In a closely-watched ruling with potentially far-reaching effects, a federal bankruptcy judge has ruled Stockton, CA may proceed with cutting health care benefits for retirees while it is in bankruptcy. This seemingly tiny crack in the dike protecting public pension benefits could easily turn into a major breach and perhaps even threaten the dike itself. Yes, this is that serious. Those who want to break public unions and their pensions will be lining up on one side while those defending the pensions will frantically be looking for ways to block bankrupt municipalities from restructuring labor and pension agreements.

Mike Shedlock, no friend of public unions, states it bluntly and succinctly:

This is a good start for what needs to happen. The next step needs to be huge clawbacks on promised benefits, preferably top down, so that those with the highest pension benefits bear the brunt of the hit.As soon as cities realize this is the way out, a flood of bankruptcies will be on the way.

Retired employees had sued to block the Stockton cuts from happening but the judge issued a temporary order denying them and said a formal decision was coming. Stockton’s lawyers argued bankruptcy law allows the city considerable range in restructuring its finances. This includes breaking or modifying existing agreements, something that a bankruptcy judge can also do. Public unions and their pension funds enjoy rather extraordinary protection in California. The state has to make up any shortfalls in their funding. Pension agreements are difficult for an ailing city to renegotiate even as unfunded pension obligations are perhaps the biggest drain on their finances. Indeed, pension obligations are a primary reason for the Stockton bankruptcy (along with the real estate crash.)

But those rules don’t apply in bankruptcy. A city or court can simply order pension benefits be restructured and reduced and unions and pension funds have little recourse except to sue. Such lawsuits might block implementation of the changes temporarily but it’s difficult to see how they could win.

San Bernardino and Mammoth Lakes in California have also filed for bankruptcy. Compton, CA says talk of them needing to file bankruptcy is hooey even as they request an outside audit and have no reserves.  (This brings to mind the old saying, “if they deny it then it must be a bigger story than you think.”) But many cities have wobbly finances like Compton will be filing bankruptcy soon enough. Pensioners, most of them quite blameless, will be hurt.