City of Stockton, CA Is Declared Bankrupt by Federal Judge, Despite Protest from Creditors

Who are the creditors? Wells Fargo Bank, Franklin California High Yield Municipal Fund, Franklin High Yield Tax-Free Income Fund.

Wells Fargo has been seizing Stockton's public properties for lack of payment to the bondholders. It has already taken the new City Hall and three parking garages.

As often is the case for troubled US municipalities, Stockton has lost big in the interest rate swaps with Wall Street banks. Here's the city's document on bond deals and multiple interest rate swaps with Wells Fargo and Merrill Lynch over the municipal wastewater treatment system, entered on June 5, 2007.

That was about the height of the real estate bubble. Slightly over one year later, the entire financial system was on the verge of collapse, and Ben "Blackhawk" Bernank cut the rate to near zero. Stockton, as with many other cities across the US, have been stuck with paying interest to the banks at a high, fixed rate while receiving peanuts from the banks at a variable rate which remains near zero.

From Reuters (4/1/2013):

Stockton eligible for bankruptcy protection: judge

(Reuters) - The city of Stockton, California, is eligible for bankruptcy protection, a federal judge ruled on Monday, turning aside creditors' arguments that the city was not truly insolvent when it sought protection and had improperly failed to seek concessions.

U.S. Bankruptcy Court Judge Christopher Klein's ruling permits Stockton to proceed with its Chapter 9 bankruptcy protection filing from last June in a case with precedent-setting potential for other cash-strapped U.S. cities.

In a lengthy preamble to his ruling, Klein said Stockton's bondholders had failed to negotiate in good faith with the city prior to its filing for protection. He added the city was "by any measure insolvent" prior to its filing.

Stockton is the largest U.S. city to have ever filed for bankruptcy. Its case is being closely watched in the $3.7 trillion municipal bond market as it is likely to have key implications for other struggling municipal and county governments, their employees and their bondholders.

The city's capital market creditors had argued the city could have done more to cut costs and raise revenues.

Since at least the 1930s, bondholders in most major municipal bankruptcies consistently have been repaid their entire principal. But Stockton is expected - along with Jefferson County in Alabama and San Bernardino in California - to break with that tradition.

Bond insurers Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp were joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund in contesting Stockton's bid for bankruptcy eligibility.

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