(FORTUNE Magazine) – MOST FOLKS PROBABLY HAVE certain images in mind when they think about San Diego. A gentle breeze blowing off the Pacific. Aircraft carriers idling at their berths. Well-fed folks lining up putts on country-club greens. Money oozing from the wireless and biotech juggernauts up and down the coast. In short, a Shangri-la with bulging brokerage accounts and government largesse.

How, then, to square this idyllic vision--a largely accurate one, by the way--with the scandals that have sprouted in California's second-largest city faster than wildflowers after a desert rain? There's so much slime in this town that civic leader George Mitrovich, president of the City Club of San Diego, calls it "the most screwed-up city in America."

How bad could it be, you say, when the weather is always mild and parking at the beach is free? Those virtues might be part of the problem. San Diego, it turns out, is a city to which people with money love to move, but they don't care to pay a whole lot of taxes once they arrive. One foul-up has followed another over the years--a delayed payment by the city to its employee pension fund, a sweetheart lease to real estate developers--and San Diego is now virtually broke. Some even speculate that the city might consider selling its jewel of a public golf course, Torrey Pines.

Adding insult to injury, for the better part of 2005 it's been unclear who's in charge. Consider that in one week in July, the city had three mayors: the one who resigned after being called one of the worst mayors in America by Time magazine; his successor, who served for one business day before being convicted in a federal bribery trial; and then a city council member, who serves today on an interim basis. On Nov. 8, voters elected a new mayor, Republican ex-police chief and political novice Jerry Sanders. He bested city council member Donna Frye, a surf-shop owner turned politician and environmentalist.

Of all the prickly problems Sanders will face when he takes the oath of office in December, the most visible is a pension fund scandal that has left the employee fund in a $1.4 billion hole. When a former member of the board that oversees the fund blew the whistle on its mismanagement in 2002, the fiscal problems snowballed. Today the Securities and Exchange Commission is probing alleged misstatements in a municipal bond offering. The FBI and U.S. Attorney are sniffing around the conduct of pension-board members. As a result, the city can't borrow money in public markets because its bond ratings are either too low or, in the case of Standard & Poor's, nonexistent. "They don't want to let us back into the bonds until they make sure we aren't a bunch of crooks," says Jerry Butkiewicz, a local labor leader and important power broker.

The city council, in open warfare with its independently elected city attorney, Michael Aguirre, called in Arthur Levitt, former chairman of the SEC, to audit San Diego's finances. Aguirre has branded Levitt an outsider, accusing him of riding the "consulting circuit" at San Diego's expense. Aguirre has enraged so many people that a union group has printed bumper stickers demanding his recall. Pat Shea, a lawyer involved with Orange County's bankruptcy a decade ago and a failed 2005 mayoral candidate, has called for the city to put itself into receivership.

The city's embarrassments extend far beyond its pension and budget crises. In July, Michael Zucchet, a baby-faced, 35-year-old city council member and acting mayor for a day, was convicted of accepting a bribe from a Las Vegas strip-club owner who wanted the city to overturn its ban on the touching of dancers. The conviction was overturned this month, though Zucchet still faces trial on two other charges. The area's war-hero Congressman, Randy "Duke" Cunningham, is under federal investigation over a bribery case of his own for allegedly selling his home at an above-market price to a defense contractor with whom he is friendly.

The business community is almost nowhere to be seen in the crisis. Corporate heavyweights like Qualcomm and the many high-tech companies clustered along the Interstate 805 corridor are staying on the sidelines. "I've never seen a city with the assets and resources this great city has that has been as dysfunctional in its political and business leadership," says Levitt, who's been shuttling coast to coast from his home in Connecticut. "Normally you'd see these kinds of leaders band together to reach a solution." Not in San Diego.

San Diegans have different ideas about the root of their collective problem. Diann Shipione, an investment advisor and former pension-board member, compares the city to a beautiful woman whose wiles have faded more than a bit with age. "San Diego had the luxury of being able to rely on its looks for a long time," she argues. "Now we're beginning to realize it takes more than looks to be a great city." (Shipione, by the by, is the wife of bankruptcy lawyer Shea. They were married by ex-mayor Dick Murphy, the one who quit after Time anointed him a lousy mayor.) Others blame the city's laid-back ways. "We don't really want to do the hard work," says Peter Q. Davis, a local banker who ran unsuccessfully for mayor in 2000. "We'd rather head for the beach."

Perhaps it's just a coincidence that so many of the city's prominent politicos have run into trouble at precisely the same time. But there's no doubt that San Diego has structural issues that need fixing. Starting in January, it will switch to a "strong- mayor" system that gives the city's chief executive more power, as New York City did when it gave Michael Bloomberg control over its schools. The lack of authority is former Mayor Murphy's excuse for what others have called his indecision. "I'm just a city council member," he told me days before he left office, a pained look on his face when he learned that I work for a sister publication to Time. "I'm just a legislator. And that makes me the worst mayor in America?"

Another concern is one shared by municipalities all over the country: San Diego doesn't bring in enough revenue to cover its spending. And it's not because its citizens can't afford to pay. "We're a cheap city," says Sol Price, the 89-year-old founder of Price Club, which later merged with Costco. "We're the only city in the state with no parking meters at the beach."

It's possible that San Diego could be headed for better times. Sanders will have real power beginning next year. Levitt's group expects an audit to be completed by springtime, which would allow the city to borrow money at reasonable rates again. Oh, and the weather will still be beautiful.

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