Will Stockton, Calif., Be the Biggest Municipal Bankruptcy Ever?

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Paul Morris / Bloomberg / Getty Images

A pedestrian crosses Weber Street in Stockton, Calif., on Feb. 7, 2012

At half past five on a weekday afternoon, the Rose Barbershop is the only downtown business open for blocks in Stockton, Calif. Don Nagai used to give haircuts late into the night, but now "it's a ghost town," he says, putting the finishing touches on his last customer. "Same thing during the day; it's too dangerous for people to hang around," shrugs William Koga, 53, a longtime patron who said there had been two shootings over the past week near his corner grocery store. With crime surging and an undermanned police force struggling to keep up, both men were cynical about the city they've always called home. "But," adds the 84-year-old Nagai, with a touch of gallows humor, "that Forbes [magazine] is full of s--- — Stockton is maybe the second worst place to live."

In recent years this inland port city of nearly 300,000 people has earned several distinctions, none of them good. Twice atop Forbes' list of America's Most Miserable Cities ... Second highest violent-crime rate in California ... Second highest home-foreclosure rate of all major U.S. metro areas. Now, Stockton is on the verge of another dubious benchmark: bankruptcy. In its third straight year of fiscal emergency, the city faces a deficit of as high as $38 million on its $165 million general fund budget. As required by state law, the city council is in mediation with creditors and unions. If a deal is not reached in the coming weeks — and prospects are bleak — Stockton will become the largest municipality in U.S. history to go bust.

While Stockton has been down on its luck for as long as memory serves, many residents insist its fiscal crisis is a function of bad management during the flush years of the housing boom. Long an agricultural hub for Central Valley farms and situated about 80 miles (130 km) east of San Francisco, it went through a steady financial decline that saw its once thriving downtown hollowed out by poverty and crime. Scores of people decamped for the north of the city, or left altogether. Street gangs multiplied. Then, in the early 2000s, the housing boom drew developers back to the region in droves. Plush subdivisions went up overnight to attract families with easy credit who could not afford the Bay Area.

Prior to the housing boom, reckless spending on public-employee contracts put the city's long-term health at risk, according to active city officials. As coffers started to fill up from the swelling tax base, the sweetheart deals got sweeter. If an employee worked for one month, for instance, they and their spouses were eligible for retiree health care for life, a policy that had the predictable effect of moving people to quit working early. Today Stockton has 94 retirees with pensions of at least $100,000 a year, Reuters reported, amounting to twice the number of California towns its size. The city's long-term health liabilities alone amount to more than $400 million.

Meanwhile, Stockton's urban core was given a face-lift to seduce homeowners. Tens of millions of dollars were poured into building a marquee waterfront area comparable to San Antonio's river walk, complete with a gleaming sports arena, theater complex, marina and walkway. A celebrity chef was invited to run a restaurant, rent free, on the first floor of the historic Stockton Hotel. When it came time to open, the city paid singer Neil Diamond $1 million to headline a kickoff concert. "Then," says longtime resident Robert Weaver, 76, "the whole thing ground to a standstill."

The housing bubble burst, followed by the Great Recession. City revenue streams dried up (plunging more than $50 million compared with prerecession years), slashing municipal services across the board, from public parking to bike police. The downtown quickly reverted to a no-man's-land: waterfront entertainments were shuttered, the grand hotels given over to low-income and student housing. A fancy high-rise municipal complex that officials had paid $35 million for is now being rented out, leaving the city council to debate its woes in their old building, where a red, white and blue banner out front reads with fitting irony: "Stockton: An All America City."

"Stockton did something very similar to what many American families did: the city overcommitted to long-term obligations that even under the best of times the city could not afford," says Bob Deis, the city manager since mid-2010. "So if there was not a recession, the city would have been having the conversation we're having in four or five years. But then the perfect storm happened."

For decades, Stockton has had some of the state's highest crime rates, and the loss of over a quarter of the police force — not to mention less pay and benefits to those who remain — has taken a grim toll. Last year there were 58 homicides in the city, an all-time high, according to police-department figures, and more than double the total for 2008, when the humming economy corresponded to the lowest level of violence in 30 years. The city is on track to surpass that record this year with 14 murders so far, including four in a three-day stretch. On Wednesday, an officer was shot by a teen (he survived). "We're doing our best with what we have, but it's violent out there," says Joe Silva, a police-department spokesman.

Extra resources will not come easily. The value of area homes has fallen 75% over the past six years, with some economists forecasting that it could take another 20 for housing markets to return to their boom-day levels. What's more, with unemployment locked above 16%, the tax base is diminished and homeless shelters are overbooked. "There's nothing anymore in Stockton," says Nicole Trout-Lacy, 33, who spent a year job hunting before being forced out of her apartment with her three children. They now live in the Stockton Shelter for the Homeless, sleeping on the floor because of a lack of beds. "If not for this place, we'd all be living in the tent city outside."

Given the city's huge obligations and shrinking capacity to generate revenue, Deis says it's critical for Stockton to "break itself from the boom-and-bust cycle." With guidance from a team of urban-development experts from around the country, city leaders are pursuing a new plan to revitalize the downtown — this time with private money. "We're investing a huge amount of resources to make this process work", says Deis, praising the tenacity of the current city council in going after bloated labor contracts to find some fiscal breathing space. "But we're not in control of it," he adds.

Despite all the gloom and doom, some Stocktonians are taking the long view. Alphonso Maynard, 47, vividly recalls the height of the 1980s' crack epidemic. Standing in front of a Starbucks near the waterfront, he swears that "it used to be much, much worse here," pointing to a onetime flophouse that has been converted into an office building, then a drug-dealers' park that is now a school. "This city still has real potential if the right funds and motivation are in place. I think it'll bounce back again." In the shadow of the vacant sports arena where he works part-time, a young couple strolled by the river hand in hand. Perhaps they were glad to be all alone.