Facing $296 million of unfunded liabilities, a $45 million budget shortfall, and depleted general fund reserves, San Bernardino filed for Chapter 9 bankruptcy on August 1, 2012. The city sought protection from its creditors while it developed recovery plans in hope of achieving financial stability. In our Fall 2012 issue we examined the factors that resulted in the City of San Bernardino’s insolvency and outlined the bankruptcy process (See “Municipal Bankruptcy” in the Fall 2012 Inland Empire Outlook).
Just over two years later, San Bernardino is still in the midst of this arduous process and economic recovery has been slow to come. The city has been enmeshed in court challenges by CalPERS (California Public Employees’ Retirement System) and has been undergoing increasingly difficult negotiations with public unions, most notably the San Bernardino City Professional Firefighters. In addition to severe budget cuts, the city is also experiencing a rise in crime rates as well as relatively high unemployment rates in comparison to similar-sized municipalities in California. Although the current state of San Bernardino is far from ideal, a new city council led by first term mayor Carey Davis, as well as potential economic expansion in a variety of sectors offers some reasons for optimism about the future.
In the years leading up to bankruptcy, San Bernardino suffered heavily as important sources of revenue fell, notably property taxes, vehicle license fees, and redevelopment funds. San Bernardino Fiscal Year CAFR reports for 2006-2008 show that property taxes generally accounted for about 30% of total revenue. The Great Recession demonstrated that property taxes can also be extremely volatile. San Bernardino experienced a huge housing boom from 2001-2007, and a corresponding growth in property tax revenues, when cheap financing facilitated a disproportionate number of sub-prime mortgages. Cities like San Bernardino that experienced an influx of residential construction were especially hard hit when the housing market crashed. While home prices around the country fell by 24% from 2005 to 2010, they fell by over double that in San Bernardino, which also experienced a foreclosure rate around almost four times the national average. From 2008 to 2011, property tax revenue fell from $74.7 million to $46.7 million, a steep 37% decrease. Meanwhile, Proposition 13 barred San Bernardino and all California cities from attempting to make up this lost revenue through increased property tax rates. The 1978 constitutional amendment pegs the statewide property tax rate to 1 percent of the property’s assessed value at the time Prop 13 was enacted or the sale price when the property changes hands. Annual increases of assessed value are limited to 2 percent in the years the property is not sold.
San Bernardino also suffered a loss of approximately $30 million a year in redevelopment revenues when redevelopment authorities (RDAs) were officially dissolved on February 1, 2012. (See “Redevelopment Authorities Under Fire” in the Spring 2011 Inland Empire Outlook). Along with straight forward development projects such as the city’s minor league baseball stadium and renovated historic theatre, San Bernardino also used its redevelopment revenue to fund items less clearly related to development such as its public access television station. Moreover, it used redevelopment funds to pay citywide operating expenses including the salaries of the city manager, code enforcement officers, human resources staff, the city clerk, and the city attorney. As former mayor Patrick Morris said in 2012, “One might say [the loss of redevelopment funds] was the nail in the coffin in terms of our unbalanced budget.”
In July 2012, Riverside-San Bernardino-Ontario had one of the highest foreclosure rates of any metropolitan area in the U.S, with Business Insider reporting that 1 in every 187 homes receiving a foreclosure notice. In that same month, the City of San Bernardino had an unemployment rate of about 16%, twice the national average. Despite enacting labor cuts of about $10 million annually, including reducing its workforce by 20% from 2008-2012, the city still faced substantial debt and filed under Chapter 9 (Adjustments of Debts of a Municipality) of the federal bankruptcy code. According to the Congressional Research Service, “The focus of Chapter 9 is not necessarily to attempt to balance the rights of the debtor and its creditors but to meet the needs of the municipal debtor.” So while creditors can force individuals and businesses into bankruptcy, they cannot compel municipalities to file under Chapter 9 or propose alternative reorganization plans. As part of the bankruptcy process the city adopted a Pendency Plan in November 2012, which according to a February 2013 City Manager’s Budget Message is “essentially a balanced budget that enables the City to provide basic services during the bankruptcy process and prepare the Plan of Adjustment.” After the United States Bankruptcy Court for the Central District of California ruled San Bernardino was eligible for bankruptcy protection in August 2013, the city rushed to draft a plan that both satisfied its creditors and balanced the budget. Under Chapter 9, municipalities have considerable latitude in developing a reorganization plan that accommodates their unique economic and political conditions; however, the municipality’s creditors must approve the plan before it goes into effect. The Congressional Research Service advises that “the municipal debtor and a majority of its creditors reach an agreement on a plan to readjust the municipality’s debts.” Formulating this agreement, however, has been no easy task for the City of San Bernardino.
The city’s biggest challenger throughout the bankruptcy process has been CalPERS, the powerful agency that administers the state’s public employee pension system. CalPERS requested that the bankruptcy court lift the automatic bar on collection actions to allow it to sue the city in state court to force San Bernardino to continue making payments during the bankruptcy process. Judge Meredith Jury denied Calpers’ request on the grounds that the city would be left without funds to pay its employees and that the city’s ability to reorganize in bankruptcy would be undercut. The agency then responded with a lawsuit challenging San Bernardino’s filing, arguing that since the City did not attempt to negotiate with its creditors and did not properly reorganize its finances before filing for bankruptcy, it is not eligible for bankruptcy protection. After Judge Jury ruled the city eligible, CalPERS filed an appeal. The case is still pending before the Ninth Circuit Court. In August 2012, San Bernardino city officials decided that CalPERS should be treated like any other creditor and ceased payments to the biggest pension fund in the country, an unprecedented action. Although the city resumed pension contributions in July 2013, CalPERS argued in court that the $17 million in missed payments must be paid in full. State courts have consistently upheld the “California Rule,” which states that once a city grants a pension increase that pension must be paid in full regardless of the circumstances. More recently in Detroit’s bankruptcy case, the largest municipal bankruptcy in history, the court ruled that federal bankruptcy law took precedence over state laws. CalPERS adamantly stated that the Detroit ruling does not apply to California. In an amicus brief, CalPERS argues that “Congress did not envision that Chapter 9 would become a haven for municipalities that seek to ignore and break state laws and constitutional provisions in order to adjust their debts.” With roughly $280 billion in invested assets, CalPERS could have easily absorbed the $17 million loss, but the agency is concerned that this decision could set a precedent of struggling municipalities using the bankruptcy system to delay or withhold pension payments. “We are under the microscope, no question about,” said Mayor Carey Davis to the New York Times in April. “San Bernardino took a different approach in bankruptcy as related to pensions, and everybody is waiting to see how it comes out.”
After Judge Jury expressed frustration over the slow progress of negotiations and the city’s formation of a plan of adjustment in May, the two parties finally reached an interim deal in June. The specific details have yet to be released as they are subject to a court-imposed gag order, but according to the June 2014 Status Conference Report the city will begin making payments on the debt it owes to CalPERS, a tough break for the city attempting to regain its financial footing.
CalPERS is not the only group that has challenged the City of San Bernardino. The city has been conducting ongoing negotiations with its public safety unions, a sector that accounted for nearly 50% of total expenses in 2012. Around 500 city employees, about a third of the city’s payroll, have been laid off. One hundred of these are police, cutting the force by nearly thirty percent. In August 2014, the city reached an undisclosed tentative agreement with the police union, but talks with the firefighters have been ongoing. Currently, a provision in San Bernardino’s charter has resulted in unsustainable salaries for the police and fire departments. Enacted in 1955, Section 186 of the City Charter guarantees that police and firefighters get paid the average of the monthly salaries of “like or more nearly comparable positions of the police and fire departments of ten cities of California with populations between 100,000 and 250,000.” The problem is that most of these cities – such as Pasadena, Irvine, and Hunting Beach – have higher per-capita income and much broader tax bases than San Bernardino. For instance, according to U.S. Census data, the 2012 median household income in Huntington Beach was $81,849 compared to $39,097 in San Bernardino. According to expert testimony earlier this year, the city currently pays an average of $190,000 annually to its top 40 firefighters, with the next 40 being paid an average of $166,000.
In September 2014, Judge Jury rejected the current bargaining agreement between the city and firefighters, allowing the city to form a new contract. Jury stated that she recognized that the cuts were a hardship on the fire department, but also that the city’s ability to reject the firefighter’s collective bargaining agreement was a significant step in its recovery from bankruptcy. Mayor Davis has stated that charter reform is a top priority, especially after the City Council had no choice but to approve $2 million in raises to public-safety workers last year, despite massive debt and cuts in nearly all other areas. Fire union president Jeff English defended the language of the charter in a statement to the San Bernardino Sun: “Since 1955, Charter Section 186 has worked successfully to remove politics from determining firefighter salaries with an objective average wage formula. Repealing 186 would be a political action that would divide the community and damage the city’s ability to move forward.” Charter reform will be on the ballot this November under Measure “Q”, which states, “Compensation of police, fire and emergency safety personnel shall be set by resolution of the Mayor and Common Council after collective bargaining as appropriate under applicable law, as it does for other City employees.”
Overall, the economic condition of the City of San Bernardino has not improved significantly in the past two years, though the potential outcomes had the city not filed for bankruptcy could have been much worse. For the month of July, San Bernardino had an unemployment rate of 12.2%. With the exception of May and June, this is the lowest figure since October 2008, but is still significantly higher than the state average of 7.8%. Further, according to U.S. Census data from 2012, over 30% of the population were living below the poverty line in 2012. According to the LA Times, an economic ranking from the consumer financial website WalletHub ranked San Bernardino the Least Recession-Recovered City in the U.S. WalletHub looked at the 150 most populous cities in the country and scored them on various economic indicators, including changes in unemployment rates, median income and home prices. Public funding in all areas of the San Bernardino budget has been slashed. Earlier this year, all three branch libraries faced the threat of closure and many public pools have remained closed. To generate additional revenue, the city is contemplating raising its 8.25% sales tax, which is already higher than the state average of 8.08%, as well as imposing new development and impact franchise fees.
Crime is also up. According to the website Neighborhood Scout, San Bernardino is only safer than 4% of cities in the U.S., with a resident’s chance of becoming a victim of crime at 1 in 95, significantly higher than the national rate of 1 in 236. According to the New York Times, an aggressive gang intervention effort helped cut the homicide rate by almost half since the 2005 peak, but it shot up over 50% in 2012 following San Bernardino’s bankruptcy and ensuing cuts to the police force. “All of our crime is up, and the city has a very high crime rate per capita anyway,” Police Chief Hardy said to the New York Times. “I can’t police the city with much less than this. We’re dangerously close as it is.”
Despite all of this, there are still reasons for optimism. Although not limited to the City of San Bernardino, the San Bernardino County Workforce Investment Board has created a “Rapid Response” program that matches business consultants with companies facing difficulties. The program uses federal funds from the Department of Labor to hire consultants to work on a variety of cost-saving and revenue increasing projects. In the past two years, the county-wide program has saved 686 jobs, created 114 new positions and assisted the companies with $13.5 million in operational cost savings and revenue according to the Workforce Investment Board.
Following its bankruptcy filing, San Bernardino received some good news when Amazon announced it would be building its first distribution center in California at the former Norton Air Force base. When the fulfillment center first opened in October 2013 it employed 700 people. Now, Amazon says that over 1,400 people work there, and they are looking to hire more. Although these figures are not likely to create a noticeable change in unemployment rates, the presence of a successful warehouse from a leading company may drive more business to the area. Within the Inland Empire, Amazon also operates a distribution center in Moreno Valley and is planning to open a third in Redlands in late October.
The Inland Empire’s recent commitment to the development of the “logistics sector” is also a promising potential source of revenue growth for the city. The County of San Bernardino Economic Development Agency along with the County of Riverside Economic Development Agency have partnered with the City of Los Angeles Harbor Department with the goal of enhancing international investment, stimulating job creation, and promoting economic development. The two counties are hoping to increase the volume of goods manufactured in the Inland Empire that eventually get exported through the Port of Los Angeles. “More than 80 percent of all goods shipped through the Port of Los Angeles pass through the Inland Empire and that makes it a powerful catalyst for economic opportunity in our region,” said Cindie Perry, Deputy Director, Economic Development Department for the County of San Bernardino, recently to the Daily Bulletin. “We have available, affordable land for development, local and national economic development programs, and an abundant, skilled workforce that continues to grow. When port-related businesses expand in our counties, the impact is felt on a local, national and global level.”
Despite many setbacks, the San Bernardino International Airport has also shown signs of moving forward, an encouraging sign for the city. Located on the former site of the Norton Air Force Base about two miles southeast of the city, the 1,329-acre airport continues to undergo developments and improvements. Although SBIA is still awaiting its first commercial passenger carrier, the airport board and interim executive director AJ Wilson have been busy at work. According to the San Bernardino Sun, the SBIA’s maintenance hangars are leased to various companies and the airport is in the process of building an additional 30 general aviation hangars. The board also approved a five-year lease with Unical Aviation Inc., a global supplier of aircraft parts, at $200,000 annually. According to a press release from the Inland Valley Development Agency, the airport has invested over $21,800,000 on 14 local projects and generated over 280 estimated direct construction jobs. The Southern California Association of Governments projects that by 2035 SBIA will serve 2.8 million passengers, significantly less than the 30.7 million predicted passengers at Ontario International, but still positive news for the city.
Lastly, the city is also considering allowing medical marijuana dispensaries in hopes of garnering additional revenue from regulation fees and cutting back the high costs associated with shutting down illegal dispensary operations. It is estimated that 20-30 dispensaries are currently operating in the city and that shutting down a single dispensary costs around $720 in staff hours. Currently, 40 California cities allow dispensaries. Palm Springs, which decided last year to legalize regulated marijuana dispensaries, has dramatically cut the number of unauthorized operations and is expecting to collect over $1,000,000 this fiscal year.
Interested in more? Read the remainder of the Fall 2014 IEO here.
Featured image photo credit: Amerique, Wikimedia Commons
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