When Stockton becomes the largest U.S. city ever to file for bankruptcy, it will strike a hard blow to residents, especially city employees and retirees whose health benefits and pensions helped drive the city toward insolvency.
City Manager Bob Deis said late Tuesday that officials were left with little choice but to recommend bankruptcy after failing to hammer out deals with creditors to ease the city's $26 million budget shortfall.
Deis expects the city to file for Chapter 9 protection by Friday.
Stockton will join a number of other cities and counties across the nation that have plunged into financial crisis as the recession made it tough to cover rising costs involving current and former employees, bondholders and vendors.
"What's going on in Stockton is endemic to what's going on all over the state and the country," said Michael Sweet, a San Francisco bankruptcy attorney at Fox Rothschild LLP. "Local governments are hurting and strained under the current pension and compensation systems. These systems are not appropriate for the type of economy this country has evolved into."
At a standing room-only Stockton City Council meeting Tuesday, numerous former city employees talked about their life-threatening medical conditions and said cuts to their health benefits prompted by the city's financial straits meant they would, in effect, lose their insurance.
"Some people will be devastated. There are those who have such severe medical problems that they will not be taken up by any medical company," said Gary Gillis, a retired fire chief on the board of directors of the city retiree association. "This plan appears to be a sledgehammer or a machete."
Several retirees broke down in tears after the city approved changes to their medical benefits as part of a bankruptcy budget adopted by the City Council.
"For me, bankruptcy might as well be a life sentence," said Gary Jones, a retired police officer, who was diagnosed with a brain tumor 10 years ago. Jones said his medical insurance enabled him to undergo chemotherapy and other treatments, which he said will be unaffordable at the lower level of coverage.
During the past three years, the city has dealt with $90 million in deficits in part through drastic cuts in police and fire personnel, even as residents said they have to deal with recurring break-ins and robberies, a climbing murder rate, homelessness and plummeting property values.
Once a beneficiary of the housing boom, the city now has the second-highest foreclosure rate in the nation. Its unemployment rate has doubled in the past decade and now hovers around 16 percent while a fifth of residents live below the poverty line.
"The average citizen will not put up with this," said Gregory Pitsch, a 22-year-old unemployed resident who made an unsuccessful run for mayor. "Their home prices have plummeted, they have no jobs, a lot of people are getting fed up so that they have to resort to crime."
Betty Garcia, who co-owns a downtown jewelry store with her husband, said her community is starting a neighborhood watch group to respond to a rise in crime and lack of police response, which they expect will only get worse.
"We already hear gunshots every night," Garcia said. "It's becoming like listening to the train go by. People don't even call the cops anymore."
Experts say municipalities such as Stockton must find a way to lower their contractual obligations to current and former employees as the cost of health care skyrockets and people are living longer.
"When times were good, it was easier to expand benefits and pensions and not pay as much attention to the unfunded liabilities that were growing," said David Dubrow, a bankruptcy lawyer at Arent Fox LLP in New York City. "Now that times are not good and not good for prolonged periods, those costs are becoming severe."
Some states have passed legislation related to changing pensions and retirement benefits for new employees, Dubrow said. But it's difficult to change the rules for existing employees and even more complicated for retirees, because state constitutions and other legal issues may prevent such restructuring.
In Stockton, pensions will not be affected by a bankruptcy filing, but health benefits for employees and retirees will.
There are about 2,400 retirees in the city and slightly less than half of them receive medical benefits. The unfunded liability for those benefits stands at $417 million.
As of July 1, the bankruptcy plan approved by the City Council reduces contributions to current employee and retiree health benefits and eliminates benefits for employees with less than 10 years of city service. And as of July 2013, it completely eliminates city-funded medical benefits for retirees.
Thirteen cities, counties and other government entities filed for bankruptcy protection last year — the highest annual level in nearly two decades.
Stockton, a river port of 290,000, would be the seventh U.S. municipality to file this year and the first California city since Vallejo, which sought protection in 2008, according to James Spiotto, a Chicago bankruptcy attorney who tracks municipal bankruptcies.
Since Congress added Chapter 9 to the bankruptcy code in 1937 to allow municipalities to seek protection, some 640 government entities have filed. Last year's 13 filings more than doubled the six filed in 2010. That was the most since an equal number were filed in 1994.
Bankruptcy is a bandage for Stockton that won't solve the city's deeper problems, said Garcia, the jewelry store owner.
"With all the cuts, it's just so much, it will have a trickle effect on everybody," Garcia said. "If we make it out of this, I don't know how much skin we'll have left."