published Saturday, November 12th, 2011

The road to bankruptcy

The stunning $4 billion bankruptcy filing Wednesday by Alabama's Jefferson County, home to Birmingham and the state's largest metropolitan economy, will be widely seen as a sad nadir by what was once one of the South's mightiest industrial centers. Yet the county's bankruptcy did not come simply because of industrial decline in a city now known better for its medical and financial industries.

The bankruptcy is more about factors other than Birmingham's economic position. It's due mainly to mismanagement, failed leadership, public corruption, and yet another complex Wall Street derivatives deal that crashed in the 2008 financial implosion -- all of which left the county unable to manage rising interest on its debt while its broker's now-foregone fees climbed to more than $750 million. That amount is notable -- it's nearly four times as much as the $150 million margin that kept Jefferson County from a reaching a negotiated financial settlement of $2.19 billion this week to avoid bankruptcy.

Since the possibility of bankruptcy arose, there's been serious scrutiny of the enormous sewer bond package at the heart of the county's problems. Unfortunately, it came too late to prevent the dilemma that has now saddled Jefferson County with the largest municipal bankruptcy in U.S. history -- a record failure more than double the previous record in 1994 of the Orange County, California, $1.7 billion bankruptcy.

As a result of the belated scrutiny, J.P. Morgan Securities, the arm of Wall Street's JPMorgan that sold Jefferson County on a bond package built on interest-rate swaps that ballooned disastrously, agreed in 2009 to forfeit $752 million to settle a complaint of fraud by the Securities and Exchange Commission. That sum included a foregone "termination fee" of $648 million and payments of $25 million in penalties to the S.E.C. and $50 million back to Jefferson County.

Though the settlement let J.P. Morgan Securities off the hook, it didn't undo the debt or the soaring interest rates Jefferson County faces on the bond deal, a burden which has compounded the county's other interest costs and additional difficulties in attempts to refinance the debt.

Jefferson County got into this quagmire the old-fashioned way: its weak leaders, several of whom have since been convicted for taking bond-related bribes, borrowed more money than they should have in a deal they couldn't or didn't understand. On the part of some, that obviously stemmed from personal greed. Others apparently agreed that borrowing money to fix the county's old, inadequate, foul and leaking sewer system -- a project finally mandated by a federal court after a long history of environmental complaints -- was better than a pay-as-you-go approach of raising sewer rates or property tax rates by an amount figured to be less than 10 percent.

The cost of the sewer project rose from an original figure of $250 million to some $1.5 billion under the bond deal. That amount soared as fees, corruption, bribes and unforeseen hikes in interest costs were tacked on. Since Jefferson County's overhang of debt materialized, county officials have laid off hundreds of public employees, slashed all public services, and negotiated hard to avoid bankruptcy. At the end, four recalcitrant county commissioners -- still afraid to raise sewer fees (by 6.5 percent) and mistrustful of the governor's promised fiscal support -- rejected a negotiated settlement of $2.19 billion.

Their myopic decision will only aggravate the harm of the financial failure and lower credit rating that will now burden Jefferson County's fiscal future with inevitably higher costs for bonds and capital improvements. Ironically, JPMorgan has now become the county's largest creditor, holding roughly a billion of Jefferson's $3.14 billion for sewer construction. At least, there is some rough justice in the company's stake in Jefferson County's future fiscal health.

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