SAN FRANCISCO/SAN BERNARDINO, July 15 (Reuters) - In August 2010, almost two years before the San Bernardino city council abruptly voted to seek bankruptcy protection, city manager Charles McNeely gave a presentation to the council that became known as "Groundhog Day."
McNeely, who has since resigned, warned that the city of 210,000 was facing financial ruin. The sharp fall in housing prices had slashed tax collections even as employee pay and benefit costs spiraled upwards. Years of budgetary gimmicks would come home to roost in the form of a $40 million deficit in the current fiscal year, he predicted.
"He used that analogy because the city had every year been doing the same stupid things," Tobin Brinker, a former city council member, said, noting the comparison with the comic movie in which the lead character keeps reliving the same day.
McNeely's wake-up alarm, which itself came three years after a management consulting firm had warned of big problems ahead, went unheeded. Instead, local leaders continued to engage in bitter political and legal warfare over the city's biggest expense -- pay and benefits for police officers and firefighters -- and failed to warn local residents and financial markets of the depth of the problems.
While San Bernardino was in economic decline even before the Great Recession and took a big hit from the housing bust, the slide toward bankruptcy has as much to do with the city's poisonous politics and the outsized influence of public safety employees as with the broader economy.
The city charter pegs police and firefighter pay to the wages offered by comparably sized California cities, a heavy burden for a city suffering a 15 percent unemployment rate. The city calculates that public safety spending now accounts for 73 percent of the general fund budget, with overtime for firefighters cited by McNeely and others as especially burdensome.
The city imposed a temporary 10 percent pay cut several years ago, but the firefighters union successfully challenged the move in court and the city now owes its members back pay. Two union-backed candidates won city council seats last year. Pension costs, meanwhile, will reach $25 million this year, double the 2006 level.
The firefighters union, for its part, rejects the notion that it is at fault, accusing Mayor Patrick Morris of being "anti-public safety" and questioning the city's budget numbers.
"At this point, I don't think anyone should trust any numbers that come out of the city," said Corey Glave, general counsel for the San Bernardino Professional Firefighters. "Right now the firefighters are tired of hearing that it's their fault for everything. They are going to work and do their best job."
The political infighting, vividly on display in the days since the city council's surprise July 10 vote to seek bankruptcy protection, even extends to fraud allegations advanced by James Penman, the long-time city attorney.
Penman said ahead of the bankruptcy vote that financial documents had been falsified in 13 of the past 16 years, but toned down his claims the next day, telling reporters that "evidence of suggested wrongdoing" had been turned over to unnamed government agencies.
Pressed by reporters, the San Bernardino County sheriff's department confirmed an investigation "related to allegations of possible criminal activity within departments of the San Bernardino city government." It is not clear the investigation has to do with budgetary chicanery -- and Penman, who ran twice unsuccessfully for mayor against Morris, is seen as a political ally of the public safety unions.
"He needs to put up or shut up," said city councilman Fred Shorett, who voted against the bankruptcy. "He's trying to get everybody's eye off the real issue, which in my view is compensation for police and fire."
Matt Wilson, whose accounting firm has audited the city's finances each year since 2007, said he has no idea what Penman is talking about. "We didn't find anything that was misrepresented," he said. "We issued an unqualified opinion each year."
The interim city manager, Andrea Miller, who took over after McNeely resigned in March, also said she had not "seen anything in that arena that has caused me any concern." A switch in financial software systems has uncovered some accounting errors, she said, but they are insignificant.
She broadly corroborated McNeely's account of how the crisis came about. "We just don't have cash reserves to fund operating costs," she said.
A CITY IN DENIAL
McNeely, who served three years as San Bernardino city manager after 13 years in the same post in Reno, Nevada, said the writing has been on the wall for years. The city, 65 miles east of Los Angeles, had suffered economic reversals for years, first from the loss of heavy industry decades ago, then from the closure of a big military base in the 1990s, and most recently from a housing boom that went bust.
As far back as 2007, a review by consulting firm Management Partners Inc said San Bernardino's finances were at risk because public safety spending was growing faster than city revenue. The review added that the city charter's special treatment for public safety salaries was a form of "autopilot" budgeting that provided "little incentive for labor groups to negotiate at the bargaining table."
In his 2010 presentation, McNeely projected that spending would outstrip revenue through 2015. For the current fiscal year, he predicted spending would exceed revenue by $40 million, which is about the difference city officials forecast last week.
"I don't know how you could come out of that meeting not understanding we had a serious problem," he said. "I told them, 'You're headed for trouble, it's a train wreck, you can't keep doing business this way.'"
Around the same time, the mayor rang alarm bells in a column in the San Bernardino Sun newspaper, warning of insolvency due to a "long-term lack of fiscal discipline."
But what followed were more short-term fixes: spending and pay cuts, modest layoffs, deferred purchases, the tapping of reserves, borrowing from a now-shuttered redevelopment agency, and selling city property. What was really needed was a larger overhaul of budget priorities, said McNeely.
"I didn't see them dealing with the issues and I didn't want to be part of that anymore," he said.
Former fire chief Mike Conrad said there was no sense of urgency around the fiscal problems. "It was nibbling around the edges," Conrad said. "All of us that were department heads were not surprised the city was headed for a fall."
Shorett, the city councilman, says that even now he doubts the council has the will to press city unions for serious pension concessions. Pension deals were actually sweetened as recently as 2007.
"You have unions on one side of the table negotiating with people they just helped elect," Shorett said.
"Herding cats is not even close to the reality of this place," said Jim Morris, chief of staff to the mayor and also the mayor's son. As recently as April, he said, warnings of a looming financial disaster went unheeded by some in the city council's chambers, where "there's always been this sense of questioning the professional management's numbers."
SURPRISE BANKRUPTCY VOTE
The city council vote made San Bernardino the third California city to seek bankruptcy protection in the last two months. Because the move caught local residents and municipal bond investors by surprise, it raised concerns that other California cities may have hidden fiscal crises.
The city of Stockton, which like San Bernardino has suffered severely from the housing crash, telegraphed its situation months ahead of time, and became the largest U.S. city to file for bankruptcy only after a mediation effort failed to produce an agreement with creditors.
Similarly, the problems in the ski resort city of Mammoth Lakes, which faces a nearly $43 million legal judgment that would swamp its budget, were well known long before it filed for bankruptcy.
In San Bernardino, the depth of the problems were evident only to insiders.
"A year ago it looked like the city had a tough budget in front of them, but it looked like they took tough decisions," said Dick Larkin, director of credit analysis at muni bond broker-dealer HJ Sims.
But a financial report for the city council dated July 9, which precipitated the bankruptcy vote, made it clear that little had been solved.
City finance officials project that San Bernardino will have about $120 million in general fund revenue for the fiscal year that began on July 1 -- down from a peak of about $140 million in 2007. That leaves it about $45 million short for its commitments. The city also has so little cash on hand it may not be able to meet its contractual and debt obligations as early as this month.
The report said spending had outpaced revenue for some years, reserves were depleted, and the old ways to pay off deficit spending were no longer available. And labor costs are projected to rise by $10 million a year in the coming years as concessions expire and contributions to the state pension fund increase.
The city also expects to pay more for its employees' pensions and faces rising liability expenses from accidents linked to street and other public works repairs it has postponed, Miller said.
"It's a whole series of things coming together," Miller said. "Ultimately the city could not bear all that."