How a Plan to Help Stockton, Calif., Pay Pensions Backfired

The following is an excerpt from an article in 

The New York Times
Tuesday, September 04, 2012

How a Plan to Help Stockton, Calif., Pay Pensions Backfired

By MARY WILLIAMS WALSH

Jeffrey A. Michael, a finance professor in Stockton, Calif., took a hard look at his city’s bankruptcy this summer and thought he saw a smoking gun: a dubious bond deal that bankers had pushed on Stockton just as the local economy was starting to tank in the spring of 2007, he said.

Stockton sold the bonds, about $125 million worth, to obtain cash to close a shortfall in its pension plans for current and retired city workers. The strategy backfired, which is part of the reason the city is now in Chapter 9 bankruptcy. Stockton is trying to walk away from the so-called pension obligation bonds and to renegotiate other debts.

After reviewing an analysis of the bond deal, underwritten by the ill-fated investment bank, Lehman Brothers, and watching a recording of the Stockton City Council meeting where Lehman bankers pitched the deal, Mr. Michael concluded that “Stockton is entitled to some relief, due to deceptive and misleading sales practices that understated the risk.”

“Lehman Brothers just didn’t disclose all the risks of the transaction,” he said. “Their product didn’t work, in the same way as if they had built a marina for the city and then the marina collapsed.”

Financial analysts and actuaries say essentially the same pitch that swayed Stockton has been made thousands of times to local governments all over the country — and that many of them were drawn into deals that have since cost them dearly.

Since virtually all pension obligation bonds turn on the same basic strategy that Stockton followed, Mr. Michael’s research could be a road map for avoiding more such problems, or perhaps for seeking redress. His analysis was part of his August economic forecast for the region, which he prepares as director of the Business Forecasting Center at the University of the Pacific.

There are about $64 billion in pension obligation bonds outstanding, and even though issuance has slowed, more of the bonds are coming to market, even now.

Officials in Fort Lauderdale, Fla., are scheduled to vote on a $300 million pension obligation bond on Wednesday, for instance. Hamden, Conn., has amended its charter to allow for the bonds to rescue a city pension fund that is wasting away. Oakland, Calif., recently issued about $211 million of the bonds, following the lead of several other California cities and counties.

For more, visit www.nytimes.com.