Commentary by Joe Mysak
April 11 (Bloomberg) -- They're talking more about Chapter 9 municipal bankruptcy in Jefferson County, Alabama, the home of the largest city in the state, Birmingham.
Who can blame them?
The county is now being whipsawed by an ill-thought-out debt policy and the collapse of the bond insurers. Credit-rating downgrades all around have triggered a series of events that are no longer in the county's control, leaving it at the mercy of securities firms that have little room for maneuver themselves.
This has produced a steady series of stories in my new favorite newspaper, the Birmingham News, all about how the county is preparing to declare bankruptcy any day.
Perhaps the best article ran on Sunday, April 6. It began: ``Jefferson County officials have laid the groundwork for the largest municipal bankruptcy in the nation's history while publicly saying they have no imminent plans for a filing.''
The one that ran on Wednesday, April 9, was no less compelling: ``Talks on the sewer system's debt crisis aren't making progress, increasing the odds that the county will file municipal bankruptcy, Jefferson County Commission President Bettye Fine Collins said Tuesday.''
This is how it ends for the little county that was going to teach America how to use interest-rate swaps.
Make no mistake. This is a story all about public finance and ``derivatives,'' whose use by states and localities exploded during the past decade.
Orange County
The Jefferson County bankruptcy, if it comes, and it's hard to see how it can be avoided, will eclipse that of the 1994 filing by Orange County, California. ``Derivatives'' are at the center of both death-spirals.
Orange County invested in them -- securities whose value was tied to other securities and markets. The county investment pool, which for years spun off handsome returns for the school districts and local governments that were its participants, found itself holding a bunch of junk when its investors asked for their money back.
Jefferson County played the derivatives game as part of financing a $3.2 billion sewer cleanup. The county engaged in a batch of interest-rate swaps with the banks that helped underwrite the debt, in a strategy designed to save the county and its taxpayers some money. The strategy backfired, demonstrating the speculative, risky nature of swaps.
Two Acts
The bankruptcy will be the biggest in the municipal market's history by virtue of the county's debt load, according to the News. Jefferson County has $3.2 billion in sewer debt; Orange County lost $1.6 billion in its investment pool. I'm sure the matter will be debated. I'm also sure Orange County will be happy to pass the crown to Jefferson County.
There are going to be two acts to this drama.
First, of course, is the actual filing itself. The county seems to think that this will allow it to hold its creditors at bay and proceed in a business-as-usual fashion.
County officials have stated they have no intention of cutting back services or raising taxes or sewer fees. The most the county seems willing to do is to earmark part of a school construction sales tax to pay off its now-overdue debt.
``We are dealing with a virtual immovable force on Wall Street,'' the News quoted Commissioner Collins as saying.
I have a feeling that it's not going to work out precisely this way for Jefferson County and its residents. Every municipal bankruptcy is different, as is everything else in Muniland, but go ask Orange County how Chapter 9 worked. It's not going to be painless, no matter how well it's planned out.
The Bottom
The first act is humiliation. The second is recrimination.
The second act of the Jefferson County bankruptcy is going to focus on Wall Street and all the banks, law firms, advisers and consulting firms that helped put the county where it is today. The county was not well-served, for all the money that changed hands. In this act, the county sues to get some of that money back.
And there was a lot of money, which seems to be at the heart of the Securities and Exchange Commission's inquiry into the county and its infatuation with swaps and derivatives. The agency has said it is looking at pay to play, or bankers and others forking over cash in exchange for jobs.
The SEC's investigation is just part of a larger probe into the reinvestment-of-proceeds business across the municipal market in general. This has been going on for years, but there are signs it will erupt with a barrage of criminal prosecutions.
The stock-market guys say you have to reach a bottom before you can recover, and that a bottom is often signaled by the collapse of some big entity. Many people thought it was Bear Stearns Cos. In reality, it's Jefferson County.
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