San Bernardino's bankruptcy case becomes a battle of titans

The battle lines have formed in San Bernardino's effort to enter Chapter 9 bankruptcy protection.

On one side is CalPERS, the state's public employee retirement system, which is the city's biggest creditor and brooks no lapse in payments from its member agencies. CalPERS has challenged San Bernardino's petition for bankruptcy protection and asked for a reversal of the stay that prevents lawsuits against the city until its bankruptcy case is decided.

On the other side is the broke city itself and an influential if unreliable ally: Wall Street, in the form of the city's pension-obligation bondholders.

Those bondholders are investors who collectively own more than $50 million in debt the city issued in 2005 to fund its obligations to CalPERS. The city still owes $48.6 million on those pension-obligation bonds.

Attorneys for the bondholders filed a document with the court rebutting most of the points CalPERS and the San Bernardino Public Employee Association made in their objections to the city's bankruptcy filing.

Some expert observers said they expect CalPERS' attempt to sue San Bernardino for back payments to be rejected by U.S. Bankruptcy Court. But that's just a skirmish in the overall war.

The real action revolves around Wall Street's attack on the primacy of payments to CalPERS. Investors want the retirement system to be just one of the creditors like everyone else, not an entity that gets its money before the other creditors fight over the remaining scraps.

See what has happened here? San Bernardino couldn't afford to make its CalPERS payments as far back as seven years ago. Instead of making the fiscally sound decision to cut spending, city leaders borrowed $50.4 million so that the city could meet its pension payment obligations.

Financial firms were happy to sell those bonds to their customers, not worrying too much about the possibility that the city might not be able to pay them back - despite the ominous sign that San Bernardino was borrowing a huge sum in order to pay ongoing expenses.

CalPERS, meanwhile, saw no problem in the fact that one of its member agencies had to borrow tens of millions of dollars to keep making its pension payments. The pension system appears untroubled by its huge unfunded liability - officially $228 billion, higher according to some observers - and the fact that burgeoning pension payments are pushing more municipalities toward insolvency, so long as the money keeps coming in.

City employees were not bothered by the borrowing either, so long as their pensions kept growing.

For its part, the City Council was improvident enough to increase the pension-payout formula for safety employees in 2006 and for nonsafety employees in 2007 - after having to borrow tens of millions to pay for the existing pension plans, which clearly the city already could not afford.

It's hard to find a hero to root for in this bunch.

San Bernardino's bankruptcy effort is poised to become a battle of titans because - unlike Vallejo and Stockton - the city stopped making payments to CalPERS some $6.9 million ago. CalPERS claims primacy over all other creditors under California law, but Bankruptcy Court is federal. (Ask former medical marijuana provider Aaron Sandusky, who could get 10 years to life in federal prison next month for his conviction for peddling illegal drugs, about differences between state and federal law.)

Bond sellers and holders see this case as a showdown with CalPERS, in which they hope to do away with the retirement system's payoff primacy and gain equal footing as creditors.

That leaves San Bernardino as a pawn in a much bigger game, where the major players are worried about the money they think is coming to them - and not really all that concerned about the city's future.

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