Jefferson County At the Brink of Bankruptcy Filing – Bonds Are Now Junk

The credit crisis and the failure of auction rate securities have wreaked financial havoc to individual investors and communities across the country. Jefferson County, Alabama is at the top of that list.

Problems for Jefferson County, which has more than 650,000 residents and includes the state's largest city, Birmingham, began when county commissioners unsuccessfully tried to refinance $3.2 billion of sewer system debt. Approximately 3 years ago, Jefferson County, with the direct assistance of J.P. Morgan and other brokerage firms, began employing high risk interest rate swaps which are essentially derivative contracts that allow participants to trade exposure to floating rate and fixed debt. Jefferson County sought to lower their borrowing costs in repairing the county's sewer.

The Jefferson County bond investments were recommended to investors as safe investment grade rated bonds – one of the safest categories of fixed income available for investors to purchase. Investors were told that Jefferson County bonds were insured and only slightly riskier than a investing in a money market fund.

Initially, the plan concocted by Wall Street was supposed to protect the county from rising interest rates on its sewer bonds. That didn't happen, however, and the county not only faced interest rates as high as 10 percent, but also turned over $120 million in fees – six times the prevailing rate – to JP Morgan and others.

The questionable financing deals for Jefferson County have been the subject of state and federal investigations, with several former county officials and others convicted of bribery and corruption. The bond swaps are at the center of an investigation by the Securities and Exchange Commission (SEC).

Bankruptcy Looming?

With options running out and financial crises a daily occurrence, Jefferson County commissioners are now considering filing Chapter 9 bankruptcy to solve their financial problems.

At a legislative meeting held August 15, David Bronner, CEO of Retirement Systems of America, offered to buy Jefferson County's sewer system if the county files for bankruptcy. He says he would then sell the system back to the county in seven years at the same price he paid for it.

Bronner's $32 billion pension fund has invested in a gamut of projects, including golf courses and nursing homes. His latest proposal entails buying Jefferson County's sewer system for up to $1.4 billion.

Not everyone is sold on Bronners idea. Jefferson County Commissioner Shelia Smoot claims a bankruptcy would cause long-term damage to the county, the state and its municipalities for years to come, leading to possible tax increases and making it more costly to borrow money and harder to finance infrastructure improvements.

According to Bronner, more than 500 cities and counties have turned to Chapter 9 bankruptcy as a way to clean up their balance sheets. At the very least, Bronner's plan would put the Wall Street banks that initially created the county's financial troubles – and for which Jefferson County paid them more than $120 million in fees – on the hook to pay some of the county's astronomical debt.

In early August, Jefferson County agreed to a $44 million payment to Wall Street banks and creditors to extend a payment on overdue sewer bond debts until Nov. 17. It is the county's fourth forbearance since March 31.