating event at G.M. was they were out of cash and had no ability to raise the capital they needed,” said Harry J. Wilson, the lone Republican on President Obama’s special auto task force, which led G.M. and Chrysler through an unusual restructuring in bankruptcy, financed by the federal government.

Mr. Wilson, who ran an unsuccessful campaign for New York State comptroller last year, has said he believes that New York and some other states need some type of a financial restructuring.

He noted that G.M. was salvaged only through an administration-led effort that Congress initially resisted, with legislators voting against financial assistance to G.M. in late 2008.

“Now Congress is much more conservative,” he said. “A state shows up and wants cash, Congress says no, and it will probably be at the last minute and it’s a real problem. That’s what I’m concerned about.”

Discussion of a new bankruptcy option for the states appears to have taken off in November, after Mr. Gingrich gave a speech about the country’s big challenges, including government debt and an uncompetitive labor market.

“We just have to be honest and clear about this, and I also hope the House Republicans are going to move a bill in the first month or so of their tenure to create a venue for state bankruptcy,” he said.

A few weeks later, David A. Skeel, a law professor at the University of Pennsylvania, published an article, “Give States a Way to Go Bankrupt,” in The Weekly Standard. It said thorny constitutional questions were “easily addressed” by making sure states could not be forced into bankruptcy or that federal judges could usurp states’ lawmaking powers.

“I have never had anything I’ve written get as much attention as that piece,” said Mr. Skeel, who said he had since been contacted by Republicans and Democrats whom he declined to name.

Mr. Skeel said it was possible to envision how bankruptcy for states might work by looking at the existing law for local governments. Called Chapter 9, it gives distressed municipalities a period of debt-collection relief, which they can use to restructure their obligations with the help of a bankruptcy judge.

Unfunded pensions become unsecured debts in municipal bankruptcy and may be reduced. And the law makes it easier for a bankrupt city to tear up its labor contracts than for a bankrupt company, said James E. Spiotto, head of the bankruptcy practice at Chapman & Cutler in Chicago.

The biggest surprise may await the holders of a state’s general obligation bonds. Though widely considered the strongest credit of any government, they can be treated as unsecured credits, subject to reduction, under Chapter 9.

Mr. Spiotto said he thought bankruptcy court was not a good avenue for troubled states, and he has designed an alternative called the Public Pension Funding Authority. It would have mandatory jurisdiction over states that failed to provide sufficient funding to their workers’ pensions or that were diverting money from essential public services.

“I’ve talked to some people from Congress, and I’m going to talk to some more,” he said. “This effort to talk about Chapter 9, I’m worried about it. I don’t want the states to have to pay higher borrowing costs because of a panic that they might go bankrupt. I don’t think it’s the right thing at all. But it’s the beginning of a dialog.”

Copyright 2011 The New York Times Company. All rights reserved.

NYT: Court Rules on Debtors and Doctors in Training

By ADAM LIPTAK

WASHINGTON — Medical residents must pay Social Security taxes, the Supreme Court ruled on Tuesday.

In a second decision, this one featuring the first opinion from Justice Elena Kagan, the court ruled that some bankrupt debtors who own their cars outright are not entitled to shield a standard monthly amount for the “ownership costs” of their vehicles.

The case concerning medical residents considered a federal law that exempts students from paying Social Security taxes. Allowing residents to take the exemption would cost the federal government $700 million a year, the Justice Department said.

In announcing the decision, Chief Justice John G. Roberts Jr. said the question it presented boiled down to whether residents were “workers who study or students who work.”

Residents often work 50 to 80 hours a week, the chief justice wrote. They can make $50,000, and they often receive health insurance and paid vacations. But they work under the supervision of more senior doctors who also instruct them, and they attend lectures and take exams.

Chief Justice Roberts, writing for a unanimous eight-member court, said the law itself did not clearly answer whether residents were mainly workers or students. But he said a 2004 Treasury Department regulation had drawn a reasonable line.

The regulation says that students who would otherwise qualify for the exemption lose it if they work more than 40 hours per week, even if they learn from what they do.

“Regulation, like legislation, often requires drawing lines,” the chief justice wrote. “Focusing on the hours an individual works and the hours he spends in studies is a perfectly sensible way,” he went on, of drawing the line between students and workers.

Justice Kagan recused herself from the case, Mayo Foundation v. United States, No. 09-837, because she had worked on it as United States solicitor general.

But she wrote the majority opinion in the day’s second decision, Ransom v. FIA Card Services, No. 09-907, and she announced it from the bench in a crisp and conversational style.

The dispute in that case also concerned the meaning of a federal law, this one allowing some debtors a standard monthly allowance for car-ownership costs.

Jason M. Ransom, a Nevada man, claimed the applicable $471 allowance for a 2004 Toyota he owned outright. A credit card company seeking repayment objected, saying that only people making loan or lease payments should qualify for the deduction.

Over the course of his five-year repayment plan, the deduction would have allowed Mr. Ransom to shield $28,000 from creditors.

Justice Kagan, writing for the eight-justice majority, said “a debtor who does not make loan or lease payments may not take the car-ownership deduction.”

She acknowledged that the ruling could give rise to occasional curious outcomes. For instance, a debtor with only a single loan payment remaining would be entitled to the entire deduction.

“But this kind of oddity,” she wrote, “is the inevitable result of a standardized formula.”

She added that allowing Mr. Ransom to take advantage of the deduction could produce even odder results. “On Ransom’s view, for example, a debtor entering bankruptcy might purchase for a song a junkyard car” to take advantage of the deduction, Justice Kagan wrote.

Justice Antonin Scalia dissented, saying his colleagues had misread the law and misunderstood their own roles. “The point of the statutory language is to entitle debtors who own cars to an ownership deduction,” he wrote.

He was scornful of the majority’s effort to avoid odd practical results. “Our job, it seems to me, is not to eliminate or reduce those oddities,” he wrote, “but to give the formula Congress adopted its fairest meaning.”

And he countered what he called the “imagined horrible” of a wreck bought just to take advantage of the ownership deduction with one of his own.

“A debtor entering bankruptcy might purchase a junkyard car for a song plus a $10 promissory note payable over several years,” Justice Scalia wrote. “He would get the full ownership expense deduction.”

Copyright 2011 The New York Times Company. All rights reserved.