Some points on the initial ruling:
1. I agree with the initial ruling allowing Stockton to proceed with its bankruptcy. The city was clearly insolvent by any reasonable legal definition. That decision does not restructure the city's debts. It merely opens the door to the process by which the debts will be restructured.
2. The case has some interesting legal ramifications. California's law places pension obligations ahead of other creditors; federal bankruptcy law does not. The end result will have implications as to the credibility of similar state pension protections. If the ruling requires CalPERS to take a haircut, along with all the other creditors, then the decision will mean that pension protections have to be handled at the federal level. If not, then it could bolster the credibility of such state-based protections and one might witness additional states adopting legislation toward that end.
My early guess is that the decision will actually wind up being a fairly narrow one. It will be based on federal law. However, as the judge initially found that the "capital markets creditors" acted in bad faith e.g., they did not pay their agreed share of mediation costs, the ruling could protect contributions that have already been made to CalPERS while imposing a haircut against future contributions.
My personal opinion is that the creditors who loaned funds to Stockton for purposes of funding its pension obligations failed to conduct their due diligence. They did not adequately study the city's cost structure and consider revenue stream scenarios against that cost structure. In the context of a burst housing bubble that dramatically reduced real estate valuations, a scenario where the city would take a significant and enduring hit to revenue was the most likely one.
That the supposedly "sophisticated" lenders missed the proverbial elephant is and ought to be their problem. The excuse "we didn't know" is not believable, as empirical evidence from financial distress cases demonstrate that when an entity begins borrowing to meet basic obligations, that's a huge red flag. The city had a fragile financial structure and the fragility of that structure was readily apparent had due diligence been undertaken and or had these lenders had a reasonable understanding of financial structures. The city was in a "speculative" situation whereby it was borrowing to cover its cash payment obligations (as opposed to expenditures that could readily be deferred or cut or assets that could be used for security). The bottom line is that taxpayers should not be expected to fund the bad risks undertaken by others.
Having said that, I do believe all creditors, including CalPERS should share in the restructuring. However, the bad faith and naivete of those making the risky loans, among other factors, should be considered in the court's determination of how those haircuts will be spread.
