A City in Crisis
AMERICA’S SO-CALLED FINEST CITY has dug itself into a multibillion-dollar hole. Bankruptcy may now be the only salvation for San Diego, judged a decade ago to be the best-managed municipality in the country. The fear of receivership is so great it’s made strange bedfellows of organized labor and a once-popular mayor, who is reduced to deflecting calls for his ouster as demands for heads to roll echo up C Street to City Hall.
It’s now “we can fix it” versus “bankruptcy” at “Enron by the Sea,” as the clock ticks for a city unable to borrow money until it gets its financial house in order. Mayor Dick Murphy and most of the city’s top brass contend they have the situation under control. The lame-duck mayor hopes to salvage what’s left of his tarnished legacy while his colleagues on the city council try to avoid political suicide.
Meanwhile, the labor unions have suddenly found a friend in Murphy as they attempt to cobble together a plan to retain retirement benefits that could be wiped out in Chapter 9 bankruptcy. The only ones who stand to gain from bankruptcy, they insist, are lawyers and developers.
Bankruptcy proponents, however, claim the course corrections were charted in a fog of denial and are leading San Diego into an even greater fiscal storm. Rumors of a Murphy recall effort have quieted, but should the tentative alliance with labor dissolve, he could face an early exit from office.
THE HEART OF SAN DIEGO’S fiscal woes lies in the employee retirement system, which, due to decades of underfunding, has racked up a $2 billion —and growing—deficit . Former Mayor Susan Golding and her then-city manager Jack McGrory have been singled out for initiating the pension underfunding in 1996, which snowballed into the financial mess the city is in today.
But Diann Shipione, a former trustee of the San Diego City Employees’ Retirement System (SDCERS), says they merely institutionalized the practice of robbing Peter to pay Paul that started in the early 1980s. It was Shipione who blew the whistle on the city’s persistent underfunding of the pension plan, as well as what she calls the phonied-up financial disclosure statements to bond-rating agencies—which spawned investigations by the Securities and Exchange Commission and the U.S. Attorney’s Office.
The seeds of today’s crisis, she says, were sown during the taxpayer revolt of the late 1970s. That populist uprising culminated in the passage of Proposition 13 in 1978 and was later topped off with Proposition 218 in 1996. Together, they limit elected officials’ ability to increase taxes.
With that factor combined with raids on local revenue by the cash-strapped state legislature—as well as the city’s below-average tax and fee structure and its reluctance to cut back during economic downturns—revenue did not keep pace with expenses. By 1996, the city could not meet its minimal pension obligation, and a deal was struck with the labor unions to increase benefits while purposely withholding money from the pension fund. Following the stock market bubble-burst in 2000, the terrorist attacks in 2001 and the subsequent recession, this insidious arrangement was renewed in 2002.
[City politicians] looked at the retirement system as a piggy bank,” says Joan Raymond, president of the American Federation of State, County & Municipal Employees (AFSCME) Local 127 in San Diego. “They needed that money for the Republican National Convention, Qualcomm Stadium, Petco Park and other things.”
The unfunded pension liability mushroomed to $1.37 billion this year. Add the $545 million unfunded liability for retiree healthcare benefits, and the total debt the city owes the retirement system is nearly $2 billion. Shipione contends even that figure is low, because the retirement system uses an outdated formula for calculating its liability. Under the formula commonly used today, the shortfall is at least $2.5 billion, if not $3 billion.
“The mayor and city council do not fully appreciate the extent of the problem,” says Shipione, whom the mayor did not reappoint to the pension board when it was realigned in April.
Councilmember Jim Madaffer disagrees. “The sky is not falling on the city of San Diego. We got a report that the pension fund is up by more than $1 billion over the past six months.”
The most recent quarterly update on the fund by investment measurement service Callan Associates Inc. states SDCERS has “enjoyed relatively strong performance results.” However, it also predicted “the next 3-7 years will prove to be a challenging return environment for the capital markets. Achieving nominal and real actuarial return objectives will likely require . . . value added above the benchmark.”
Meanwhile, city manager Lamont Ewell had to lop $10 million off this year’s budget and will need to cut up to $50 million from next year’s to make ends meet. The city has no certified audits for fiscal 2003 or 2004 and is fiscally “flying blind,” as the real possibility of criminal indictments at City Hall has turned genteel politics into a barroom brawl. Without the 2003 audit, the city can’t sell bonds to raise needed cash.
But the mayor and city manager contend the $2 billion deficit is not a real number. It’s an actuarial estimate of longterm needs that changes each year, they say, and will get better once the “dog years” of 2000 and 2001 are out of the five-year average used in calculating the liability.
Tell the employees who are counting on that nest egg for their retirement that it’s not a real number, counters Shipione, who contends the “books are cooked” to make things look better than they really are. Both she and City Attorney Michael Aguirre have called for an independent audit of the pension plan.
The KPMG audit of the city’s books has been stalled, meanwhile, because that accounting firm wants to determine if any illegal activities occurred with regard to the pension plan. But the retirement system board, which sued the city, has refused to turn over the necessary documents, claiming attorney-client privilege.
Aguirre has urged the mayor to ask the retirement board to waive attorney-client privilege and reinstate him as the board’s legal counsel so he can make a determination. At this writing, they were still at loggerheads, undercutting the city’s ability to sell bonds.
THE MAYOR AND MOST of the councilmembers believe a combination of belt-tightening, fee and tax increases and bonds will end the flow of red ink. Critics of the plan say its fundamental assumptions are flawed, and one camp touts bankruptcy as the best option.
In February, Mayor Murphy unveiled a seven-point proposal for solving the pension problems. The key provisions include a two-year salary and benefits freeze for the city’s 11,500 employees and issuing pension obligation bonds. Other provisions call for an increase in employee pension contributions and elimination of the controversial Deferred Retirement Option Plan. Murphy says his proposal would cut the pension deficit by approximately $600 million over the next two years and help close next year’s budget gap by almost $40 million.
The linchpin of the mayor’s bailout plan is successful labor negotiations. Which is why Democrat-leaning labor is now cozying up to the Republican mayor, City Hall observers say. If the negotiations break down, the mayor could ask the city council to declare an impasse and impose salary and benefit reductions for one year—and extend the reductions next year if needed. But that could be the last straw for the unions, and trigger a Murphy recall they currently oppose.
Aguirre, who has butted heads with Murphy since taking office in December, has a different plan for wiping out $600 million of the pension fund deficit. He believes the increased benefits granted to city employees in 1996 and 2002 are illegal and should be declared void. Either way, it still leaves hundreds of millions of dollars of unpaid-for benefits, says Aguirre, who threatens to hold up next year’s appropriations unless the council acts to increase revenue.
“There is no way to get out of raising revenue,” Aguirre says. “We’re going to be taking a very strong stand in the city attorney’s office that the appropriations ordinance cannot go forward until and unless proper provision is made to pay those unpaid benefits.”
The city and employee labor unions are at the bargaining table, but the four unions want to see an audited financial statement before making any concessions.
“Everything they’re telling us needs to be verified,” says the AFSCME’s Raymond, who says her members typically receive pensions of about $21,000 a year and that the highly publicized sweetheart deals given to a few union officials are the exception, not the rule.
“The city needs to meet us halfway,” adds Johnnie Perkins, spokesman for Fire Fighters Union Local 145. “It’s a 50-50 situation, but the city wants labor to be 100 percent of the solution.”
WHERE THE MAYOR AND UNIONS do see eye to eye is on the matter of bankruptcy. “Bankruptcy is not an option,” says Murphy. “It would only destroy the city’s credibility on Wall Street and cost millions in legal fees.”
The estimated tab of $30 million to $50 million makes bankruptcy the wrong choice, say opponents. Councilmembers Scott Peters and Brian Maienschein term talk of bankruptcy “irresponsible.”
“I would probably sell land at Qualcomm Stadium before declaring bankruptcy,” Councilmember Madaffer says.
Councilmember Michael Zucchet says he not only has faith the steps the council is taking are leading toward financial stability, he doubts the city could pass the crucial insolvency test.
“The problem with bankruptcy for me is that I haven’t heard from anyone a compelling argument to say we’re insolvent,” he says. “You can’t just declare bankruptcy. You have to show real inability to pay your debts.”
Although Councilmember Donna Frye says all options need to be on the table, she believes bankruptcy is unnecessary. “It can be avoided, if we just do our homework,” she says. “Whether we have the political will to do that is an entirely different matter.”
Carl DeMaio, president of The Performance Institute in San Diego, agrees.
He calls bankruptcy “a last resort” but says the mayor’s plan doesn’t go far enough. He derides the wage and salary freeze as a “public relations stunt” because it doesn’t occur until after the current round of slated pay raises takes effect on July 1. The biggest problem, DeMaio contends, is that salaries and benefits have outpaced revenue growth by as much as 13 percent during the past five years.
“Labor costs have skyrocketed, crowding out investment for services and infrastructure —the underfunded pension plan is a symptom, not the problem,” says DeMaio, who vows to initiate a referendum to block any attempt by the city to sell pension obligation bonds.
“We have done the polling, so if they are banking on that, they’d better come up with a different bank. You don’t pay off credit card debt with a credit card.”
Proponents of declaring bankruptcy insist the city will be bankrupt eventually, so it’s better to do it sooner rather than later. Patrick Shea, a San Diego attorney who served as a trustee in Orange County’s bankruptcy in 1994—and is Shipione’s husband— contends a Chapter 9 filing brings everyone to the table, rather than handling it piecemeal, as is being done now.
Shea acknowledges municipal bankruptcy is a drastic measure. But he argues San Diego’s situation is sufficiently dire. City officials have made a series of bad decisions to cover up past bad decisions, he says, and working it out at this stage requires experts who have no political stake.
“Bankruptcy allows you to bring all those issues to a single forum where an agreement has to be reached amid all the parties—employees, beneficiaries, vendors,” Shea says.
Dealing with the pension alone is unrealistic, he continues. Any measures taken to deal with the pension could lead to costly litigation. In bankruptcy, all parties would be at the negotiating table from the start.
Besides, Shea adds, the city’s leaders have not proved themselves to be effective problem-solvers. “It’s clear that the people who are charged with managing the financial affairs of the city don’t have the tools in the toolbox to deal with it,” Shea says. “Bankruptcy attracts a core of sophisticated and talented legal and financial professionals who have taken problems like this and resolved them.”
Shea contends the city already pays through the nose for attorneys and consultants, yet has little to show for it. He and other municipal bankruptcy attorneys characterize Chapter 9 receivership as a recovery program an entity chooses rather than a hideous fate that befalls it—like an addict checking into rehab before hitting rock bottom.
Paul Glassman, an attorney with Los Angeles law firm Greenberg Traurig, and David Kupetz, of SulmeyerKupetz in Los Angeles, were both trustees in Orange County’s bankruptcy. They say Chapter 9 is far softer on the bankrupt entity than corporate bankruptcy, known as Chapter 11. The municipality cannot be forced to liquidate assets, and creditors and organized labor have far less clout than in Chapter 11, Glassman says.
Adam Brauer, an Arizona bankruptcy attorney who formerly handled Chapter 9 cases, has followed San Diego’s situation closely and deems the city “ripe for Chapter 9,” adding that it would actually restore credibility on Wall Street. “The mayor is saying, ‘We’ve never missed a payment,’ ” Brauer says. “That’s all well and good, but a few years down the road, you’re not going to be able to say that, and the financial burden will be a lot more. Chapter 9 is the right way to go for this city.”
Glassman is not convinced qualifying for bankruptcy would be a slam dunk, but it never is for any municipality. “Eligibility is always challenged,” he says.
San Diego would have to prove that it had exhausted every reasonable alternative to bankruptcy, which could include more spending cuts or seeking new revenue streams. However, once that hurdle is cleared, “all of the cards are stacked in the city’s favor,” giving it enormous negotiating power with its creditors.
Shea believes it is fear of this diminished clout by one of the city’s major creditors—the retirement system and the labor unions it benefits—that is driving the city council’s opposition to bankruptcy.
“That’s why Dick Murphy and all the union guys are so afraid of bankruptcy,” he says.
In addition, the city could not be forced to sell land at Qualcomm Stadium.
Chapter 9 “is written that way to protect the municipality, the taxpayers, the citizens and the assets of the community” from the politicians, Shea says.
A higher hurdle is that the people who must vote for bankruptcy—the city council—might see it as a political career killer. “They have egg on their face,” says Brauer. “No one wants to be an elected official whose community had to file for bankruptcy.”
Nor do the labor unions want bankruptcy; thus they are willing to negotiate a compromise in wage and benefit hikes. But if no deal is reached and the city council opts to arbitrarily impose a wage-and-benefits freeze on city employees, the unions could switch sides and consider backing a Murphy recall, insiders say.
THE RECALL IS A DONE DEAL. That was the claim in March as rumors surrounding Mayor Murphy reached a climax. The arguments for a recall, which cannot begin before June 9, centered on the mayor’s “poor judgment” and “indecisiveness” as a litany of offenses were trotted out, not least of which is the city’s financial crisis coming to a head on his watch. A crisis he exacerbated, his critics say, by voting to increase employee benefits while continuing to underfund the pension system. And with only about a third of the city’s voters supporting Murphy in the last election, the biggest question mark was whether enough signatures could be gathered in the short time allotted to get a recall measure on the ballot, not whether he would survive the recall.
Murphy shrugs off the prospect: “I’m not going to worry about it. I need to focus on the city’s challenges.” Under scrutiny, the rumors quieted down. No one emerged to seriously support a recall, let alone underwrite a campaign estimated to cost between $300,000 and $500,000.
Hotelier Doug Manchester, figured to be the guy writing the check, demurs. “I am unequivocally not funding a mayoral recall,” he says, although he does believe a change of quarterback is needed.
Padres owner John Moores and veteran business leader and philanthropist Malin Burnham were also named as potential check writers, but both oppose a recall.
“Without Dick Murphy’s leadership in putting the financing in place for the city’s portion of the new ballpark, there would be no Petco Park, the continuing downtown renaissance would not have happened,” Moores says. “The mayor should get his share of credit for redeveloping downtown San Diego.”
While Burnham agrees new leadership is needed at City Hall, he says a recall would make matters worse. “What this city needs is a new city manager, and the sooner the better —this afternoon.” And it needs to be someone from outside San Diego, he contends. “Someone without political baggage and with the stipulation that he or she remains city manager under the strong mayor.”
The strong-mayor form of government for the city, championed by Murphy and approved by voters last November, takes effect in January.
The San Diego Regional Chamber of Commerce also opposes a recall. “Our position has been that at a time like this, a recall effort would send an even greater perception of instability to Wall Street and others watching this around the country,” says spokesman Mitch Mitchell. “Instability is not what we need right now.”
It’s one of the few things on which the chamber and organized labor agree. “A recall does nothing to solve the problem,” says Perkins of the firefighters’ union.
Adds DeMaio: “A lot of people are willing to let the [federal] investigation run its course, then see what needs to be done. Labor is perfectly happy with Murphy because they have him over a barrel.”
WHILE RECALL TALK has quieted down, there are plenty who believe Murphy should go. Peter Q. Davis, who finished third behind Murphy and County Supervisor Ron Roberts in last year’s mayoral primary and was not reappointed by Murphy to the Port Commission, has his own version of the three R’s: “No on recall; yes on resignation and receivership.”
He believes a recall would be successful, but that the new mayor would be unlikely to receive 50 percent of the votes. “Again, we would have a person the majority of voters did not feel is ‘their’ mayor,” Davis says. It would be better for the city if Murphy resigned and a full election was held, he believes.
Attorney Michael Conger, who successfully sued the retirement system on behalf of a city retiree, feels more strongly about it. Not only should Murphy go, he says, there should be a wholesale housecleaning at City Hall.
“From where I sit,” says Conger, “knowing the details of who did this, they all need to go, because they completely and totally created this chaos . . . and possibly committed securities fraud in doing it. They couldn’t meet payroll, and to keep the employees from complaining, they gave them a raise.
That’s not just a mistake, that’s a character flaw.”
Moores believes that when we have a “strong mayor,” the situation will improve. “Even now, few voters really know who is to blame because so many politicians, appointed officials and public agencies have had a rather fuzzy role in the pension crisis,” he says. “The voters should have a single neck to choke.”
Voters could still opt for Murphy’s neck. The mayor is weak enough politically, DeMaio says, that if he is not seen as being decisive and coming up with a workable solution, more than enough people are ready to roll on a recall.
Davis concurs. “There are probably 10,000 people in San Diego that could probably fund a recall” at the maximum contribution level of $250, he says. “Murphy’s indecisiveness, his obsession with secrecy, and now his alltoo- apparent vindictive nature have contributed to the present problems,” Davis says. “What we now need is a new mayor.”
Adds Manchester: “If there was some [recall] movement afoot, and somebody had a candidate who was qualified to step in and take over, I’d absolutely be happy to talk to them.”
America’s Finest City is not enjoying its finest hour. Bankruptcy, however embarrassing, may be the best way—if not the only way—out of its fiscal quagmire. And come autumn, San Diego might well be electing a new mayor. The question is: Who would step forward as its Arnold Schwarzenegger?