Stockton is going to have to prove in court that it's broke, going up against angry Wall Street creditors who say the city is improperly using bankruptcy to worm its way out of debt.

In a case with huge implications for city services, municipal employees and CalPERS, a bankruptcy judge Tuesday ordered a trial in late March on whether the city of 300,000 has the right to file for bankruptcy protection.

Stockton filed for Chapter 9 bankruptcy protection last June in the largest municipal bankruptcy in U.S. history. At the time, the city was too poor to meet its payroll, city attorney Norman Hile said Tuesday at a hearing in U.S. Bankruptcy Court in Sacramento.

City officials say they've already cut services to the bone, slashing police protection by one-fourth in a city that saw a record number of murders last year. If Stockton is denied bankruptcy protection, officials say they would have to essentially gut the city.

"Bankruptcy is the cure," said another city attorney, Marc Levinson. "If we're outside of bankruptcy, how do we pay our bills?"

The four-day trial, set to start March 25, could be an epic tug of war over the city's meager resources.

Three Wall Street bond creditors, who could lose millions in the bankruptcy, say the city is refusing to face up to its obligations - and is giving CalPERS a sweetheart deal at the expense of other creditors. Stockton is continuing to make its $29 million in annual pension payments to the California Public Employees' Retirement System.

"The financial market creditors are unhappy," Bankruptcy Judge Christopher Klein told a CalPERS lawyer at Tuesday's hearing. "They say if they should have to take a haircut, so should you."

The creditors are National Public Finance Guarantee Corp., Assured Guarantee Corp. and Franklin High Yield Tax-Free Income Fund.

CalPERS says cities have to make their annual payments to the pension fund, no matter what. Vallejo considered scaling back its CalPERS payments when it filed for bankruptcy protection in 2008, but changed its mind after the fund threatened to sue.

"CalPERS is here really to protect the integrity and soundness of the pension system," said the fund's general counsel Peter Mixon, who attended the hearing.

But as more cities face financial stress, CalPERS' power is being questioned. San Bernardino halted its pension payments after filing for bankruptcy protection last August, although it says it plans to resume paying in the next fiscal year. CalPERS sought permission from a bankruptcy judge to sue San Bernardino but was denied.

In the Stockton case, all sides agreed that CalPERS will have a voice.

"I understand CalPERS is a force to be reckoned with," Klein said dryly.

If Stockton stopped paying CalPERS, the city's pension plan could be terminated. Employees and retirees would be placed in a special CalPERS fund and would likely get reduced benefits.

City officials say they'd lose their employees in droves if Stockton was cut out of CalPERS.

"There's no alternative to CalPERS," Levinson said.

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