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City finances on mend in California but pensions are a roadblock

By Jim Christie

SAN FRANCISCO (Reuters) - California's fortunes have been on an upswing in recent months, rebounding from the bruising effects of the recession and the housing market's slide, but many of the Golden State's cities face uncertain futures as they struggle with pension and healthcare costs.

Losses suffered by pension funds during the financial crisis still must be made up, and spending on pensions is still rising despite a recent wave of pension reforms.

Many cities, including some of the state's largest, worry that austerity measures and higher taxes may not be enough.

At a recent meeting of California's big city mayors, "Almost all of them are worried where pension costs are going, where retiree health-care costs are going," said Chuck Reed, mayor of San Jose, California's third largest city.

One of the biggest issues looming over cities, is rising pension costs. California's $260 billion pension fund for public employees recently approved raising employer contribution rates by up to 50 percent to help fully fund its obligations in 30 years.

If cities cannot shift more of the cost for funding pensions onto current public employees, they will be forced to cut back on services in order to pay their retirees, said Joe Nation, a former state lawmaker who teaches public policy at Stanford University. "Services people associate with a city will just disappear," he said. "Parks will disappear, libraries will disappear."

Because pension benefits generally have a high level of legal protection, cities are looking for other ways to trim costs. One of those is retiree health benefits.

Stockton, which last year filed for bankruptcy, scrapped its retiree health program. In Sacramento, the state's capital, City Manager John Shirey said retiree health spending must be reined in. "We've got to end that benefit for new employees," he said.

San Jose is a key example of the importance of pension reforms. The city's revenue is improving, and San Jose may restore some services after cutting 2,000 jobs over a decade, Reed, the mayor, said. But the city's fiscal health could be derailed if a lawsuit challenging a pension reform measure, which lowers future pension benefits for current employees, that was approved last year is successful.

The measure addressed the key issue of forcing current workers to pick up a greater share of the bill for pensions, meaning that officials across California will be watching closely for the ruling on the lawsuit.

Without the $68 million in savings over four years expected from the pension overhaul, "we'll go back in the mode where we have to cut services to balance the budget," Reed said.

TAXES, LAYOFFS ... AND BANKRUPTCIES?

Many cities are also turning to tax hikes. Last November, voters approved 48 of 60 city general tax measures and more may be on the way. Stockton residents will vote in November on a sales tax hike to help fund the city's exit from bankruptcy.

Another cost-cutting front has been outsourcing to private companies, which can do many jobs at a lower cost than public agencies. Costa Mesa, in Southern California, hired a private company to run a jail.

Bill Zenoni, of Municipal Resource Group, an adviser to local governments, expects cities to keep contractors busy. "In years past that wasn't something that was considered seriously," he said.

There is another option for California's roughly 480 cities if their budgets troubles are great - bankruptcy. But that is truly a last resort because of bankruptcy's stigma, said Chris McKenzie, executive director of the League of California Cities.

Bankruptcy results in increased borrowing costs on the municipal debt market, and it is expensive in other ways. Both Stockton and San Bernardino, which also filed for bankruptcy last year, will spend millions of dollars in bankruptcy court, and they face years of work to rebuild their reputations, McKenzie said.

"The cascading effects just underscore why it's something to be done only if it's necessary," he said. "City officials are going to do their damnedest to avoid it all costs."

That doesn't mean that potential bankruptcy filings are completely off the table. Moody's Investors Service, in a report in May, said other cities could follow Stockton and San Bernardino if those two force steep losses onto bondholders. That could be "an inducement to other, similarly pressured cities to consider bankruptcy," Moody's said.

(Reporting by Jim Christie; Editing by Tiziana Barghini and Leslie Adler)

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