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We are coming to the end of the second inning in the ongoing California bankruptcies of Stockton and San Bernardino. I have posted before that the game will probably go on for many years and end up at the US Supreme Court.

Testimony finished today in an important part of the Stockton case. All of the bond insurers (Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp) joined with a few mutual funds that hold Stockton bonds. The group is challenging whether Stockton is even eligible to file bankruptcy.

Part of the bankruptcy process is that the municipality must show they attempted to solve the financial issues but were unsuccessful. The insurers’ position is twofold:

1) Stockton did NOT negotiate with all parties in good faith. They take particular issue with the city pensions being kept whole while all other parties are being asked to take haircuts. Stockton did NOT attempt to lower the payments to Calpers that support the pensions. Stockton DID ask all of the bond holders to take haircuts both on the interest payments AND the principal amount. This is why the bond insurers are actively fighting Stockton.

2) Stockton did NOT fully explore reducing expenses and raising taxes. The insurers maintain that Stockton has the financial ability to balance the budget while paying the bondholders back in full.

Bankruptcy judge Christopher Klein heard three days of testimony and said he will rule by next Monday, April 1st. It appears he has a binary choice:

1) Approve Stockton’s entry into bankruptcy, in which case the insurers will appeal his ruling.

2) Deny Stockton’s entry into bankruptcy, in which case, the city will go back to the drawing board. It is not clear if the judge will rule about the relative standing of Calpers/pensions or not.

This case, in addition to the San Bernardino bankruptcy, is being closely watched. Stockton kept making its required payments to Calpers. San Bernardino did NOT make its required payments to Calpers. Calpers in turn, sued San Bernardino for non-payment.

BOTTON LIME: It is far from clear which side will ultimately prevail in the pensioners versus bondholders. Next Monday, we will get to see who is ahead at the end of the second inning.


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