Tag Archives: Jefferson County

Varying Priorities in Municipal Bankruptcy

On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s  Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.

After Rhode Island enacted this law, the Wall Street Journal explained:

Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.

“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.

The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors.  Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:

“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?

“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.

While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.

SEPTA and interest rate swaps

Interest rate swaps became a relatively popular means for municipal governments to save some money during the 1990s and into the 2000s. The basic idea is that an issuer (the government) enters into a contract with a bank to exchange interest rate payments on a cash flow. These can be structured to exchange a fixed payment for a variable payment in return, or vice versa.

These interest payments are calculated based on an underlying asset or instrument, such as a bond. That makes interest rate swaps a derivative, as their value is derived from an underlying financial instrument.

The issuer’s goal is to hedge against fluctuating interest rates and impart some stability to their budget.The bank’s incentive is to make a fee. It works for the issuer when they guess correctly and – by way of example -the issuer agrees to a payment based on a fixed rate of interest that is low relative to the adjustable rate of interest the bank pays to the municipality in return.

But that’s not what happened as rates began to fall after 2008. Many municipal issuers found themselves paying banks a fixed rate that was high relative to the variable rate the bank was paying in return. Jefferson County, Alabama is the most notorious example, as my recent article in US News explains. At work in this larger story is the role the LIBOR interest rate rigging scandal played in suppressing the variable rate leading some governments to sue banks for damages.

Pennsylvania governments were particularly keen on interest rates swaps, with 626 swaps having been entered into across the Commonwealth. Depending on how they were structured, some entities have come out ahead. The majority have lost on the contracts. That includes SEPTA, as Pennsylvania Watchdog explains.

Is the problem with the interest rate swap concept? I’d argue that the answer lies in how they are used. What might be a good hedging instrument for the financial sector exposes the public sector to a set of risks that aren’t fully appreciated. The risks -including the real hazard that the municipality incorrectly guessed the direction interest rates would travel- are passed on to taxpayers or service users.



Bankruptcy in Birmingham

Jefferson County, AL has filed for bankruptcy protection, joining the ranks of Vallejo, CA; Central Falls, RI; Boise, ID; and Harrisburg, PA. In this case, the debt that the county used to finance a new sewer system is the main driver of insolvency. The county currently owes about $4.15 billion on the sewer system.

The Associated Press reports:

The problems were years in the making.

Its debt ballooned after a federally mandated sewer project was beset with corruption, court rulings that didn’t go its way and rising interest rates when global markets struggled.

Since 2008, Jefferson County tried to save itself the cost and embarrassment of filing for bankruptcy. But after three years, commissioners voted 4-1 to bring the issue to an end.

“Jefferson County has, in effect, been in bankruptcy for three years,” said Commissioner Jimmie Stephens, who made the motion to file for protection in federal bankruptcy court in northern Alabama.

While the last few years have seen a few cases of municipalities filing for Chapter 9, Jefferson County’s case represents by far the largest. Unlike other recent bankruptcies that were a result of both poor financial management and the economic downturn, Jefferson County’s problems were in part a result of corrupt public officials. Twenty-two people have been convicted for illegally refinancing the sewer bonds to benefit local and Wall Street financiers. Residents in Alabama’s largest county will likely face higher sewer rates as a result.

But the biggest problem for residents when municipalities file for bankruptcy protection is the resulting policy uncertainty. Businesses are typically reluctant, with good reason, to move to a bankrupt municipality. The shadow of Chapter 9 means that for years, residents and businesses will be paying higher taxes in exchange for fewer services because of the remaining debt burden. This will put the county and even the state in a poor competitive standing for new jobs.

In 1994, Orange County, CA, filed for Chapter 9 protection on $1.7 billion in debt, and residents there are still paying taxes toward that debt today. In the short term, Jefferson County will face painful and immediate cuts. The Birmingham Business Journal spoke with Commissioner Jimmie Stephens on what the future holds for the county:

“We’re looking at all of these services that are not mandated by the constitution and, from there, we will begin the reductions and take it as far as we need to, keeping in mind the services that the citizens need,” he said.


Jefferson County, Alabama works towards negotiated settlement

Jefferson County, Alabama is continuing negotiations with creditors in order to avoid a bankruptcy filing over a $3.14 billion sewer debt that emerged in 2008.  The Governor has urged Jefferson County Commissioners to avoid Chapter 9 because he fears it will hurt the credit of the entire state. Creditors have proposed turning the sewer over to an independent authority. According to The New York Times, the new authority would issue $2.07 billion in new bonds to redeem the defaulted securities. Governor Bentley has offered to back the debt as “moral obligation” bonds which would make the state a (soft) guarantor. The deadline to arrive at an agreement is now September 16.

Jefferson County, Alabama postpones bankruptcy meeting

A meeting was to be held today to decide whether Jefferson County’s government would file for bankruptcy over a $3 billion sewer project. The meeting was canceled on the news of a potential deal from JPMorgan Chase & Co that would cover $1 billion of the debt. Municipal bond markets are not likely to react much to the troubles in Jefferson as they have been obvious since 2008 when the county found itself unable to pay its debts. If the deal works Jefferson County may avoid filing the largest municipal bankruptcy in U.S. history.

Fiscal Risk: Jefferson County, Alabama and Recanati, Italy

Municipal debts are rising on both sides of the Atlantic and for similar reasons. The Washington Post reports that the same risky credit swap deals that led Jefferson County, Alabama into default are riddled in the finances of an estimated 519 municipalities in Italy. These towns face $1.3 billion in losses from poorly-constructed interest rate swaps.

Recanati, Italy agreed to take out contracts on $106 million in municipal debt agreeing to pay the bank a fixed 5 percent interest rate. The banks agreed to pay an adjustable rate (tied to an interest rate index) in return.

European interest rates were high in the mid-2000’s. Recanati realized $400,00 between 2001 and 2008 in interest rate payments. Then rates dropped. The city had to pay the bank 5 percent, while getting less than 1 percent in return.  In one year, Recanati wiped out all of its previous gains. This year the town will lose $700,000.

While Recanati officials  blame the banks for “taking advantage” of them. Another point is worth making. Governments are not private firms. The financial risks borne by governments present a fiscal risk to taxpayers. It is as true of badly-designed interest rate swap deals as it is of how some governments have invested workers’ pensions.

Municipal Bond Woes

With the recent exception of the Dubai World financial crisis, fall 2009 has been relatively kind to the stock market, which is comprised of the financial investments that generally get the most widespread media attention. The same is not true for the municipal bond market, however, whose index has fallen 5% since its September peak.

At present, Detroit looks to be the city with the most significant debt problem. Business Week reports:

A few years ago, Detroit struck a derivatives deal with UBS and other banks that allowed it to save more than $2 million a year in interest on $800 million worth of bonds. But the fine print carried a potentially devastating condition. If the city’s credit rating dropped, the banks could opt out of the deal and demand a sizable breakup fee.


The seeds of this looming disaster were sown during the credit boom, when Wall Street targeted cities big and small with risky financial products that promised to save them money or boost returns. Investment bankers sold exotic derivatives designed to help municipalities cut borrowing costs.

Last year, Jefferson County, Alabama made headlines for coming close to defaulting on its bonds but has managed to continue making payments. Now, the county has filed suit against JPMorgan for underwriting this debt, asserting that the investment bank sold the county financial instruments of little value.

The common angle in this all too common story is to come down harshly against Wall Street, which is taking heat for issuing debt with fine print attached that gives banks the right to vary their offerings depending on municipalities’ bond ratings.

Another, lesser examined take is that city, county, and state officials are taking ever-increasing risks with taxpayer money, which could either benefit or harm the people whose money they are spending. For an individual this would be an expression of a higher risk tolerance, but it is unclear whether or not the same option should be open to those in charge of the public coffers.

In the subprime mortgage crisis, banks took flack for loaning money to consumers who did not understand the fine print in the contracts that they signed. Even if we can excuse this ignorance in consumers, can we really do the same for public officials?

Rather than being angry at Wall Street for underwriting municipal debt, taxpayers should hold their politicians accountable for lacking the diligence or competency to understand the debt that they issue.

Birmingham, Alabama: National Guard Needed After Budget Cuts?

National Guard in New OrleansThe sheriff of Birmingham, Alabama warns he may need to call the National Guard to maintain order after this week’s Circuit Court ruling that Jefferson County leaders can proceed with plans to slash $4.1 million from the sheriff’s budget.

Sheriff Hale, who unsuccessfully sued the County Commission to stop the cuts, warns the decision mean the loss of 188 deputies and 300 civilian employees — more than a dent in local law enforcement.

How did Jefferson County end up close to earning the title of “biggest municipal bankruptcy in U.S. history?”

To finance a $3.2 billion sewer cleanup, six years ago, after consluting with J.P. Morgan,  the county issued floating interest rate debt instead of the typical fixed interest rate debt. It was meant to save taxpayers money. But the collapse of the subprime mortgage market drove up variable rates and has left Jefferson County hemorrhaging red ink, with unexpected debt payments of $7 million a month.

Sadly, none of this was really necessary.

sewer001.JPGAs William Selway and Martin Braun writing at Bloomberg.com note, rather than use competitive bidding (or traditional fixed interest rate bonds) to build the sewers, Jeffco took J.P. Morgan’s advice, turning to pricey (banks collected $120 million in fees on the deal) and costly (the county is $277 million debt as a result) financial wizardry.

Now residents will being paying for their sewer system many times over, and in many ways. The sewer bonds are junk. Taxes will be hiked, sewer fees are rising, and now the city needs the National Guard?

There are other ways to build,  maintain, and pay for sewers. For more, see this 2000 report from the Reason Foundation.