STOCKTON, Calif. — The long, slow slide into financial collapse is nearly complete for this Central Valley community.

On Tuesday night, City Council members approved a new budget that will guide city operations during bankruptcy and amend a $26 million budget shortfall. With that vote out of the way, city officials could file for Chapter 9 bankruptcy as early as Wednesday, which would make this the country’s largest city to go bankrupt.
The new budget will suspend debt payments, cut employee pay and reduce retiree benefits, allowing these city of about 292,000 residents to continue providing essential services through the bankruptcy process.
“This is not where any of us wanted to be,” Bob Deis, the city manager, said in a statement. “But absent restructuring agreements with our creditors, any other options would decimate the city.”
A year after nearby Vallejo, Calif., filed bankruptcy in 2008, state lawmakers passed AB 506, a bill requiring cities to hire a third-party mediator to negotiate with creditors before filing for bankruptcy. Stockton officials had hoped to avoid bankruptcy when the city became the first to enter into the new state-required mediation in March.
But on Monday night, after 90 days of mediation, the city and its 18 creditors failed to meet a midnight deadline for a deal.
"Bankruptcy is a terrible option until it’s the only option,” Marc Levinson, a lawyer representing the city, told the council. During Tuesday’s meeting, dozens of emotional residents and city retirees begged officials to avoid bankruptcy and preserve benefits.
The state constitution required that the city address its $26 million general fund deficit, of a total budget of $521 million, to meet a July 1 deadline for cities to adopt balanced budgets. The city could continue informal negotiations with creditors with the new budget, but a bankruptcy filing appeared imminent.
Bankruptcy experts and officials at other fiscally wounded cities are keeping close tabs on Stockton as it unravels.
“Everyone is watching,” said Karol K. Denniston, a partner at the law firm Schiff Hardin who helped draft the AB 506 legislation. “It’s in the interest of every teetering city to make its bankruptcy process as short and cost effective as possible.”
Despite their failure to reach an agreement, three months of negotiation between the city and its creditors could make the bankruptcy process more efficient by shortening what can otherwise be a long and costly period in court, said Ms. Denniston said. Protracted bankruptcy proceedings — like those in Vallejo — can push residents to leave, further eroding a city’s tax base.
Conventional wisdom has long held that large cities do not use bankruptcy court to restructure, said David Skeel, a law professor at the University of Pennsylvania.
“To me Stockton confirms that Chapter 9 bankruptcy is not just for small municipalities,” said Mr. Skeel. “Here’s a substantial city going into bankruptcy at a point in time when there are dozens and dozens of cities across the country in comparable states of financial distress.”
Still, such municipal bankruptcies are rare. Stockton’s road from boom town to insolvency has been a torturous one, riddled with missteps and unfortunate timing.
This city of about 292,000, some 80 miles east of San Francisco, was not so long ago a rapidly expanding bedroom community for commuters to the Bay Area. But in recent years, the city has been crushed by falling housing prices, foreclosures, the mounting costs of retiree pensions and hefty price tags for buildings paid for with taxpayer guaranteed bonds, including a hockey arena.
Since 2009, the city has cut some $90 million in spending and eliminated 25 percent of its police officers, 30 percent of its fire department and 40 percent of all other city employees.
Earlier this year, the city defaulted on several debt payments and as a result Wells Fargo repossessed a downtown building bought in 2007 for $40 million. Officials had planned a new city hall there. The bank also repossessed three city-owned parking garages.
“We have hit the wall; we are insolvent,” Mayor Ann Johnston said in a statement issued in early June, after city officials authorized the city manager to file for bankruptcy if mediation efforts failed, as they now have. “This is the action that we must take to keep the services that are important for the safety and health of our citizens.”