November 11, 2011 / 1:41 PM / 8 years ago

Wide blame for biggest municipal bankruptcy

BIRMINGHAM, Alabama (Reuters) - From corrupt and incompetent local officials to Wall Street’s credit crisis and toxic bonds, there was plenty of blame to go around on Thursday, a day after Alabama’s Jefferson County declared the biggest municipal bankruptcy in U.S. history.

The county, once a leading industrial hub in the U.S. Deep South, filed for bankruptcy court protection after failing to reach final agreement on terms of a preliminary deal with creditors led by JPMorgan Chase & Co in September to settle $3.14 billion in sewer-system debt.

Federal Judge Thomas Bennett in Birmingham set a December 15 deadline on Thursday for a hearing on whether the county is eligible to file for Chapter 9, the section of the U.S. Bankruptcy Code that covers municipal bankruptcies.

In another key hearing, set for November 21, Bennett will rule on an emergency motion from John Young, a receiver appointed by the Jefferson County Circuit Court to manage the sewer system on behalf of creditors, for relief from an automatic stay in order to try to keep his control over the sewer system.

“It’s critical to the reorganization efforts of Jefferson County that the bankruptcy court keeps the automatic stay in place and affirms the county’s rights to set rates, gain control of the sewer revenues and control of the sewer system,” said Kenneth Klee, a bankruptcy expert whose law firm, Klee, Tuchin, Bogdanoff & Stern LLP, is representing the county.

“This is a critically important hearing that will come on very early in the Chapter 9 case.” Klee said.

The head of the Jefferson County Commission, which voted 4-1 for bankruptcy, pointed to a $140 million decline in the savings expected from the preliminary deal as the trigger for the filing.

“The terms were set, they were agreed upon, and the final agreement wasn’t parallel with those terms,” said David Carrington, the commission president.

Carrington also laid blame at the feet of Governor Robert Bentley and the state’s Republican-controlled legislature for not calling a special session to raise taxes to help Jefferson County settle its debt.

For the roughly 660,000 residents of Jefferson County, which includes Birmingham, the state’s largest city, bankruptcy means a threat to essential jobs and services. More immediately, it could also mean steep sewer system rate hikes, an added burden on poor people already saddled with some of the highest rates in the country.

Consequences of the filing include a likely increase in the county’s cost to raise funds in the bond market, at least temporarily.

The impact of the bankruptcy was seen in the U.S. municipal market on Thursday. More than $1 million of the county’s thinly traded sewer bonds due in August 2012 traded at 52 basis points over Municipal Market Data’s triple-A scale as an investor required a higher yield, an MMD analyst said.

That was a big jump from the last time the issue traded on August 4 when a block of $3.5 million bonds changed hands at 7 basis points over MMD’s triple-A scale.

“The name is getting people scared,” said MMD analyst Domenic Vonella.

The debt crisis could also have a contagion effect on neighboring counties, while rattling the $3.7 trillion U.S. municipal debt market.

Jessie Morris, a notary public waiting in a long lime outside the Jefferson County courthouse in Birmingham on Thursday, said bankruptcy would likely exacerbate the impact of the economic downturn on cash-strapped county residents.

“It’s been bad. You are trying to live from paycheck to paycheck and pay your bills. People have lost jobs. This is going to make it worse,” she told Reuters.

“This is messed up,” added longtime resident Angela Abreu, a translator standing on the same line. “It’s sad. Birmingham is just getting pathetic.”

Jefferson County’s debt escalated in the mid-2000s when bond issuance deals to upgrade its sewer system soured amid widespread corruption, bribery and fraud charges that led to some 22 convictions, which included elected officials and government workers.

Costs ballooned as interest rates rose, and the county had teetered on the edge of insolvency since its debt was downgraded in 2008. With more than $5 billion in total indebtedness, the Chapter 9 filing on Wednesday surpassed that filed by Orange County, California, in 1994.

Larry Langford, a Democrat and former mayor of Birmingham, was sentenced to 15 years in prison last year for his role in corrupt business deals that fueled the multibillion-dollar sewer debt. Langford presided over the county commission during the height of the bond swaps that led to the run-up of the massive debt.


JPMorgan, which has said it wanted to avoid bankruptcy, has already paid more than $75 million and waived about $647 million in fees as part of a settlement with the U.S. Securities and Exchange Commission over charges of fraud in connection with Jefferson County’s sewer debt.

Carrington, who heads the five-member county commission, said Jefferson County was continuing to pursue claims against JPMorgan and some of its affiliates.

Other leading unsecured creditors of the county include Bayerische Landesbank in Munich. JPMorgan holds roughly $1.2 billion of the county’s sewer debt, although it says the bankruptcy will have no material impact on its financial results.

According to Carrington, a leading reason for the collapse of the preliminary agreement was that the estimated savings from the deal had shrunk by about $140 million.

The savings was direly needed because, apart from its sewer bond debt, Jefferson County’s general fund budget was slashed to $217 million this financial year from $312 million last year and there was a $40 million shortfall, Carrington said.

The county had also agreed to take $10 million out of its reserve fund — pushing it to the limit, he said.

In a court document supporting its claim for bankruptcy relief, Jefferson County said its sewer rates had already more than quadrupled over the last 15 years and said further steep rate hikes demanded by the court-appointed receiver would violate “reasonable” and “nondiscriminatory” provisions of Alabama law.

To subsidize the rate hikes from its own general funds, the filing also said the receiver, Young, had demanded that the county pay to him $75 million in general fund cash, the court filing said. This was based “on the novel theory that he (Young) — not the county — was the rightful recipient of the $75 million received by the county from JPMorgan Securities,” it said.

“The county therefore faced the intolerable circumstance of having an unelected third party attempt both to impose unreasonable sewer rate increases on the county’s citizens and to seize the last monies in the county’s general fund reserves, all for the benefit of the holders of the very indebtedness that has wreaked havoc on county’s solvency and financial wherewithal,” the filing said.

“The receiver’s looming demand for the payment of $75 million from the county and the possibility that the receiver might succeed with his efforts to seize all the county’s remaining restricted general funds rendered impracticable all further negotiations with the county’s creditors,” it said.

Some analysts have said the action should not be viewed as a harbinger of more bankruptcy filings in the municipal bond market. Municipal bankruptcies remain rare.

What happens in Jefferson County, and in its federal bankruptcy court could set something of a precedent for other troubled municipalities after the recent high-profile debt crisis in Pennsylvania’s capital of Harrisburg, however.

Klee, a professor of law at UCLA, was one of the principal draftsmen of the 1978 U.S. Bankruptcy Code. His firm was hired by Jefferson County on July 26 and he said there were several potential upsides to Wednesday’s bankruptcy filing.

“At the end of the day, JPMorgan has an incentive to settle in the bankruptcy and try to negotiate a third-party release,” Klee told Reuters in a telephone interview.

A manhole cover bears the logo/design of Jefferson County, Alabama August 9, 2011. REUTERS/Marvin Gentry

“And at the end of the day the other creditors have an incentive to settle with the county and try to target JPMorgan in some litigation and recover ... that’s the dynamic in play there,” he said.

“There’s lots of incentive for JPMorgan to want to negotiate with the county and for the county to want to negotiate with JPMorgan,” Klee said.

“It (the bank) can also write a check to help the county with its general fund problem in the short run,” he said.

Writing by Tom Brown; additional reporting by Verna Gates in Birmingham and by Karen Pierog and Jim Christie; Editing by Carol Bishopric

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