July 19, 2012 at 9:11 AM ET
The city of San Bernardino, Calif., took a giant step towards filing for bankruptcy protection from its creditors Tuesday when it declared a fiscal emergency.
The designation allows the Southern California city of about 210,000 to skip lengthy negotiations with its debt holders and go straight to filing for Chapter 9, which gives financially-stressed cities and towns protection from its creditors while it renegotiates the terms of its debt.
It's expected that San Bernardino will make its filing in 30 days at the U.S. Bankruptcy Court in Riverside, California, said City Attorney James Penman.
The City Council voted 5-2 to declare the emergency and file for bankruptcy protection amid a dire cash crunch that has officials worried San Bernardino can't meet payroll in August.
"The horse is out of the barn — the whole world knows we're insolvent," Councilman Fred Shorett said, according to the San Bernardino Sun. "I will be supporting going forward with Chapter 9 and fiscal emergency."
The city, located 65 miles east of Los Angeles, could become the third municipality in California to seek protection from its creditors since late June. Stockton and the ski resort city of Mammoth Lakes have already filed in bankruptcy court.
A fourth city, Compton on the outskirts of Los Angeles, could be the next city to turn to bankruptcy protection.
Compton will run out of cash to make its payroll on September 1, a city official said.
San Bernardino has burned through its reserves and is out of other ways to pay for its longstanding deficit spending. It faces a deficit of nearly $46 million.
"This problem has been coming for a long, long time," said Shorett. "It's here, now."
The extent of San Bernardino's financial problems became public suddenly last week, prompting its city council to vote on July 10 to begin the process of moving toward Chapter 9 bankruptcy protection as part of a plan to overhaul the city's finances.
That move caught San Bernardino's residents by surprise and many have spoken out against a bankruptcy filing, fearing its stigma for the city.
San Bernardino's employees are particularly concerned about what bankruptcy means for their pay and benefits.
"This sets a bad example for the people of San Bernardino," said Steve Tracy, the representative for San Bernardino's firefighters union. "It shows the city can make contracts, agreements, and can renege on them by filing for bankruptcy."
San Bernardino's financial staff expects to present a short-term budget to the council on July 24 and city administrators have been authorized to begin negotiations with the city's employee unions.
Eyes on California
The municipal debt market, which has been keeping a close eye on California, also was caught off guard by the July 10 vote and its analysts are still trying to piece together how San Bernardino's finances fell apart without city leaders stepping in to prevent it.
"They either didn't know, which is shameful, or they did know, which is worse," said Dick Larkin, director of credit analysis at municipal bond broker-dealer HJ Sims.
Penman said last week that financial documents had been falsified in 13 of the past 16 years but has not made evidence of the claim public.
A former city manager who warned the city council in mid-2010 that San Bernardino faced financial ruin, the city's mayor and its auditing firm say they are unaware of any wrongdoing.
Larkin said he expected the city council would press ahead with a Chapter 9 filing given the severity of the city's financial trouble.
"They seemed hell bent to do it," he said. "I understand they're just about out of cash. I got the feeling that when they voted last Tuesday, they were out of options."
A state law approved after Vallejo, California, declared bankruptcy in 2008 requires financially troubled cities to enter into talks with creditors to try to avert bankruptcy.
But the law also allows cities to skip talks and move directly toward a bankruptcy filing by declaring a fiscal emergency and stating that they are unable to pay their obligations within 60 days.
Reuters and The Associated Press contributed to this report.
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