A federal judge on Monday approved the city of Stockton's petition for bankruptcy in a case that sets the stage for a lengthy battle between bondholders and the California pension system.
In a case being studied by other cash-strapped American cities including Detroit, U.S. Bankruptcy Court Judge Christopher Klein's decision was a setback for bondholders and insurers who had resisted the California city's bankruptcy filing. Stockton is the largest U.S. city ever to file for bankruptcy.
The judge also signaled that the California Public Employees Retirement System's position in the case was not above review. Stockton, a city of 300,000, has so far not reduced pension payments to retired city workers, although it has eliminated retiree healthcare benefits.
"This does not mean there is not potentially a serious issue involving Calpers," Judge Klein said. "But at this point I do not know what that is." He added that there were "very complex and difficult questions of law that I can see out there on the horizon," relating to Calpers.
The decision on Stockton marks the start of a lengthy restructuring of the obligations that currently overwhelm its finances, which were crippled by the housing crisis and recession.
Investors in the $3.7 trillion municipal bond market are concerned that if Stockton is able to avoid paying bondholders in full without cutting pension payments, other cities will pursue a similar strategy as they struggle to cope with budget shortfalls.
Kenneth Naehu, head of fixed income at Bel Air Investment Advisors in Los Angeles, agreed that the case could cloud the issue of where bondholders stand in relation to retirees and pension funds in a municipal bankruptcy.
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