"We think Chapter 9 protection is the only choice left," City Manager Bob Deis told the City Council, referring to the section of the federal bankruptcy code that applies to municipalities.

Municipal Bonds

Stockton's expected bankruptcy filing won't create a sell-off in the $3.7 trillion municipal-bond market because investors of tax-exempt debt have known about the city's budget deficit and rising health-care expenses, Matt Fabian, managing director at Concord, Massachusetts-based Municipal Market Advisors, said in a telephone interview.

"There's been enough talk about municipal bankruptcy and worries about it that when one actually happens, it's a little beside the point," Fabian said. "It's hard to see one city's faltering pushing the market weaker."

Investors will buy municipal debt for its relative safety and low default rate, said Chris Ryon, who helps manage $8.25 billion of municipals, including a $367 million California fund, at Thornburg Investment Management. The average cumulative default rate in the past four decades was 0.13 percent for municipal bonds versus 11.2 percent for corporate debt, Moody's Investors Service data show.

'Extremely Low'

"The overall default rates in municipal bonds are extremely low and Stockton is a small participant in the $3.7 trillion market," Ryon said in a telephone interview.

A taxable Stockton pension bond sold in 2007 and due September 2037 traded June 25 as high as 80.68 cents on the dollar, down from when it traded as high as 102.03 cents on the dollar on Feb. 15, according to data compiled by Bloomberg.

The City Council's approval paves the way for Deis to proceed with the bankruptcy filing. Stockton, a river port about 80 miles (130 kilometers) east of San Francisco, ran out of options after three months of negotiations with creditors ended June 25 without enough concessions to close a $26 million deficit.

"We've worked really hard with our creditors and we've been unable to close the gap," Deis said. "If we get any agreements in the near future, then those will be honored in Chapter 9."

Break Contracts

Bankruptcy would allow the city to break contracts with creditors without the threat of lawsuits, though it won't assure the city's recovery, he said.