Jefferson County, Alabama: The nation’s largest municipal bankruptcy Ever was the result of a crappy Wall Street Deal i
curiouscapitalist.blogs.time.com
Jefferson County has long been the canary in the municipal bond market coal mine - a sign that there were big problems brewing in the market for local government debt that could spread like the bank problems in 2008, and we fear Italy and the rest of Europe’s debt problems now, to the rest of the economy. Indeed, last year, Meredith Whitney, the bank analyst who famously and correctly alerted the world to the problems growing at the nation’s largest banks before the financial crisis, loudly predicted that we could soon see a destabilizing wave of muni-bond defaults.
So it’s easy to see Jefferson County’s bankruptcy, which was filed late on Wednesday and at over $4 billion is the largest municipal bankruptcy in U.S. history (Orange County, Calif., for reference, was a $2 billion bankruptcy), as a sign that the crisis Whitney predicted is now going to play out. Want more evidence? Jefferson is only the latest in a string of recent muni-bond defaults that have been filed in the past few months, including Harrisburg, Pa., Central Falls, R.I., and Boise County, Idaho.
The problem with that logic is that Jefferson County’s bankruptcy will be no surprise to anyone in the muni-bond market, or even a regular reader of national news. Indeed, it turns out municipal bankruptcies are like asteroids, apparently we can see them coming years in advance. Even before the government set up the TARP bank rescue fund, county officials in Birmingham, which is Alabama’s largest city and located in Jefferson County, were calling the Treasury Department and telling officials there that it was their county and not the banks that needed a bailout. A very good Fortune story called Birmingham on the Brink which the magazine published in October of 2008 said Jefferson County’s bankruptcy filing was almost certain, and it implied imminent. Three years and nearly a month later, here we are.
Jefferson County’s problems stem in part from a, quite literally, crappy Wall Street deal. In the early 2000s local official realized that they had spent too much updating their sewer system, which had regularly overflowed in heavy rains. The sewer system’s alone accounts for $3 billion of Jefferson County’s overall debt. There was no way the fees generated by the sewer system could pay the interest on the debt building it had run up.
Wall Street, thankfully, had a solution. Jefferson County’s financial advisers, lead by JPMorgan Chase, told the county to refinance its sewer debt into something called auction-rate securities - a trick that would allow the county to pay lower short-term interest rates on what was long-term debt. The trick would dramatically lower the county’s financing costs. Some local officials called it magic.