The decline and fall of California
San Bernardino, Calif. — On the front door of the San Bernardino city hall is a sign that reads: “Out of Order.” Broke city, broken door: There’s a certain pleasing symmetry in the fact that the San Bernardino city council meets behind a door that, like the city government itself, does not work and is in need of replacement. On this particular evening in late July, the council has met to make public what everybody already knows: Intellectually bankrupt, morally bankrupt — the city is under criminal investigation for sundry financial shenanigans — San Bernardino is above all old-fashioned bankrupt bankrupt, a pitiful penniless pauper that cannot even afford a cup of coffee: Seriously — the coffee guy wants cash up front now and has stopped serving the municipal office building until the city makes good on its latte liabilities. This is a paddle-free scato-riparian fiscal expedition of the first order.
After a great deal of self-congratulatory speechification — during which one council member used the phrase “the buck stops” no fewer than five times without once getting it quite right, laid out a little Boston Consulting–style two-by-two matrix to explain his analysis of the situation, repeatedly reminded the citizens of how often he had “prayed for strength” during his four long months in elected office, and generally made a po-faced spectacle of himself — after all that, the feckless ladies and clueless gentlemen of the San Bernardino city council voted to seek shelter under Chapter 9 of the U.S. bankruptcy code, a law that deals specifically with municipal bankruptcies and grants cities an extraordinary level of protection during financial reorganizations. A phalanx of pant-suited she-bureaucrats and the city attorney explained that in addition to filing for bankruptcy, the city needed to declare a fiscal emergency, because it did not have enough money even to last through the 60-day waiting period that would follow initiating the bankruptcy. The moment was not without levity: When one of the ladies of the city council inquired as to which court would hear the case, the city attorney explained that he was pretty sure the city’s filing under federal bankruptcy law would be heard in federal bankruptcy court. When another council member inquired as to why the city was filing under Chapter 9 instead of the more famous Chapter 11, the city attorney gently explained that the municipality was filing under the municipal-bankruptcy law because it is a municipality, not a guy with hospital bills and a mortgage in default.
San Bernardino spends about 75 percent of its general-fund budget on salaries, benefits, and pensions, with the vast majority of those expenses coming from one class of employee: public-safety workers, meaning cops and firemen, who earn as much as $230,000 a year with overtime. Their pensions, as will not surprise anybody who has been paying attention to government finances in recent years, are extraordinarily generous. In 2007, a consulting firm warned the city that its budget was in trouble because its personnel costs were growing considerably more quickly than revenue, and the city’s response was . . . to offer even more generous pensions in the same year. The firemen are fat and happy in the California sunshine, but the rest of San Bernardino is not doing as well: “When times were good, my wife and I didn’t go hog-wild and play the let’s-get-a-bigger-house game,” says Mike Potter, who works for a local construction firm. “But now times aren’t good. At my company, 50 percent of the employees have been laid off, and I’ve taken a 15 percent pay cut. I was the head of engineering, and now I’m also a part-time receptionist and janitor.” He is one of the lucky ones — the local unemployment rate runs around 15 percent — and he is blunt on the subject of what encumbers San Bernardino and other bankruptcy-bound California cities: “The public-employee unions are killing us. They are killing our cities, our states, and our country.”
John Magness, the biggest real-estate developer in San Bernardino, is bearish on the city’s near-term prospects. “No respectable developer would risk its relationships by getting its clients to locate in a city with this risk,” he says. He estimates that his company’s projects have added $1 billion to the city’s tax base and about 5,000 jobs over the past decade, but finds himself “reluctant to encourage customers to come here in this uncertain environment.” He spoke in favor of the bankruptcy filing and fiscal emergency, arguing that it would give the city an opportunity to run a river of reform through the Augean stables of its finances, renegotiating contracts and rewriting the city charter. The local business leaders were nearly unanimous in endorsing the measures.
The citizens, as usual, were a mixed bag: One argued that the city’s economic prospects could be turned around by recruiting a Trader Joe’s to open, while another argued that the city’s most pressing problem was the official harassment of “legitimate cannabis-based businesses.” While a bottle of Trader Joe’s Three-Buck Chuck and a few bong hits might take some of the sting out of the city’s straits, its problems go much deeper. San Bernardino, like many California cities, like the state of California, and like the United States at large, is finding out the hard way that it is not as rich as it thought it was ten years ago. It’s rich, of course — and California is fabulously rich — but it’s like the rich guy who has taken out a $10 million mortgage on a house that turns out to be worth only $1 million: A million-dollar house is still a lot of house, but you have to make some adjustments. In 1999, at the peak of the dot-com stock-market bubble, California reformulated its pensions and other public-employee-compensation practices, making them much, much more liberal than they had been. The state’s Democrat-run legislature did this on the theory that pension investments would keep offering double-digit returns more or less forever, which led elected officials to make big promises and set aside approximately zilch to make good on them. If borrowing money to acquire an asset based on the theory that the appreciation of that asset will more than offset the cost of financing the borrowing sounds to you like the woeful tale of a million subprime mortgages, then they really could have used you in the California legislature a decade or so ago, or at Fannie Mae. In bubble after bubble after bubble, the country keeps repeating the practice that everybody swore off after the great market crash of 1929 and the Great Depression: investing on margin. California took out something very much like an adjustable-rate mortgage, financing present political consumption by in effect borrowing against future returns on the assets in its pension system — but the returns didn’t materialize. CalPERS, the gigantic statewide pension system, was until a few weeks ago projecting 7.5 percent returns on its investments. Real returns: just over 1 percent. The entirety of the state’s finances are from top to bottom exactly what one San Bernardino resident called his city’s fiscal charade: a shell game.
The results in San Bernardino are pretty much in-your-face. Once a prosperous and well-scrubbed place, the city is now in such a sorry state that a local café owner complained about the hookers tricking near her business. Vagrants are a source of constant complaints. San Bernardino is suffering from crime and slumification — more than a few residents suggested that if the city should need to make budget cuts, low-income housing programs are a good place to start, and they pretty clearly would want them cut even if the city were absolutely flush — and it is widely remarked upon that many of the city’s most influential businessmen no longer live in San Bernardino, having fled for well-heeled Rancho Cucamonga or other safe havens. With the locals getting gone, outsiders aren’t eager to get into the market. A developer described spending six years trying to recruit a Home Depot to open in the city. Whatever the orange-apron brigade’s reservations about opening up shop in San Bernardino, available real estate surely was not among them. The Carousel Mall across from city hall is one of those sprawling two-story midcentury retail complexes, and it has a grand total of nine shops open. Most of the top floor is gated and shuttered, while the lower level has given up on retail entirely and converted the stores to office space. The garishly painted eponymous carousel is still and silent. On the upside, parking is a breeze.
While the city faces a great deal of trouble with its personnel costs, an even more toe-curling potential calamity awaits in the form of hundreds of millions of dollars of liabilities in economic-development grants, according to Warner Hodgdon, an astringent critic of the city government. The city offered the development concessions in the belief that the state would be picking up the tab, but Sacramento has some hairy fiscal problems of its own and is getting ready to leave San Bernardino and other cities twisting in the hot desert wind on those liabilities. Nobody seems to appreciate the irony that San Bernardino’s economic future has been nuked by over-ambitious economic-development programs, and Hodgdon doubts whether the fiscal emergency and bankruptcy will be sufficient to deal with that problem. “I question whether this is a wise move,” he said. “I spent ten years as chair of the economic-development agency. We were an all-American city, not all-American buffoons.”
The buffoonery is epidemic. Little places such as Mammoth Lakes have gone fiscally toes up, as have bigger cities such as Vallejo. Bankrupt Stockton, one of the most dangerous cities in the country, has substantially reduced its police force, and signs of disorder are everywhere: garbage, police tape, vandalized properties. In the city’s Garden Acres neighborhood — a.k.a. “Okieville” — tattooed young men ape the style and mannerisms of Sinaloa gangsters. But like a lot of cities burdened with gigantic pension liabilities, Stockton is paying so many police so much not to police that it can’t afford to pay police to police. Just outside Los Angeles, the city of Compton is probably bankruptcy-bound, too. Compton, once synonymous with ghetto gangsterism, had been making something of a comeback, but like San Bernardino it grossly (and perhaps criminally) mismanaged its finances, shuffling money around from special-fund accounts to pay general-fund bills, leaving it with a looming deficit almost equal to its annual budget. Its bonds are junk, and its auditing firm, Mayer Hoffman McCann, was fined $300,000 for failing to detect irregularities leading up to a 2010 corruption scandal in Bell, Calif. And even that firm won’t sign off on the city’s current financials: It quit rather than publish an opinion on the statements, citing unresolved fraud allegations. Mayer Hoffman McCann: Straight outta Compton.
The bad news is that there are a lot of Comptons, Stocktons, and San Bernardinos out there. Los Angeles may prove to be one of them. The good news is that things have gone so sour that some California politicians have discovered that it hurts less to act than it does not to act. That is true at the municipal level but not yet true at the state level, which makes for some interesting mayors-vs.-legislators politics.
“The enemy isn’t Democrats or Republicans,” says San Jose city councilman Sam Liccardo. “The enemy is algebra.” Liccardo, a Democrat, is bracingly honest when it comes to his fellow partisans in Sacramento: “The fact is the unions own the Democratic party,” he says, and San Jose’s pension-and-personnel reforms have not made the city’s Democratic elected officials any friends in Sacramento. “Party orthodoxy is much more strictly enforced at the state level, because the unions decide who wins and who loses,” Liccardo says. San Jose mayor Chuck Reed, also a Democrat, has been out front on the pension issue, and he’s maybe had a little easier time with it than have the authorities in Compton or San Bernardino. His city is the capital of Silicon Valley, and his base of affluent Northern California professionals are not sending love letters to Paul Ryan, but they know how money works. “They may be liberal,” he says, “but at some point you have to decide: Are we going to provide services or not?”
Reed has formed an unlikely partnership with the Republican mayor of San Diego, Jerry Sanders; the two authored letters to the legislature defending pension-reform efforts at the city level. “This isn’t a partisan issue — 66 percent of our citizens voted for the pension-reform initiative,” Sanders says. “The state has been negligent, and a rift has broken out between the municipalities and the state.” San Diego converted most of its pensions to a 401(k)-style plan, which, in addition to being more sustainable than a defined-benefit program, has the virtue of encouraging politicians to be prudent. “The employees can check their accounts,” Sanders says, “so we have to make our contributions. They get to watch it grow.” While San Diego is not entirely out of the woods — Sanders worries that a second national recession is on the horizon — the mayor is understandably proud of the fact that the city is projecting budget surpluses for the next five years. On the most critical issue facing California’s struggling cities, he finds himself in agreement with his Democratic counterpart in San Jose: “Chuck is absolutely right.”
California is a state with Hollywood at one end and Silicon Valley at the other, and driving along Route 1 between the two, you’d think its highways did nothing but connect money with money and success with success: From San Francisco’s financial district down to Big Sur, from Beverly Hills to the solidly middle-class precincts of Orange County, California still is home to some of the richest, most productive, most energetic, and most creative people in the world, and watching the morning fog burn off of the Pacific, you can appreciate why every billionaire, rock star, and cult leader with any ambition at all makes his way to the Golden State. It’s enough to make a Republican take up yoga. But there’s another route between Los Angeles and San Francisco, too, through the blasted desert and agricultural backcountry. You don’t have to get very far out of Los Angeles before you’re in the world of “PIGS FOR SALE” signs, low-rent evangelical radio, and those millions of illegal aliens that Californians spend their time studiously not talking about. Unlike the wannabe Sinaloa bad boys up in Stockton, the backcountry farmboys have a sense of humor about Mexico’s infamous syndicates: One produce-hauling entrepreneur moving a load of fresh tomatoes up Interstate 5 had the wit to call his carting business “CARTEL.” He was running a big diesel, but in the more desolate corners of the state you wouldn’t be too surprised to see a cart being pulled by oxen. It is sobering how empty, run-down, and poor much of interior California is. Bakersfield and environs is enough to make you wonder why the Joads even bothered: Tulsa is Paris by comparison.
San Jose and San Diego may be havens of relative fiscal sanity, but they are surrounded by Stocktons, Comptons, and San Bernardinos, along with the vast inland expanses that in many places have a disconcertingly Third World ambiance. Departing Los Angeles mayor Antonio Villaraigosa set many observers on edge when he talked about bankruptcy in connection with the city’s fiscal future. “He says a bankruptcy won’t happen under his watch,” says Kevin James, a Republican fiscal warrior running to replace him, “but his watch is over in a few months. He didn’t say anything about what happens after that.” The bankruptcy of the nation’s second-largest city would not be a disaster in and of itself — it would only be San Bernardino writ large, a public confirmation of what everybody already knows.