At first blush, federal bankruptcy Judge Christopher Klein appeared to give Stockton and its legal ally, the California Public Employees' Retirement System, a major victory this week.
Klein declared that the much-troubled city is, indeed, insolvent and therefore can use bankruptcy to address its severe financial problems.
That impression was bolstered when Klein chastised the holders of city bonds and bond insurers for not bargaining in good faith with the city.
The creditors had urged Klein to reject the bankruptcy plea because, they said, Stockton had refused to treat its pension obligations as debts to be reduced through bankruptcy, thus discriminating against private bondholders by forcing them to take big haircuts.
But the details of Klein's ruling imply that the city and CalPERS may not prevail on the pension issue when he weighs the city's plan to deal with its debts a plan that now excludes CalPERS as a creditor.
"The city is going to have a difficult time confirming a plan over an objection and claim of unfair discrimination without being able to explain that problem away," Klein said a strong indication that despite his criticism of bondholders' tactics, he is open to their position on the underlying issue.
Previously, he had ruled that contractual health care promises to retirees could be reduced or eliminated via bankruptcy because federal bankruptcy law carries more weight than state law.
That ruling had startled CalPERS and sparked a legal and political drive by the huge pension fund to declare that pensions have a special status, hinged largely on an argument that the federal government must respect state laws. But Klein reiterated this week that federal bankruptcy law supersedes even the state constitution's prohibition of "impairment of contract."
"I've been party to impairment of millions of contracts and it's all constitutional," Klein noted.
The whole situation is an uncharted legal territory, and Klein made it clear that he expects the conflict over the status of pensions to make its way through the federal appeals process potentially all the way to the U.S. Supreme Court regardless of how he rules on Stockton's bankruptcy plan, should the city and bondholders fail to achieve a compromise in the meantime.
It is, in a sense, part of a larger, still-evolving debate in political, legal and financial circles over the status of public pension obligations.
The Governmental Accounting Standards Board and Moody's, a major bond rating house, have been pushing state and local governments to treat unfunded pension liabilities as bond-like debt on their balance sheets.
Were that view to be ratified by the federal courts via Stockton's bankruptcy, it would have major impacts not only on pension systems, but on the entire municipal bond market.