The Breakdown | Explaining Southern California's economy
Business & Economy

San Bernardino bankruptcy: Much worse than Stockton

San Bernardino City Hall. The city's fiscal crisis could make its possible bankruptcy far worse than Stockton's.
San Bernardino City Hall. The city's fiscal crisis could make its possible bankruptcy far worse than Stockton's.
David McNew/Getty Images

The San Bernardino City Council voted last night to prepare to file bankruptcy. If the Inland Empire city does enter Chapter 9, it would be the third California municipality to do so this year, following Stockton and Mammoth Lakes.

But according to the bankruptcy lawyer who helped draft AB 506, the new California law that compels cities considering bankruptcy to first submit to a "neutral evaluation" process, and an economist who studies the Inland Empire, San Bernardino could look a lot worse than either of the cities that have already filed for Chapter 9.

"The San Bernardino situation is extremely challenging," said Karol Denniston of Schiff Hardin in San Francisco. "They don't seem to have considered the 506 process." 

A call to an aide to Mayor Patrick Morris to determine whether San Bernardino had considered going through mediation was not returned. [UPDATE: The mayor's Chief of Staff, Jim Morris, got back to me late Wednesday to explain that the city had considered the mediation requirement and is working with bankruptcy attorneys to ensure that the city is complying with state law. He also said that a fiscal emergency hasn't yet been declared but that it could soon be, in reponse to what he described as San Bernardino's cashflow crisis.]

Denniston appeared on KPCC's "AirTalk" this morning with both Morris and economist John Husing. She said that San Bernardino, which faces a budget deficit of more than $40 million, is in an "unprecedented situation." 

"The headline is: Don't wait until you have no money to declare bankruptcy."

She noted that under California's new law — which enabled neither Stockton nor Mammoth Lakes to avoid Chapter 9, but which put Stockton in a better position to exit bankruptcy quickly and with less cost — a city has to either mediate or declare a "fiscal emergency."

"The fiscal emergency part isn't a model of clarity," she said. "It was added to the law at the last minute. The idea was that you could have an Orange County situation — something so drastic happening that the city has no control."

Orange County went bankrupt in 1994 when its investments went south and the markets moved against the city. 

Denniston suggested that San Bernardino might declare bankruptcy soon, citing a fiscal emergency, while simultaneously participating in mediation. But she said that San Bernardino's creditors could be extremely upset by the sudden nature of the city's fiscal crisis, particularly if reported allegations that the city has been juicing it budget numbers turn out to be true. These are the very creditors that San Bernardino will need to provide the liquidity it needs to get through Chapter 9.

"It's hard to tell if we're looking at Bell or something more benign," she said. "But this is ten times worse than Stockton. They've had a smooth landing into bankruptcy. They have the process under control."

Bell of course is the city near Los Angeles that was plunged into a scandal in 2010 over misappropriation of funds by city officials. 

On "AirTalk," Mayor Morris denied that there was any criminal activity related to San Bernardino's budgeting process.

John Husing said that San Bernardino's dire finances are the nadir of a decline that began in the 1980s.

"In 1977 it was an all-American city and in incredibly good shape," he recalled. But then Kaiser shut down a steel plant, an Air Force base closed, and bue-collar retirees started to retire. "Their houses were then gobbled up by real estate players who turned the whole neighborhood from owner-occupied to rental."

He added that San Bernardino's woes are common to California's older cities (San Bernardino's charter is 105 years old). Much of San Bernardino's annual budget is consumed by salaries and benefits for current and retired police and firefighters, with whom the city has endured recent legal wrangles, according to Morris.

"Newer cities contract with the sheriff's department, which leads to savings," he said. Cities that saw a lot of growth in the past decade are particularly vulnerable to San Bernardino's problems.

But age, cops and firefighters, and changing demographics only tell part of the sad story. Husing said that 43 percent of the city's population was on public assistance in 2010, retail sales taxes has slumped by 30 percent since 2005, and nearly 70 percent of homeowners in the city were underwater on their mortgages.

This perfect storm of fiscal disasters is what has apparently put San Bernardino's back against the wall. Even mediation — or some combination of mediation and bankruptcy — may not be a panacea for the city.

"If you look at what's stacked up against San Bernardino, you have to ask if there's anything to fight over," Denniston said. "They're saying the process could take two or three years, but they have no way to pay for it. This is an epic tragedy."

Follow Matthew DeBord and the DeBord Report on Twitter. And ask Matt questions at Quora.