Stockton’s fall into bankruptcy is a cautionary tale for California governments that must be heeded to stop future disasters. For all the reasons that Stockton ended up in this predicament, and there are many, the issue of pensions and public benefits rides above the rest.

For a place that once bore the names “Fat City” and “Mudville” before being named for the California territory’s first military governor, the old names are synonymous with the city’s situation in recent times. Fat during the housing boom sinking into the mud accompanying the housing bust with the second most foreclosures in the state and the drop of tax revenue that accompanied the bust.

During the “fat” times, city officials gambled big spending on a waterfront development, a sports arena, and a new city hall that either didn’t return hoped for revenues or, in the case of the city hall, the building was repossessed. California Common Sense, made up of Stanford students and alumni, released a report on How Stockton Went Bust considering the numerous issues.

While the debt created by these gambles is part of the burden the city bears, labor costs and retirement benefits more than double that debt. As the Wall Street Journal noted yesterday, “The city has a little over $300 million in general fund backed debt, but an $800 million unfunded liability for pensions and retiree health benefits.”

It is difficult to read about retired employees with medical conditions who were counting on health care coverage that may now be lost. Prudent fiscal management could have avoided such scenarios. If government doesn’t learn from what is happening in Stockton, the situation is bound to be repeated elsewhere in the state. Besides cutting back benefits, the city has reduced services laying off 25% of its police officers, 30% of its firefighters and 43% of general city staff.

It doesn’t have to be this way. Tough changes to the benefit packages must be made to prevent further bankruptcies. The Journal points out successful moves in Providence, RI to prevent bankruptcy by capping pension benefits and suspending cost of living increases – deals union members backed to preserve jobs. Michigan has made strides in controlling costs and reduced employee pension and health care debt liability.

The same can and must be done here. Mayor Chuck Reed in San Jose proved if you make the argument the voters would understand and go along. The question for California is will the unions stop raising barriers to reforms by filing lawsuits and will lawmakers pay attention and make the necessary changes to pension law?

Acting sooner than later will prevent more chaos for governments and their workers. Ignoring the problem will produce more Stocktons – or should we say more “Mudvilles.”