These days, Bettye Fine Collins doesn't talk like a power politician. "It's not easy being me," she complains. It's not hard to understand why. As president of the County Commission in Jefferson County, Alabama, she's the top elected official in one of the nation's most financially troubled jurisdictions. The county of 660,000, anchored by Birmingham, has teetered on the brink of bankruptcy since April 2008. That's when Jefferson County ceased making payments to creditors holding bonds that paid for its sewer system. "It's a long, terrible situation," Collins says. "I don't think there's another situation in this country that would compare."
Despite the downbeat tone of her rhetoric, Collins is a powerful presence. The sewer crisis has served only to highlight the clout that she and the rest of the Jefferson County Commission possess--and their ability to use that power to dance around pressure points. To wit: Since the crisis hit, the commission has neither filed for bankruptcy nor raised sewer rates nor found other revenue to help pay its debt. Despite court hearings, endless debate over bankruptcy and pleas to state and federal officials for help, the county has managed not to do much of anything. In the midst of that inaction, creditors have been powerless to force the county to pay. If Jefferson County does file for bankruptcy soon, it's likely to be because of an unrelated fight with the Alabama state legislature over taxes--not its mountain of sewer debt.
Jefferson County's problems stem from a noxious mix of incompetence, political paralysis, corruption and bad luck. While a possible solution is in the offing, the tale is a cautionary one--for municipalities across the country, as well as anyone who is owed money by a local government.
Jefferson County's saga began in 1993, when members of the Cahaba River Society complained that the county's sewer system was discharging raw sewage into waterways. Federal officials issued a consent decree in which Jefferson County promised to upgrade the system.
To do so, the county issued $3 billion in bonds, an incredible amount for a sewer system with only 150,000 customers. As sewer rates rose to meet those costs and Jefferson County struggled under its debt, county officials looked for a way to lessen its loan payments. In 2002 and 2003, they refinanced their bonds with variable-rate and auction-rate securities. Auction-rate securities are bonds where the interest rate is reset by auctions conducted by brokerage firms every few weeks. "It's a little like someone buying a house and getting a pretty good 30-year fixed-rate mortgage," says Christopher "Kit" Taylor, former executive director of the Municipal Securities Rulemaking Board. "Then somebody says, 'Why don't you get an adjustable-rate mortgage?'"
Auction-rate securities were supposed to be safe, but the auction-rate market collapsed in February 2008. That wasn't the county's only misfortune. The bond insurance companies that were backing the county's debt suffered their own fiscal problems and their credit was downgraded. All of which caused the county's interest rates to skyrocket, much like a homeowner whose subprime mortgage has just reset. Revenue from sewer fees could not keep up with the borrowing costs. On April Fool's Day 2008, Jefferson County couldn't make its payment on its debt. Instead, it reached an agreement with its creditors to pay the interest and get an extension on the principal.
These forbearance agreements have continued ever since. Last September, creditors took the case to federal court, hoping a judge would appoint a receiver to force the county to pay the nearly $4 billion it now owes. It wasn't until this June that the judge ruled that federal law prevented him from appointing a receiver. In other words, Alabama's most populous county simply hasn't been paying its sewer debt for the past 16 months.
Why not? For one thing, Jefferson County's choices are truly unappealing. The county could raise sewer rates again, but they already are among the highest in the country. The county could file for bankruptcy, but elected officials worry that such a move would be a black eye for the county with potential long-term fiscal consequences.
County commissioners and other Alabama political players have conceived a variety of creative ideas to solve the sewer mess--to no avail. Governor Bob Riley spent last fall negotiating with creditors but, despite winning concessions, he couldn't find a plan that the county would accept.
The county's most promising solution was to tap excess sales tax revenue intended for school construction and use it to pay off the sewer debt. Riley supported the idea as part of his deal with creditors. Collins and other county commissioners were in favor of it, too. However, those efforts were rebuffed this spring by the state legislature, which has the final word in Alabama, where counties lack robust home rule. Jefferson County and state legislators have a long history of not getting along.
That political tension is also at the heart of Jefferson County's other fiscal crisis. In January, a state judge overturned the county's occupational tax, which had accounted for one-quarter of its general-fund budget. The legislature could have reinstated the tax this spring but didn't.
While a legislative special session still could do so, the county has made massive cutbacks--reducing department budgets by one-third, cancelling road maintenance contracts, closing courthouses and laying off hundreds of county workers. But the county still is on the brink of bankruptcy. "We're having to downsize this government," Collins says, "to the point that it may not be able to operate."
The difficulty of the dual crises that Jefferson County faces is only one of the reasons the county hasn't paid its sewer debts. There's another one: No one has been able to force it to do so.
The county issued revenue bonds, not general obligation bonds, which limits the creditors' claim to revenue other than from the sewer system. The federal judge who heard the creditors' case chastised the county for being irresponsible but also acknowledged that he couldn't appoint a receiver: Under federal law, federal receivers can't set local utility rates.
Some of the creditors now are pursuing their case in state court. Jeffrey Cohen, a municipal bankruptcy expert, doesn't think they'll get far. Although other experts disagree, his reading of Alabama's constitution rules out a state-appointed receiver who could force the county to raise rates. "It's a stalemate," he says. "Debt isn't being repaid and bondholders can't do anything about it."
Nor do all the bondholders necessarily deserve a generous remedy. The creditors include the bond insurance firms, which helped sparked the crisis when their credit ratings were downgraded. They also include investment banks, such as J.P. Morgan, which Jefferson County officials say pushed the county to make risky financial decisions. The Securities and Exchange Commission is investigating J.P. Morgan's role in the sewer bonds.
That's not the only hint of wrongdoing. Some 20 people, including three county commissioners, have been convicted of crimes involving the construction and financing of the sewer system. That has given Jefferson County's current commission the will to resist paying. Why, they argue, should taxpayers or ratepayers be punished for the greed of Wall Street banks and lawbreaking by local officials?
Jefferson County's particulars are not all that different from other insolvencies: Chapter 9 bankruptcy, which covers municipal defaults, is kinder to debtors than other forms of bankruptcy. There's no risk, for instance, of Jefferson County being forced to liquidate, the way a Circuit City or Linens n Things are. "When you're dealing with a municipal debtor," says Kenneth Klee, a law professor at UCLA, "the law does not allow you to take a park or a bridge or a city hall."
As a result, creditors are just as eager as local government officials to avoid a bankruptcy filing. They may even be more eager. In May 2008, Vallejo, California, filed for municipal bankruptcy. Yet Vallejo's unions, knowing that Chapter 9 would work against them, fought unsuccessfully to win a court ruling saying the city wasn't actually insolvent and wasn't eligible for bankruptcy.
This dynamic gives cities nearing default a tremendous amount of leverage. They can threaten bankruptcy and demand that creditors make allowances. In Jefferson County, the creditors already have offered $1.3 billion in concessions, but the County Commission hasn't taken the deal.
Variations on the situation in Jefferson County could play out elsewhere. The recession has put local governments on vastly weaker financial footing. According to Richard Lehmann, publisher of a newsletter that tracks bond defaults, there were only 29 municipal defaults in 2007 totaling $300 million. In 2008, those numbers skyrocketed to record highs: 150 defaults, totaling $7.8 billion.
Many of the defaults have been in what are known as "conduit bonds," where municipalities issue bonds on behalf of private companies, without any obligation for the government to guarantee the debt. Other municipal defaults are concentrated in nonprofits or small limited-purpose governments. Dozens of Florida's Community Development Districts, for instance, went into default last year as a result of the housing bust.
Some of the problems affecting these entities are buffeting general-purpose governments, too. Soon, other large jurisdictions may be unable to pay their bills. In this context, Jefferson County is serving as something of a test case. How far can a municipality go in not paying its debts? How long will it let a dangerous situation linger until it takes action?
This summer, the county commission took action to counter the loss of the occupational tax by slashing the budget. More remarkable, though, was a newfound unanimity on the sewer crisis. The commission voted unanimously in support of restructuring its debt. New bonds would be issued that would, in effect, turn back the clock. Jefferson County would owe what it would have owed had it issued bonds with a fixed interest rate of around 3.5 percent. Creditors would be responsible for the exorbitant costs from the auction-rate debacle. A new oversight board would supervise the sewer system. Unused money from the county's sales tax for school construction would be dedicated to paying the sewer creditors.
Creditors still have to agree to the deal, as does the state legislature. A positive outcome is not a sure or quick thing. "Most likely, there will be deal at some point," Klee says. "The only question is when."