Financial Crisis Shock Waves Reach Municipalities

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The governor and his press staff did not return repeated requests for comment. On Sept. 26, The Birmingham News quoted Riley as saying he is "probably less optimistic now because we've been doing this long enough that if people were going to make the necessary concessions, it seems like they would have been made by now."

The commission's admittedly poor handling of the situation and the slow negotiations have led to a lawsuit. On Sept. 16, the county's bond insurers—Financial Guaranty Insurance Co. and Syncora Guarantee (SCA)—and the Bank of New York Mellon (BK), the county's bond trustee, filed suit against the county, alleging mismanagement of the bond debt and asking that a court-appointed receiver take control of the sewer project. The following week the county countersued for $100 million, claiming that the bond insurers "had the duty to Jefferson County to manage their portfolios and establish reserves against the risk of loss," the counterclaim states. "Syncora and FGIC had insured portfolios of overly risky residential mortgage-backed securities. Syncora and FGIC thus breached their duties to Jefferson County." Collins and the county commission say they were shocked by the bond issuers' involvement with subprime loans. "I had no idea that the bond insurers were getting off into the subprime residential mortgage business," she says. "That was such a shock to my system, because you sit here and you pay millions of dollars for insurance and you feel you're protected—well, guess what? We weren't." Syncora spokesman Michael Gormley says the company hopes to reach a settlement to avoid a county bankruptcy case.

Future Borrowing Burdens

A Chapter 9 bankruptcy case, which allows municipalities with debt they cannot pay to restructure financially, is a relative legal rarity. There have been 564 cases in the past 71 years, and municipalities strive to avoid such filings at all costs because of the steep borrowing burdens any future lender will impose. Bankruptcy experts such as Chicago attorney Jim Spiotto warn that while Chapter 9 can initially ease the financial burden, it will scare future creditors away, making life hard for Jefferson County. "Bankruptcy is essentially a narcotic, in legal respects," he says. "First, you have the euphoria of not having to pay people. But, like with most narcotics, reality sets in and the pain starts."

Jefferson County employees may soon be faced with problems similar to those of city workers in Vallejo, Calif., a town of 116,000 just northeast of San Francisco. In May, Vallejo petitioned for Chapter 9 relief after it admitted it would be unable to pay many of its employees—namely, police and firefighters. A court granted the relief, prompting many police and firefighters to look for work in other cities where they wouldn't have to face 13% pay cuts or uncertainties regarding their medical retirement benefits and their pensions. Vallejo's police force, which had 147 officers in 2007, is now vastly understaffed, with only 119 officers, according to Chris Norem, a spokesman for Vallejo employees. City officials, including Mayor Osby Davis, did not respond to several requests for comment.

Vallejo's plight may soon prove a lot more common. Experts warn that the U.S. economy's struggles could give rise to a wave of new Chapter 9 filings as massive amounts of unfunded pension debt become problematic. Currently there is $800 billion in unfunded pension obligations for government workers, who account for only 12% of the workforce. Compare that with the mere $450 billion in pension money private enterprise owes the bulk of America's workforce, and some think municipalities everywhere will soon have promises to retired workers they will have trouble keeping or may be forced to break altogether. "Promising things to workers that you can't legitimately provide is not good government," says Spiotto. "That has to be addressed." The credit squeeze is also likely to curtail government bond issues. Research firm Municipal Market Advisors has cut its 2008 forecast for new bond issues from $450 billion to $425 billion, the Associated Press reported on Sept. 26, with a further reduction possible.

Burnsed is an editorial assistant for BusinessWeek based in Atlanta.