A federal judge announced on Tuesday that Detroit is eligible for bankruptcy protection – the first time in US history that a major city has been declared bust.

Judge Steven Rhodes of the United States bankruptcy court rejected an attempt by the city's pension funds and unions to have the bankruptcy action thrown out.

“The city needs help,” said Rhodes. Detroit is facing "mounting crime rates, spreading blight and a deteriorating quality of life. The city no longer has the resources to provide its residents with basic police, fire and services."

Outside the courthouse in downtown Detroit protesters worried about the fate of city pensioners chanted: "Protect our pensions. Now" and "No justice. No peace." Under one plan floated by Kevyn Orr, the state-appointed emergency manager, Detoit’s pensioners face swingeing cuts to their benefits.

In court Rhodes said the city’s pension liabilities were “complex and confusing.” The city borrowed about $1.4bn in 2005 to eliminate its unfunded pension liabilities. Then it "entered into a wager," Rhodes said that it lost “catastrophically”.

Orr has argued that pension and benefit cuts are essential to balancing Detroit’s books. Rhodes ruled that pension rights could be “impaired” but warned he would not necessarily approve any plan with steep cuts.

Lawyers representing city workers have said they appeal any verdict that cuts benefits, which they argue are protected by Michigan’s constitution. "Resolving this issue now will likely expedite the resolution of this bankruptcy case,” said Rhodes.

Rhodes said the city had made all the cuts it could make. "The city cannot legally increase its tax revenues nor can it further reduce its expenses without further endangering health and safety," he said.

Once the US’s fourth largest city and now its 18th, Detroit’s woes escalated during the recession as its already battered housing market collapsed and unemployment soared. The city had a population of close to 2m in the 1950s and is now home to around 700,000, more than a third of them living in poverty.

Orr has calculated the city’s debts at $18bn, a figure disputed by his critics, but no matter the real sum Detroit’s bankruptcy dwarfs all other municipal bankruptcy filings. The previous record was held by Alabama's Jefferson County, which filed for bankruptcy with debts in excess of $3.1bn.

Before the new year, lawyers for the city are expected to submit a plan to pay off the city’s debts. Orr has said that the city must reinvest in itself, improving services in a city where close to half the street lights do not work and violent crime is at record levels. He has said he plans to step down next September and hopes the city might emerge from bankruptcy in 2014.

Protesters outside of the bankruptcy court. Photograph: James Fassinger /theguardian.com Photograph: James Fassinger/theguardian.com

But the cost of the so-called chapter 9 bankruptcy is likely to be felt in Detroit for years to come, warned experts.

Jim Spiotto, head of the bankruptcy at Chapman & Cutler, said chapter 9 bankruptcy had always been the last resort for major US cities. New York, Cleveland and Pittsburgh have all teetered on the edge on bankruptcy in the past but all found alternatives to declaring bankruptcy, he said.

“Chapter 9 is rarely used and the only one of any real size is Detroit,” he said. “The complexity, expense and uncertainty of these types of filings make them very unattractive.”

Spiotto said that the stigma that bankruptcy causes in capital markets when the city comes to borrow money again would have very real consequences for Detroit. “If you pay 2% more interest for 30 years, that’s 60% more money that you are not spending on employing people, infrastructure. It’s a very expensive business,” he said.

In the long-term he said Detroit, like New York and Pittsburgh before it, needed to come up with a plan to grow its revenues. “Bankruptcy does not solve systemic problems it just brings the debt down to levels that are manageable. The recovery plan has to be about bringing new investment to Detroit, getting good salaries for new workers, creating a new tax base for the city,” he said.

The filing is unlikely to end an already heated dispute with city workers, who represent Detroit’s largest creditors. The city’s workers are owed $3.5bn in pension payments and another $6bn in healthcare costs. Under one proposal floated before the bankruptcy was approved creditors would receive just 16¢ on the dollar for the pensions they are owed. The average Detroit pensioner gets $19,000 a year – the cut would leave them with $3,040.

Ryan Plecha, a lawyer at Lippitt O’Keefe who represents the Detroit Retired City Employees Association and Retired Detroit Police and Fire Fighters Association, said such a cut would be “catastrophic.”

“People would not be able to survive in that,” he said.

Orr is now expected to restart negotiations with creditors ahead of submitting his reorganisation plan to the bankruptcy court. While negotiations are expected to be fraught, under chapter 9 Orr now has more power to push his plan through.

Under a process known as “cramdown” he only needs the majority of one class of creditors to approve his plan before he can resubmit it to the court.

Spiotto said Orr now had much more room to manoeuver but the city’s problems were far from over. “This is a debt readjustment. If you don’t solve the systemic problems then you will just do this again.”