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California city approves plan to exit bankruptcy

By Jim Christie

VALLEJO, California (Reuters) - The city council of Vallejo in California unanimously approved a financial plan late on Tuesday to exit its landmark bankruptcy, which the town declared two years ago in the face of mounting fiscal woes.

Vallejo, a former Navy town located between San Francisco and the state capital of Sacramento, became the largest city in the most populous U.S. state to declare bankruptcy -- a rarity for U.S. governments -- amid slumping revenue and escalating costs for its work force.

Vallejo's bankruptcy garnered national attention and revived memories of Orange County, California seeking bankruptcy protection more than a decade earlier, which marked the biggest-ever U.S. municipal bankruptcy.

Vallejo's bankruptcy filing prompted some analysts to predict similar bankruptcies by local governments across California given the steep economic downturn in the state.

It spurred consumers to cut spending amid a tumbling housing market, hurting local U.S. government revenues, which rely heavily on revenue from sales and property taxes.

Vallejo's five-year plan tackles $195 million in unfunded pension obligations, creates a rainy-day fund, lowers benefits for new city workers and reduces payments toward retired employees' health care.

The plan may in coming weeks go before the judge hearing Vallejo's bankruptcy case, who will scrutinize its details, including how it proposes paying the city's bondholders, said Howard Cure, director of municipal research at Evercore Wealth Management.

"There is a lot to prove," Cure said.

Mayor Osby Davis said he was hopeful the judge would accept the plan.

"I see this as a stabilization plan," Davis said. "We're doing the best we can with what we have."

City Manager Phil Batchelor said the city of roughly 120,000 would face tight budgets under the plan, with barely enough money for the most essential of services.

"We will be treading water for five years," Batchelor said, adding that Vallejo can only afford to set aside $5 million for creditors holding roughly $50 million of the city's debt.

The vote by Vallejo's city council may help calm the U.S. municipal debt market, hit recently by net outflows as investors have cashed out, fearing more fiscal troubles for state and local governments, said Evor Vattuone, founder of Aspire Capital Management in Walnut Creek, California.

"It can only be a good thing at this point," Vattuone said.

Mitchell Savader, chief executive of Savader Asset Advisors, said the plan extends belt-tightening by Vallejo over the past two years, which has included slashing the city payroll.

"They've already taken a lot of the difficult steps," Savader said.

Some residents at the city council meeting linked a rise in prostitution to a 40 percent cut to Vallejo's police force.

Vallejo's payroll and pension expenses compounded its financial woes and some analysts said other local government across California would also run into similar trouble due to generous benefits for public employees.

Local governments, however, have tackled fiscal problems by raising revenue with fees and taxes and by cutting payroll and programs.

Many are also clamping down on pension and retiree health expenses.

Officials in San Diego, California's second-largest city, are even considering doing away with costly traditional pension benefits altogether in favor of defined-contribution retirement plans similar to 401(k)s common in the private sector to cut expenses.

(Editing by Neil Fullick)