Vallejo, California, is notable for many things. It was the state capital, for example, if only briefly, in 1851. It is the home of Boomerang, Kong, ROAR! and V2: Vertical Velocity, evocatively named rollercoasters at the sprawling Six Flags Discovery Kingdom theme park. And, as of this week, it is seeking to declare itself bankrupt.

Faced with tax revenues that are spiralling downwards, the Mayor and council members voted unanimously this week to file for bankruptcy. Joanne Schivley, one councillor, said that nobody wanted to go down this road, but added: “There do not appear to be a lot of options left. We are going to be out of cash by June 30.”

If it happens, Vallejo will become yet another victim of the American property crash. In the United States, homeowners pay a local tax that is calculated as a percentage of the market value of their house. That’s fine when property values are robust, but America is suffering its worst property slump since the Great Depression, with values down 15 per cent over the past 12 months – and some states, not least the West Coast giant California, have suffered much bigger declines.

Some towns – cities in local parlance – have experienced house price falls of about 40 per cent in the past two years, with as many as one in thirty-one households falling into serious arrears with their mortgages.

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While Vallejo could still be bailed out with emergency funds by California, the city has voted in favour of applying to a court for bankruptcy protection under legislation known as Chapter 9. Such a move, particularly by a city such as Vallejo, is very rare. Should the application be accepted, the city would try to negotiate with its creditors, including Wall Street banks that have bought municipal bonds issued by the city.

In the short term, such a move could threaten salary payments to council workers and the provision of utilities such as electricity to council buildings. But in the medium to long term, filing for bankruptcy protection would have far more serious consequences for the residents of Vallejo.

The city would find it either prohibitively expensive or impossible to raise new money through the bond market – a big source of funding – because it would be seen as too risky a creditor. Should the municipal bond market become closed to the city, new infrastructure projects such as roads and bridges could be threatened. In addition, services such as schools and public safety could be reduced. Bad enough in the poor, rural Mid-West, but in the prosperous Bay Area conurbation surrounding San Francisco?

While the city has suffered a fall in tax revenues because some homeowners have entered the foreclosure process and have lost their properties, other residents have stopped paying their property tax as they demand a revaluation of their home.

The city, which has 117,000 residents, is forecasting a $16 million (£8.2 million) deficit for the year starting in July. While it has an annual budget of about $89 million, salaries and pension payments for the local police and firefighters take up about 80 per cent of that sum. Labour unions have demanded pay rises for workers such as firemen and policemen.

James Spiotto, a partner at the law firm Chapman and Cutler in Chicago, would not rule out the possibility that other cities that have also experienced sharp property price falls would have to declare themselves bust. “There is always the possibility that this will become contagious,” he said.

The office for the Mayor of Vallejo failed to return calls yesterday.

Value for money?

House prices in Solano County, California, which includes the city of Vallejo, fell by 26 per cent in March compared with March 2007*

US housing
Sales of existing single family homes (not new builds) March 2007 – 5.33 million across the United States March 2008 – 4.35 million across the United States

Average sale prices of existing family homes
March 2007 – $216,200 across the United States March 2008 – $198,260 across the United States

Source: National Association of Realtors, *DataQuick Information Systems

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