SAN BERNARDINO, Calif. — In this sweltering Southern California city, officials tried to keep the budget in check by selling assets, cutting spending and asking public employees to take a hit as tax revenues dwindled.
But San Bernardino officials found themselves staring at a bleak prospect Tuesday night: Vendors hadn't been paid and cash was running out to make payroll, threatening to shut down the city altogether.
That prompted elected officials in the city of 210,000 people to take the sudden move of authorizing the city attorney to seek federal bankruptcy protection, becoming the third California city poised to do so in less than two weeks.
"The city needs breathing room and the bottom line is we cannot default on payments to our employees without violating the law," City Attorney James Penman said ahead of the contentious vote, which took many by surprise and set the city apart from those elsewhere where such an action came only after months of consideration.
Bankruptcy experts say the decision in San Bernardino – some 60 miles east of Los Angeles – could sound an alarm to cities across the state and country that are grappling with weak property and sales tax revenues as their pension obligations continue to rise.
"People are waiting to see whether these are the exceptions to the rule or whether we have a new trend," said Jim Spiotto, a Chicago attorney who tracks municipal bankruptcies. "I do think it may be something of a wake-up call."
In some instances, cities like Harrisburg, Pa., and Mammoth Lakes, Calif., have considered bankruptcy as a way to cope with a specific debt. In contrast, cities like Stockton, Calif. and Central Falls, R.I., have sought bankruptcy to deal with an unbearable financial outlook due to rising costs and stagnant revenues, said Michael Sweet, a bankruptcy attorney with Fox Rothschild's San Francisco office.
"Those are the ones you want to watch," Sweet said. "The cities that have a higher reliance on property tax revenue to support their general funds are the ones that are going to feel the most pain."
San Bernardino is facing a budget shortfall of $45 million and annual deficits over the next five years. That's even after the city slashed the workforce by 20 percent over the last four years and negotiated $10 million in annual concessions from employees in each of the last three years.
The problems stem from weak property and sales tax revenues combined with escalating pension costs and a loss of state redevelopment funds, city officials said.
At a packed City Hall meeting, Penman said budget officials had presented falsified budget documents to the City Council for 13 of the last 16 years, reporting a surplus and masking the city's deficit.
Asked about his statements at a Wednesday news conference, Penman said he believed an outside investigation was needed as early as February, but had not realized the scope of the problem until this month.
He said evidence of financial mismanagement had been given to "appropriate government agencies," but would not say which agencies or give further details on the evidence, citing the pending bankruptcy proceedings.
"The information was discovered in probably the last 60 days, and the elected officials became aware of it very recently," Penman said.
Jim Morris, the mayor's chief of staff, said Wednesday that some inaccuracies in past budget reporting diminished the size of the problem but he did not believe officials deliberately misrepresented the data.
Four council members voted for the authorization, two opposed it, and one abstained.
Penman said the city is likely to declare a financial emergency on Monday, but it was not clear when the formal bankruptcy filing would come.
Marcus Nelson, owner of a local barber shop, wasn't surprised by the announcement, noting there are only three businesses on his block.
"It is kinda scary, knowing that the city doesn't have money," the 40-year-old said. "Small businesses know we can't make money, so it is kinda scary."
San Bernardino, which soared economically during the housing boom and has suffered since the bust, could become the second largest in the nation ever to file for bankruptcy. Stockton, the Northern California city of nearly 300,000, became the biggest when it filed for Chapter 9 on June 28. The much smaller city of Mammoth Lakes voted for bankruptcy July 3.
Those two cities used a new state mediation process to contemplate bankruptcy over a period of several months – a stark contrast to San Bernardino's quick-fire decision under a dire cash crunch.
Before Stockton, a California city had not filed for bankruptcy since Vallejo in 2008.
Jerry Newfarmer, president of government consulting firm Management Partners, said some of California's most financially stressed cities are in the inland parts of the state, where housing prices plummeted. But he said many municipalities made tough cuts ahead of time and he doesn't foresee a flood of new bankruptcies across the state.
In the counties that are home to Stockton and San Bernardino, the share of homes in some stage of the foreclosure process was more than three times the national average in 2011, according to foreclosure listing firm RealtyTrac.
Gov. Jerry Brown declined to speculate on the fate of other California cities. He said the problem is the state, and the country, have lived beyond their means, "means created by a mortgage bubble, by greed, by mistakes, by people not knowing what the hell they were doing, and millions of people have been hurt."
"Cities may not have the money they need, and they have to take whatever reasonable steps they can under the law," he told reporters in Los Angeles on Wednesday.
Since Congress added Chapter 9 to the bankruptcy code in 1937 to allow municipalities to seek protection, about 640 government entities have filed. About half of states allow cities to seek bankruptcy protection, which is considered a measure of last resort because it can raise cities' borrowing costs, Spiotto said.
For many years, municipalities muddled through tough financial times with support from the states, and in places like Michigan, some are still doing so.
"I think this cries out for the need for increased oversight and the ability to provide forms of bridge financing to work through it," Spiotto said.
Taxin reported from Orange County, Calif. Associated Press Writer Michael R. Blood contributed to this report from Los Angeles.