Financial Crisis Shock Waves Reach Municipalities

Jefferson County, Ala., may be headed for the largest municipal bankruptcy ever. With the economy shrinking, it may not be alone

by Brian Burnsed

It's not just on Wall Street where dubious financial decisions are creating casualties. Municipalities, many of which made enormous financial promises when the economy was strong, are now confronting heavy fiscal burdens. When the last major bank crisis hit public coffers in the late 1980s, 33 municipalities declared bankruptcy. And despite only eight municipal bankruptcies since 2005, some experts believe that Wall Street's troubles could soon squeeze a growing number of municipalities, which will be forced to cover bond payments and outlays to retirees. One prime example of this problem is Jefferson County, Ala., where the state's largest city, Birmingham, is located. The county is now saddled with $3.2 billion in debt from sewer upgrades and finds itself on the brink of becoming the largest municipal bankruptcy in U.S. history.

The current troubles began in 1993 when Jefferson County was sued by residents living near the Cahaba River, who claimed that the county's sewer systems were pumping raw waste into local streams. The county settled the suit three years later, agreeing to fix the situation by overhauling its sewage system and to issue bonds to fund the project. "We didn't know what was under the ground," says Jefferson County Commission President Bettye Fine Collins, who has been on the commission since 1994 and voted against settling the case. The county was forced to rebuild or replace sewer systems in the 22 municipalities inside its borders and agreed not to seek financial assistance from the cities. Some of the systems were found to have clay pipes that had been underground since the first sewers were laid in the early 1900s.

Heeding the advice of financial advisers, Jefferson County officials agreed to restructure the bond debt earlier this decade, moving from a fixed to a variable interest rate. Additionally, the county spent more than $100 million for interest rate swaps, designed to keep the bonds' rates low. Unfortunately, the swaps backfired as interest rates soared amid the spreading credit crunch and ratings agencies lowered Jefferson County's bond ratings. That drastically boosted the county's bond payments.

Deadline Looming

County commissioners are now struggling to reach an agreement to restructure their bond debt before they default and are forced into bankruptcy on Sept. 30, the day the county's forbearance agreement expires. For the past seven months, Jefferson County has been negotiating with the six banks that hold the county's sewer bonds, most of which are held by JPMorgan Chase (JPM). Jefferson hopes to ease the burden of high interest rates by asking banks to exchange the county's auction-rate securities for securities with a 3.8% fixed rate and by asking JPMorgan and Bank of America (BAC) to buy back some or all of the $2.2 billion of the county's auction-rate securities.

Collins notes that the county commission's unanimous intent to file for bankruptcy has caused some of the county's creditors to "soften" their position, fearful that they'll receive only 50¢ on the dollar for their sewer bond holdings. Nonetheless, the pace of negotiations remains sluggish, and Collins herself admits that the county has mishandled the situation. "I sometimes joke we ought to write a book, and it would be how not to, instead of how to, handle this," she says. The county is also facing the prospect of bankruptcy legal costs that Collins estimates could reach $25 million to $50 million.

What happens next largely depends on the creditors' willingness to accept a slower rate of repayment, something they may be unwilling to do as the credit crisis pinches their own finances. So far, creditors seem unwilling to budge, Collins says. With a mere 48 hours until the agreement's deadline on Tuesday, the county grows increasingly desperate, evidenced by Alabama Governor Bob Riley's decision to assume control of talks with the creditors.