The California Public Employees’ Retirement System, the largest U.S. pension, is defending government workers against criticism of their benefits even while it risks losses as municipalities, faced with rising retirement costs, file for bankruptcy.

The $239.1 billion fund is the largest creditor in bankruptcy cases filed by two California cities, Stockton and San Bernardino, since the end of June, with a total of $290.8 million at stake.

Increasing retiree obligations are straining budgets of cities across the Golden State, still grappling with income- and sales-tax revenue reduced by the longest recession since the Great Depression. The two bankrupt cities represent 0.7 percent of employer contributions to Calpers, according to actuarial statements. Still, others may follow if judges relieve them of pension commitments, said Karol Denniston, a bankruptcy lawyer at Schiff Hardin LLP based in San Francisco.

“The briefs that have been filed by the insurers are interesting in that they’re arguing that Calpers should be treated like any other creditor,” she said by telephone. “Calpers is going to argue that they’re a different kind of creditor, in that they hold the money in trust for the retirees.”

Stockton, a city of about 292,000, about 80 miles (130 kilometers) east of San Francisco, and San Bernardino, with 209,000 residents, about 60 miles east of Los Angeles, both cited rising employee retirement costs as factors that drove them to seek court protection. A third community in bankruptcy, Mammoth Lakes, hobbled by a legal judgment, owes Calpers $4.2 million, according to its filing.

Stockton Precedent

“Where this is so important is that we know Stockton is going to be precedential,” Denniston said.

Stockton is trying to become the first American city since the 1930s to use bankruptcy to force bondholders to take less than the principal they’re owed. The city will need approval from a federal judge in Sacramento to impose any cuts on creditors.

In an Aug. 2 statement responding to insurer Assured Guaranty’s objections to Stockton’s bankruptcy filing, Calpers general counsel Peter Mixon argued that the interests of pensioners should trump those of other creditors.

“The obligations owed to the public workers of the city have priority over those of general unsecured creditors including bondholders,” Mixon wrote. “Unlike insurance companies, policemen, firefighters, and other public employees are not in a position to evaluate credit risk of their employers.”

Even as it defends its standing in the Stockton case, Calpers is working to counter the notion that pension costs are a significant factor in current and potential municipal bankruptcies.

‘Not Fair’

“It’s not fair to scapegoat public employees and pensions for the financial woes of our cities,” Rob Feckner, the chairman of the Calpers board, wrote in an Aug. 8 op-ed in the Sacramento Bee. Feckner is an executive vice president of the California Labor Federation, which represents 2.1 million unionized workers, about half of them in government.

“The real culprit is the economy and housing market, along with financial decisions made by city officials,” he said. “Pension costs are a small piece of the budget.”

Calpers’ position contradicts the realities facing many municipalities, said Chris McKenzie, executive director of the League of California Cities. Reducing pension costs is the top priority this year for the Sacramento-based organization, McKenzie said by e-mail.

Rising Costs

“Cities statewide have seen pension costs rise to the point that they are no longer viewed as sustainable,” McKenzie said. “Soaring pension costs are a serious concern.”

While pension costs are roughly 10 percent of most city budgets, municipalities need flexibility to deal with them when revenues slump, said Dan Pellissier, president of California Pension Reform.

“It’s ironic that Calpers is defending a system that is placing an unsustainable burden on employers’ budgets,” Pellissier said in an interview in Anaheim, California, where he spoke at a Calpers forum on pension legislation. “Calpers has to find out a way to work with government agencies that have overpromised benefits based on contribution rates that have been artificially low.”

More than 1,500 cities, counties and other units of government pay into the fund, according to a Calpers fact sheet. Such employer contributions accounted for $7.5 billion, or less than 14 percent of Calpers’ total income in 2010-11; most of the income came from investment earnings.

Investments Return

Calpers, which posted a 1 percent return on investments for the year ended June 30, has about 72 percent of the assets needed to pay long-term obligations to retirees, spokesman Brad Pacheco said.

Even if the three bankrupt cities withheld their entire payments due to Calpers, it would not “move the needle” on the pension’s funded status, Pacheco said in an e-mail message.

Robert Udall Glazier, a Calpers deputy director, said leaders of the fund view cities’ financial distress “with great concern.”

“These cities,” he said, “are our partners in providing services and a better quality of life for Californians.”

The Stockton bankruptcy case is In re Stockton, 12-32118, U.S. Bankruptcy Court, Eastern District of California (Sacramento).

The bankruptcy case is In re Stockton, 12-32118, U.S. Bankruptcy Court, Eastern District of California (Sacramento).