Stockton, California: The Bleeding Edge of a Scary Economic Trend

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Stockton CaliforniaOn Thursday, Stockton, Calif., became the biggest U.S. city in history to file for bankruptcy. At the same time, it also became the new face of America's national budget battle. For while Stockton is relatively rare in facing budget troubles so intractable that they necessitate a Chapter 9 filing, its struggle to put its financial house in order illuminates the wider problems facing the entire country in the wake of the Great Recession.

Municipal bankruptcies are nothing new -- as The San Francisco Chronicle reported earlier this week, there have been 42 since 1981. In recent years, though, the number of bankruptcies has sharply increased; since 2008, 10 municipalities have sought court protection to help them discharge their debts.

Ending Up in Court

Towns, cities and counties end up in bankruptcy court for a variety of reasons: Desert Hot Springs, Calif., got there in 2001 because of a huge housing discrimination lawsuit, while Orange County, Calif., ended up filing due to an investment fund meltdown that eventually led to the prosecution of the county's treasurer. Millport, Ala.'s 2005 failure was the result of a loss of sales tax revenue, and Washington Park, Ill., went to bankruptcy court in 2009 when a topless bar successfully fought against the city's five-figure licensing fees.

But these day, more municipalities are declaring bankruptcy for a far less interesting reason: They simply aren't bringing in enough tax money. That was the problem for Vallejo, Calif., which ended up in court in 2008 because it couldn't afford to fund its employee pensions. The same thing happened to Prichard, Ala., in 2009 and Central Falls, R.I., in 2011.

And beyond a few minor details, that's what happened to Stockton on Thursday.

From Prosperity to Poverty

Stockton's problems began in the mid-2000s, with what appeared to be a massive windfall. From 2000 to 2006, property values went through the roof, flooding the city's coffers and promising a bright future. The city, flush with cash, borrowed money for huge building projects and agreed to employee contracts that guaranteed generous yearly raises. The future looked bright.

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A couple of years later, the worm turned. Between 2006 and 2009, Bloomberg reports, property values fell by 70%, dragging down real estate tax revenues. The city found itself in a pinch: On one side, it had high-cost employee contracts and pensions; on the other side, it had falling tax revenues and no way to make up the shortfall. A 2007 bond issue only made things worse, as servicing the loan just added to the city's costs.

In California, cities like Stockton don't have the power to increase property taxes when property values drop, leaving them only one option to balance budgets: cutting labor costs. Over the past two years, the city has laid off 40% of its employees, 25% of its policemen, and 33% of its firefighters. Unfortunately, these layoffs have come at a high cost: Stockton currently has the nation's second-highest foreclosure rates, one of its highest violent crime rates, and a 20.1% unemployment rate -- more than double the national average. According to city officials, Stockton's public safety is at a "crisis level."

With no approval for a tax increase on the horizon, it doesn't look like these problems will go away any time soon. Bankruptcy -- Stockton's last hope -- will allow it to renegotiate many of its contracts and adjust its payment schedule for creditors. What it won't do is bring in more money, which the city desperately needs if it hopes to restore its municipal services.


An All Too Common Problem

Stockton's situation is hardly rare. Across the country, municipalities that tied their tax revenues to the real estate market are facing shortfalls. Some, like Vallejo, Calif., -- which filed for bankruptcy in 2008 -- were also tied down by tough union contracts, but plenty of towns and cities that didn't offer particularly generous deals to public employees are nonetheless now scrambling to make ends meet.

Even areas that have managed to keep their fiscal houses in order are feeling the blow back from the recession. For example, Birmingham, Ala., which has an outstanding credit rating, tons of cash, and a low unemployment rate, is facing fiscal problems simply because of its proximity to Jefferson County, which declared bankruptcy in 2011. And, while municipal employee layoffs offer short-term solutions, they don't address the longer-term financial problems. Renegotiating contracts will help many governments get closer to solvency, but without a significant increase in revenue, an ever-growing number of towns, cities and counties will find themselves joining Stockton in bankruptcy court.

Stockton, California: The Bleeding Edge of a Scary Economic Trend

In 2010, the combination of a tax shortfall, cuts in state aid, and a pension fund debacle had left the small city with a shortfall of more than $3 million.

When it entered bankruptcy court in November 2011, Jefferson's was the most expensive municipal bankruptcy in U.S. history. Not surprising, considering that the $4 billion crisis managed to combine a sewer bond debacle, a JPMorgan-affiliated bribery scandal and a tax dilemma. By mid-2012, the county had laid off over 700 government workers.

Following the loss of two paper companies and a military base, the small city declared bankruptcy in 1999. A decade later, following pension fund troubles, the city was back in court.

Photo by TeaCas, Panoramio

Employers are supposed to withhold federal taxes from their employees' paychecks, and the City of Gould dutifully did so. They are also supposed to send that money on to the federal government. Gould, unfortunately, forgot that part, an oversight that led the small municipality to bankruptcy court in 2008.

Photo by Water tower nut, Flickr.com

In an attempt to pay off debts accrued by a former mayor, Moffett tried to raise revenue by going hog wild in the issuing of traffic tickets. That plan ground to a halt in December 2006, when a court declared that the town was an illegal speed trap. Two months later, Moffett was seeking bankruptcy protection.

Its green-energy recycling plant was supposed to burn trash to generate electricity. Instead, it burned money, generating $320 million in debt. Additional debt from its school system and employee pension system left Harrisburg struggling to regain its financial feet. Its 2011 petition for Chapter 9 was rejected, but the city is still trying to file for bankruptcy.

In 2008, Vallejo declared bankruptcy, citing exorbitant firefighter and police salaries. Following its filing, the city renegotiated contracts, and is now searching for new sources of revenue.

In June 2012 Stockton, Calif., became the biggest U.S. city in history to file for bankruptcy. At the same time, it also became the new face of America's national budget battle.

In California, cities like Stockton don't have the power to increase property taxes when property values drop, leaving them only one option to balance budgets: cutting labor costs. Over the past two years, the city has laid off 40% of its employees, 25% of its policemen, and 33% of its firefighters. Unfortunately, these layoffs have come at a high cost: Stockton currently has the nation's second-highest foreclosure rates, one of its highest violent crime rates, and a 20.1% unemployment rate -- more than double the national average. According to city officials, Stockton's public safety is at a "crisis level."

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Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.
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