VALLEJO, Calif. -- Cobblestones show through the decrepit pavement in Sheila Dodson's downtown neighborhood, prostitutes ply the sidewalks in broad daylight and many of the century-old Victorians stand empty. Yet this is where Dodson wants to raise her family.
"Just because the coffers are poor doesn't mean there's not opportunity," she said while walking with her toddler daughter along the broken streets.
Vallejo has emerged from bankruptcy with a newfound commitment to community involvement that is exemplified by upbeat residents like Dodson and a local government now focused on innovation. But the financial fixes envisioned when the city filed in 2008 haven't all materialized, and Vallejo continues to operate in the red.
With two other California cities recently filing for bankruptcy, a third about to and others in trouble, Vallejo offers an example of what good ? and bad ? can come from a Chapter 9 filing.
"Bankruptcy brings a brutal recognition of the new normal," Vallejo Councilwoman Stephanie Gomes said. "It's Darwinism. The cities that are going to stay solvent are the ones that can evolve."
Municipal bankruptcies are extremely rare and occur for different reasons. Nationwide, there may be only one or two in a year. But with the economy still struggling, bankruptcies are becoming more prevalent.
Stockton, which in June displaced Vallejo as the largest city to file, racked up overwhelming bond debt through ill-advised infrastructure projects. The tiny Southern California ski town of Mammoth Lakes filed earlier this month because it could not pay a judgment that was more than twice the town's budget. San Bernardino is drowning in debt and the City Council last week declared a financial emergency, a move that allows it to more quickly file bankruptcy.
Compton, just south of Los Angeles, may be the next in line. City officials have said they are on pace to run out of money by the end of summer.
For Vallejo, a working-class community of 116,000 in the sun-splashed hills 30 miles northeast of San Francisco, the move toward bankruptcy was a slow downward spiral beginning with the closure of Mare Island Naval Shipyard in 1996. The local economy never really recovered, but a booming housing market helped paper over the loss of the city's economic engine.
City councils continued approving raises and benefits for workers, ignoring warnings from citizen oversight commissions. Police and fire officials could retire at 50 with 90% of their final year's salary. After one year of service, public employees could get health care coverage for life, and so could their families. Starting in 2005, the city began spending $3 million to $4 million a year more than it was taking in, draining its reserve fund.
When the housing bubble burst, property tax revenue fell by 30 percent and sales tax receipts dropped 20 percent.
By 2008, the city was facing a $16 million deficit. Local leaders held 11 mediation sessions with public employees, whose salaries and benefits accounted for about 75 percent of the $80 million general fund budget, but were unable to reach an agreement on givebacks.
Initially after bankruptcy, things were worse than anyone imagined they'd be. Road maintenance in the city was cut by 90 percent, staffing at the police and fire departments were nearly halved, and grants for arts and recreation programs were eliminated.
Vallejo Fire Chief Paige Meyer acknowledges his firefighters were in a funk.
"You go through a bankruptcy, you lose half your staff, do you really run out to your engine?" said Meyer, whose offices sit above of one the city's shuttered stations. "Some people were depressed."
Philip Batchelor, interim city manager during the bankruptcy, said Vallejo fell off a financial cliff for two prosaic reasons.
"In order to avoid bankruptcy, you need to not have leveraged yourself so much that you have lost control of your destiny and you need a trusting relationship between the bankers, suppliers, vendors, employee organizations," he said.
Some city workers were unprepared for how bad things would be during the restructuring and now wish they had done more to avoid it.
Matt Fenzl, spokesman for the Vallejo firefighters union, likened the employees' mentality to a child who is given ice cream every evening and then suddenly told the treat is unhealthy.
"We had a false sense of what was sustainable and what wasn't," he said. His advice to public employees in other struggling cities: "Be ready to make significant sacrifices to avoid bankruptcy."
During the restructuring, Vallejo escaped at least $32 million in debt, paying some creditors as little as 5 cents on the dollar. And up to $100 million in health care obligations were removed when the city cut benefits for retirees to $300 per month, down from $1,500 in some cases.
But Vallejo also racked up $13 million in legal bills and was unable to rework its pension plan, still a $165 million unfunded liability.
City leaders reached new agreements with each of Vallejo's four public employee unions. But the contracts didn't provide the cuts Vallejo needed to fully climb out of its financial hole and now the city is spending $4.8 million more than it is taking in and will have to ask its police union for concessions next year.
"It is painful to say to people who supported you in an election that I have to cut your salaries. That's hard," said Mayor Osby Davis, who has held that seat since 2007. Still, he said bankruptcy provided an opportunity to do more, and the city didn't take full advantage.
"Anybody who goes into bankruptcy, don't come out like we did," Davis said, suggesting Vallejo would have been better off if all the public employee contracts were reworked at the same time and in the same way.
Nonetheless, Gomes said bankruptcy provided the city with a needed attitude adjustment, and brought new leadership and ideas into government as many older employees left.
"All the people who could retire, they jumped ship," Meyer said. "Suddenly, we got very young."
Residents have lowered their expectations for city services and are stepping in to fill the gaps. Volunteers patrol for code violations, hold weekly graffiti cleanups, monitor the city's high-end surveillance cameras and have built a sprawling wooden playground. The number of neighborhood watch groups grew from four to more than 300.
"In a weird kind of way, the bankruptcy was a blessing," said Kathy Beistel, who founded the Kentucky Street Watch Owls after two pimps got into a shouting match on her lawn and the police failed to respond to her call. "I used to know two people on my street. Now I know everyone around me."
Residents also chipped in financially, approving a 1-cent sales tax hike. For the first time in years, the city can start thinking about fixing the traffic signals that permanently blink and taming the towering yellow fennel that contributes a tattered feeling to parts of the Vallejo's main drag.
There is even a hint of gentrification. Sheila Dodson and her husband were attracted to the spacious homes that now sell for an average of $142,000, 67 percent less than before bankruptcy.
Not everyone see the glass as half-full. Dodson's neighbor, Mark Lucey, 40, is leaving after 11 years. He hopes to find more job opportunities and less crime in California's Central Valley.
"There's nothing here for me now," he said.
Lucey represents the city's challenge: How to attract business and provide opportunities for citizens.
On a recent foggy morning, Councilwoman Marti Brown and Gomes were discussing ways to rebrand the city. Brown suggested it might be time to take down those "City of Opportunity" signs on the road into town.
Gomes wasn't so sure.
"I think `City of Opportunity' describes us really well," she said.
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