July 26 (Bloomberg) -- San Diego's $2 billion pension shortfall may decide the outcome of today's special mayoral election, with one candidate saying bankruptcy is the best solution and two others saying they would consider it.

The seventh-biggest U.S. city has about two-thirds of the money its fund will need to pay for employees retiring in coming decades. The shortfall, which threatens to force the city to cut services or raise taxes, is about twice as large as the $817 million annual budget.

``It's driving everything,'' Republican candidate Steve Francis, the chairman of AMN Healthcare Services Inc., said in an interview. ``It's the 1,600 pound gorilla.''

San Diego hasn't filed financial statements for the last three years. The lack of documents left San Diego unable to sell bonds to fix its sewer system.

Former mayor Dick Murphy, a Republican, triggered the election by quitting seven months into his second term, saying he couldn't close the gap. Six city and union officials have been indicted in connection with the pension fund, and the U.S. Securities and Exchange Commission and Federal Bureau of Investigation are investigating.

``The whole thing has basically caused the financial structure of San Diego to grind to a complete halt,'' said Patrick Shea, a 55-year-old Republican candidate who advocates bankruptcy. Shea is married to former pension-board member Diann Shipione, who in 2002 was the first to say San Diego's finances were vulnerable because the city was raising benefits without setting enough aside to pay for them.

Bankruptcy Candidate

San Diego's inability to pay into the pension fund on schedule makes it a candidate for bankruptcy, said Shea, who holds a law degree and an MBA from Harvard University.

Defaulting on debts would be a speedy resolution to the city's troubles, he says, noting that the Orange County bankruptcy lasted 18 months. San Diego's current plight has already lasted longer.

``There is only one issue in this race: Do we go into Chapter 9 now,'' he said, referring to the law covering municipal bankruptcies. ``Or do we try something else?''

Two of the leading candidates in the mayor's race, Democrat City Councilwoman Donna Frye, 53, and Republican contender Jerry Sanders, the city's former police chief, say they'd rather fix the pension fund than declare bankruptcy, though they refuse to rule it out. Frye wants a court-appointed receiver placed in charge of the pension fund, while Sanders says he will seek to roll back some benefits by wresting concessions from workers.

Campaigning Against Bankruptcy

``People don't want to see bankruptcy as the first option, nor do they want to see it as the second, third or fourth options,'' Sanders, 55, said in an interview at his headquarters. `I think it should be used if it's the only option.''

Republican businessman Francis, 50, has spent $1.7 million of his own money in the race campaigning against a bankruptcy filing.

``How do you deal with the problem?'' Francis said. Do you do it by downsizing government, or do you throw in the towel by declaring Chapter 9 bankruptcy?''

Frye leads the race, though polls show she doesn't have enough support to avoid a run-off against the second-place finisher. Frye was favored by 44 percent of respondents to a SurveyUSA poll last week conducted for local television station KGTV. Francis trailed with 27.

A runoff will be held Nov. 8 between the two top finishers if none of the 11 candidates gets a majority of votes.

The prospect that San Diego could end up in bankruptcy court has weighed on the city's credit standing. Fitch Ratings in May lowered its rating on $1.95 billion of San Diego bonds, cutting its general obligation debt two steps to BBB+, three levels above so-called junk status.

Default Insurance

Standard & Poor's has withdrawn its rating of the city's bonds, saying San Diego's failure to produce a financial statement made it impossible to assess its creditworthiness.

All the San Diego bonds that were traded July 22 are insured against default, according to prices posted on the Bond Market Association's Web site. A San Diego bond paid by revenue from its sewer system maturing in 2029 sold for $1.03 on the dollar, yielding 4.44 percent.

``One of the reasons for our last downgrade was because there was talk of bankruptcy among the candidates,'' said Amy Doppelt, an analyst for Fitch who follows San Diego. ``We would hope that once they explore the issue further that they decide that it doesn't make sense.''

To contact the reporter on this story: William Selway in San Francisco at wselway@bloomberg.net.

Last Updated: July 26, 2005 10:11 EDT