Watch CBSN Live

Trial under way in Stockton, Calif. bankruptcy case

STOCKTON, Calif. Lawyers for the California city of Stockton said Monday it has cut its budget and services to the bone and has no choice about becoming the most populous U.S. city to enter bankruptcy.

Creditors countered that the city has actually padded its spending to enhance its ability to persuade a judge to let it seek Chapter 9 protection.

The arguments came as the city faced off with its creditors at a trial to decide the issue.

Stockton has become emblematic of government excess and the financial calamity that resulted when the nation's housing bubble burst.

Its salaries, benefits and borrowing were based on anticipated long-term developer fees and increasing property tax revenue. But those were lost in a flurry of foreclosures.

In his opening argument at the trial, Mark Levinson, an attorney representing the city, argued it has no other option but bankruptcy.

"Stockton is a city of 300,000, and I venture to say none of them is happy about bankruptcy," Levinson said in federal bankruptcy court in Sacramento.

Creditors, however, complained that Stockton had failed to negotiate cuts in the money it pays into the state pension fund.

"The city is not insolvent," said Guy Neal, an attorney for the city's bond insurers. "The city has stacked the deck in favor of insolvency by padding the budget with non-essential expenditures. Stockton can and should do more to reduce expenses."

Unable to negotiate a deal, the creditors want the city to avoid bankruptcy, which would likely allow Stockton to avoid repaying the debts in full.

The trial will determine whether the city negotiated with its creditors in good faith before filing for Chapter 9 protection. The trial is expected to last four days.

The city's population grew by nearly 20 percent between 2000 and 2005 and real estate tripled in value. However, home prices plummeted 40 percent the following year before bottoming out at 70 percent.

Within two years, Stockton had accumulated nearly $1 billion in debt on civic improvements; money owed to pay pension contributions; and the most generous health care benefits in the state. Coverage had been provided for life for all retirees plus a dependent, no matter how long they had worked for the city.

Last summer, the city began negotiating with creditors - a requirement before entering Chapter 9 bankruptcy. Ten employee unions have agreed to temporary wage and benefits cuts.

Retired employees have also been asked to pick up a larger share of health care premiums to help close a $540 million retiree health care cost liability.

The biggest share of the debt is held by companies that in 2007 insured nearly $165 million in pension bond obligations to allow the city a lower interest rate and create stability for investors.

Few people doubt the city will enter bankruptcy after the trial. But that likely won't be the end of litigation.

If Chapter 9 protection is approved, a federal bankruptcy judge would still have to decide whether Stockton's bankruptcy plan is fair or singles out some groups to bear more of the financial burden than others.