Stockton, Calif., is set to file for bankruptcy protection this week, making it the largest U.S. municipality to seek protection from its creditors.

"The city is fiscally insolvent and must seek Chapter 9 bankruptcy protection," Stockton said in a statement released Tuesday. It has stopped making bond payments.

Stockton, an agriculture-based city of 290,000 people east of San Francisco, will be the seventh local government in the U.S. to file for bankruptcy this year.

The city had tried to reach a financing deal with creditors to address its $26 million budget shortfall, but was unable to close the gap. That failure led to a city council vote to adopt a special bankruptcy budget. 

The collapse of the housing market hit Stockton particularly hard, causing property tax revenues to plummet. It has the second-highest foreclosure rate in the U.S.

It has already slashed the workforces of its police and fire departments and cut 40 per cent of the workers in other departments.

Once a bankruptcy protection filing is approved, a judge decides which creditors get paid, how much and in what order.

It could allow the city to break contracts with creditors and could see union contracts dealing with pay and benefits voided by the courts.

With files from The Associated Press