Bankrupt Calif. City May Be a Harbinger

By Karl Vick
Washington Post Staff Writer
Sunday, October 19, 2008

VALLEJO, Calif. -- When this city of 120,000 declared bankruptcy in May, the extraordinary step appeared to arise from an extraordinary circumstance: Vallejo's payroll largess. Police captains in this blue-collar town north of San Francisco make more than $200,000. The city manager's $338,000 salary is more than that of the vice president or anyone on the Supreme Court.

"I think it's fair to say everybody's here because the wages and benefits are very good," said city Finance Director Bob Stout, with a tight smile.

But as the nation's financial system staggers and recession looms, officials across America's most populous state are nervously eyeing the other side of the equation that brought the City of Vallejo into the U.S. Bankruptcy Court for the Eastern District of California: tax revenue that sank with the economy while payroll and pension obligations continued their rise.

"Are they unique?" said Dwight Stenbakken, deputy executive director of the League of California Cities. "I think we may have some other cities that this whole economic downturn is going to test."

Stockton, in the Central Valley, is furloughing city employees. Sacramento is slashing budgets to make up a $58 million shortfall in the capital city, where state lawmakers -- who under California law can reach down to "borrow" property tax receipts from cities and counties -- only recently finished a budget billions in the red.

California was hit hardest by the crash of a housing market that, when it was hot, brought cities and counties fat transaction fees and a rare boost in property taxes. The follow-on credit crisis has only made matters worse, spreading trepidation and inhibiting the consumers whose purchases provide the sales taxes that drive many city, county and state budgets.

The scale of California's exposure to the downturn was made vivid this month when Gov. Arnold Schwarzenegger (R) wrote to U.S. Treasury Secretary Henry M. Paulson Jr. to suggest that the state might need to borrow $7 billion because of the freeze-up in credit markets. Last week, however, the state succeeded in raising $3 billion itself, with the governor himself investing $100,000 in state-backed bonds.

California's pain is unique -- for now. The Golden State has long been known for leading the way nationally.

"This is going to be a serious problem," said Max Neiman, associate director of the Public Policy Institute of California, a San Francisco think tank. "I think it just happens that it's hitting hard and fast in California because the system is set up to take a revenue stream out of the building and retail sectors. But as property values stagnate and if unemployment goes up, all of these things will broaden this problem across the country."

In Vallejo, the catastrophe was a long time coming. Nestled below sun-splashed hills overlooking San Pablo Bay, this was a Navy town until the shipyard was shuttered in 1996. The city's failure to replace that income stream was masked for a time by the boom in housing values and by disarray in City Hall -- Vallejo had six city managers in four years.

Employee unions, meanwhile, displayed impressive focus. They helped make the "City of Opportunity" the first in California to send arbitration issues to an outside party, which frequently ruled for the unions. Police and firefighters routinely won contracts so bountiful that in 1993 a panel of citizens predicted that, absent an interruption of the upward cycle of raises and benefits, Vallejo would go bankrupt in 2010.

The reckoning was bumped forward two years by the housing crash and a dip in sales taxes that accompanied the closure of a car dealership and a Wal-Mart. Fiscal 2008 found the city with no reserves and 80 percent of the general fund obligated to police and fire services.

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