Stockton, Calif. Inches Closer to Becoming the Largest City in U.S. to File for Bankruptcy

FRESNO, Calif. (The Blaze/AP) -- Stockton officials continued to grapple with the city's financial plight, struggling to restructure millions of dollars of debt threatening to turn the city with the nation's second-highest foreclosure rate into the largest U.S. city to file for bankruptcy.

Council members met Monday night to discuss the financial plight. The city had until 11:59 p.m.to reach a deal with its creditors under a new state mediation law designed to help municipalities avoid bankruptcy. Stockton spokeswoman Connie Cochran said those negotiations were confidential and that nothing would be announced at the deadline.

"Nothing is going to happen," until the City Council meeting, Cochran said.

Stockton, Calif. is facing a moment of decision on whether to become the biggest American city to file for bankruptcy, as the deadline for talks between the city and its creditors approaches late Monday. (AP Photo/Ben Margot, file)

Previous negotiating sessions with the 18 creditors have stretched past midnight and remained confidential. To avoid bankruptcy, any deal would have to result in sufficient savings to make the city solvent.

Officials have made preparations in case mediation efforts fail. The Stockton City Council is scheduled to decide Tuesday night whether to adopt a special budget to close the city's projected $26 million deficit in case bankruptcy protection is sought.

California cities are required by law to adopt a balanced budget by July 1 of each year.

If mediation fails and council members adopt the special budget, Stockton's lawyers could file for Chapter 9 protection in court as early as Wednesday, City Manager Bob Deis said.

City officials say this river port city of 290,000 in the Central Valley has run out of options. In recent years, thousands of new homes mushroomed in Stockton, part of a suburban housing boom that attracted buyers from the San Francisco Bay area and beyond.

When the economy crashed and the construction bubble burst, Stockton was battered by foreclosures and lost income from property taxes and other fees.

Multi-year labor contracts for city workers with escalating costs and generous retirement plans added to the burden. And expensive city investments -- a promenade, a sports arena and a hotel - failed to produce an economic boon.

The city also has high crime and unemployment rates. It has twice topped Forbes magazine's list of "America's most miserable cities."

"It's unfortunate we're here but we need to keep working with the city," said Mark McLaughlin, a member of the board of the city police officers' union, adding that he fully expects a bankruptcy filing.

To plug next year's anticipated $26 million budget hole, the proposed budget suspends debt payments and payments for legal claims; reduces payments for retiree medical benefits; further reduces some pay and benefits; and increases revenue through code enforcement and parking citations.

The proposed budget includes no major service reductions, Deis said.

"The whole purpose of filing Chapter 9 is to avoid an uncontrolled chaotic situation," he said. "Bankruptcy provides the equivalent of a pause button. It retains services and provides structure so you don't have a bunch of lawsuits."

If the city files for bankruptcy, it will still have to work out a court agreement with creditors on how to pay them upon exiting bankruptcy.

If the city is able to reach a deal through mediation, Deis said, City Council members could modify Tuesday's special budget to reflect the deal, or they could adopt the budget and come back in July to modify it.

Officials say they are optimistic, even if they decide to file for bankruptcy. They point to Vallejo, a smaller California city that filed for Chapter 9 protection in 2008 and emerged from bankruptcy last year.

"Vallejo is leaner, smarter and they've got the confidence of their citizenry," Deis said. "I think Stockton will be doing the same."

But for now, Moody's Investors Service and Standard & Poor's Ratings Services says Stockton's credit is junk.

“Moody's has its issuer rating for Stockton at a junk level Ba2 from Baa1 while S&P has its issuer rating on the city from BB to SD, one notch above its D default rating,” Reuters reports.

And although it hasn’t happened yet, Gregory Lipitz, a vice president and senior analyst at Moody's, says a bankruptcy filing by Stockton is a "high-probability event."

The Associated Press contributed to this report.