In our opinion: Absent meaningful reform, Stockton bankruptcy a precursor of things to come

While national attention was drawn to the Supreme Court's decision to uphold the Affordable Care Act and the House of Representative's decision to hold Attorney General Eric Holder in contempt, Stockton, Calif., became the largest city to formally declare bankruptcy.

Since the beginning of this year, Stockton (a city of close to 300,000) has been shirking its obligation to creditors who are owed more than $700 million. Already besieged by mounting litigation from unpaid creditors, Stockton's bankruptcy filing provides an orderly, court-supervised method to reorganize the city's financial obligations, including a retiree medical program with $417 million in liabilities.

As a part of the emerging Plan of Adjustment, it appears that the city's program for retirement health care will be phased out. That will be a bitter pill to swallow for those retirees who were planning on that assistance in the generous early retirement offered to city employees.

The harshness of today's remedy for Stockton's financial woes should remind us of how it can be cruel to be kind. During the 1990s, Stockton dramatically expanded health care benefits to retirees — a nice thing to do, right? But Stockton never provided a realistic plan to fund those benefits.

And, betting on a rising housing market, Stockton overextended itself in fancy redevelopment schemes. Bilked creditors have now repossessed a lavish new city hall building that was part of that redevelopment.

It would be easy to scoff at Stockton's folly. Prior to its bankruptcy filing it already enjoyed numerous dubious distinctions for its illiteracy, obesity and crime. But frighteningly, Stockton's finances are eerily similar to those of many government entities and municipalities that, by promising to provide lots of good things to their employees and citizens, have made promises that simply can't be kept.

Perhaps the most egregious way that this is done is through phony accounting. According to a 2010 study by Eileen Norcross of the Mercatus Center at George Mason University, "On average, state governments have assumed an annual rate of return of 7.97 percent on (pension) plan assets." When was the last time you enjoyed a guaranteed 7.97 percent return on your assets?

As Matt Mitchell, also of the Mercatus, has written, such unrealistic assumptions essentially amount to a fraud on future pensioners. Says Mitchell, "It means that they don't think it is very likely that we will actually honor our promises to public employees."

Numerous market and structural forces suggest that interest rates will remain at historic lows for some time. Unless there is significant restructuring of pension obligations, we fear that Stockton's bankruptcy may become a precursor of bad things to come, rather than anomaly.

Consequently, we might all learn a very basic lesson about prudent financial planning from Stockton vice-mayor Kathy Miller, who told American Public Media's Tess Vigeland, "It's my belief that if these very generous pensions and health care retiree benefits had been fully costed out at the time they were granted, it would have been immediately apparent that they were not affordable."

Indeed.