The disaster gathering over Jefferson County in the spring of 2008 was not going to stay in Jefferson County. That was the near-unanimous verdict of the bankers, lawyers and public finance professionals canvassed about the sewer debt crisis then engulfing Alabama’s largest county — a crisis they expected to detonate within weeks and to be felt from Mobile to Fort Payne.
Jefferson County appeared to be headed unavoidably to bankruptcy court. Its distinction as the state’s most populous county was about to be eclipsed by a more unwelcome one: home to the largest public bankruptcy in United States history.
Why Mobile pays for Birmingham’s mistakes
The bond markets and the rating agencies do not draw fine distinctions. When Alabama’s largest county commits a blunder of historic proportions, every governmental body in the state — every city, every water board, every industrial development authority — finds itself explaining that it is not Jefferson County.
One observer described the practical effect on Mobile: the city had recently issued nearly $60 million in bonds and learned that two of its previous insurers had been damaged by the subprime mortgage collapse, forcing it to turn to an insurer that had not been. “Now that insurer is not participating in any Alabama issue,” the observer said. Mobile, he added, had itself been offered the swap or “swaption” form of financing by several firms and had declined, judging it “too big a gamble to take when interest rates were so low.”
Another put it more bluntly: “Bad not just for Jefferson County but for all public financing in the state as one bond insurer has ‘blacklisted’ all Alabama issues until this is resolved.”
The instrument that did the damage
What was killing Jefferson County was a structure that had been sold across the country: variable rate debt paired with an interest rate swap. In theory it converts a floating rate into a fixed one at lower cost. In practice, it exposes the borrower to risks that are easy to describe and difficult for elected officials to price.
“It has its place, but it was marketed as risk-free when responsible lawyers and investment bankers would tell you there were, and are, a number of risks involved,” said one lawyer. “Governmental issuers just aren’t in a very good position to judge that risk, and they tend to be shortsighted even without considering political pressures, so they are susceptible.”
Jefferson County did not merely use the structure. “Jefferson County bit off some of that structure, liked it and just kept eating,” the same source said. “They ended up essentially speculating on interest rates, with more in outstanding swaps than they had debt to match it against.”
By April, the county’s debt had reportedly ballooned from roughly $3 billion to something closer to $5 billion. Much of it sat in bonds that had to be resold weekly, at rates that were climbing while buyers vanished. The rating agencies had cut the county to D. A two-week reprieve on payments had been granted, and few expected it to matter.
‘The definition of financial incompetence’
The judgments were harsh. “With 480,000 rate payers and a 329% rate increase over the last few years, the debt load is insurmountable,” said one. “This is the definition of financial incompetence. Bankruptcy appears the only way out. … The entire predicament can be summarized in one word — ‘greed.’”
Comparisons to Orange County, California, whose 1994 derivatives collapse remained the benchmark municipal disaster, came up repeatedly. So did the hope of federal scrutiny: “I hope that these deals get close scrutiny by the SEC and FBI,” one respondent said. Former commission president Chris McNair had already been convicted, and more indictments were expected.
Could the state step in?
Opinions divided. One pointed to Ohio’s intervention to prevent a Cleveland bankruptcy in the early 1990s as precedent for the governor and Legislature to act. Another thought the hole was simply too deep: “Seems to me it is far too big for the state to do anything.”
Beneath the finance ran a civic complaint. “This again goes back to the problems that Birmingham has with political leadership,” one respondent said, describing professionals in the metro area who could not name their own county commissioner and a Hoover businessman who insisted the mess “just wasn’t his concern.” The lack of engagement, he said, was discouraging — and perhaps the crisis would finally wake people up.
For south Alabama, the lesson was arriving in the form of a bill. Every bond issue in Mobile and Baldwin counties for years to come would be priced, in part, by what had happened 250 miles up Interstate 65.